Flattening the income tax looks bad for homeowner

NATION'S HOUSING

January 29, 1995|By Kenneth R. Harney

Washington -- Flat and flatter tax proposals may be hot buttons on Capitol Hill in the new congressional session, but the closer homeowners and buyers look at them the less appealing they may turn out to be.

In case you've missed the headlines, both the new majority leader of the House, Rep. Dick Armey, R-Texas, and the new minority leader, Rep. Richard Gephardt, D-Mo., are pushing plans that would radically simplify the federal tax system by imposing low, uniform tax rates on incomes for all taxpayers.

Armey's plan would tax earned income and pension distributions for individuals at 17 percent. Although not scheduled for introduction until after April 15, Armey's 1995 bill will follow the outlines of his 1994 proposal on the subject (H.R. 4585), according to a top aide. That means there will likely be a standard deduction for all taxpayers ($12,350 for singles, $24,700 for joint filers), plus a $5,000 deduction for each dependent. Interest income, dividends and capital gains from investments will not be taxed, but virtually every current deduction in the code -- including mortgage interest and property taxes -- will disappear.

The legislative details of Gephardt's so-called flatter tax have yet to be unveiled, but the Democratic alternative reportedly will carry a lower base rate on income than Armey's -- just 11 percent.

Putting aside the obvious how-low-can-you-go issue, what's the significance of a flat-rate income tax concept for homeowners? Here are some preliminary thoughts. For starters, bear in mind that under the present, Byzantine federal income tax system, homeownership is one of -- if not the -- most protected sectors of the economy:

* Mortgage interest deductions cut owners' taxes by about $55 billion last fiscal year, according to Treasury Department estimates.

* Local property tax deductions and the "rollover" deferral of capital gains on home sales saved owners a combined $30 billion.

* The zeroing out of all federal taxation on the first $125,000 of capital gains for home sellers 55 years of age or older racked up another $5 billion in estimated savings.

Taxpayers who rent rather than own their houses or apartments get none of these tax goodies, which has been precisely the intent of Congress' social policy for decades: It places high value on fostering and expanding homeownership though the use of the federal tax code.

But what happens when these long-standing benefits are abruptly stripped out of the system in exchange for a lower overall tax rate that is residence-neutral, with no special deals for you whether you rent or own?

Econ 101 gives you the answer: Tax preferences affect not only consumer behavior but the actual market values of the commodities to which they're attached. Put another way, part of the cash value of a house in the United States is its tax-shelter component. Part of its attraction to a buyer is the range of tax benefits it opens up -- including even the right to tax-deductible auto loans and vacations via home-equity lines of credit that are off-limits to renters.

What is the component of market value attributable to tax subsidies? No one knows for sure, but economists are beginning to crank up their computer models on the flat-tax issue.

Dr. John Tucillo, chief economist and senior vice president for the National Association of Realtors, says that a lower tax rate -- say Armey's 17 percent -- might not produce impressive savings for large numbers of homeowners.

"A lot of people who own homes know how to play the game," he says. If the market value of your home is going to drop by 20 percent because people choose to rent, not buy, does a modest decrease in your marginal rate look all that good?

Representative Armey's army of economic advisers has two answers to that question: First, according to spokesman Ed Gillespie, home values will not plummet under a flat tax because, unlike the current system, there will be zero taxes on capital gains -- not just on the first $125,000.

Second, with interest and dividend income tax-free -- on top of the 17 percent flat rate -- "people will have more money to spend on housing if they wish, and interest rates [on mortgages] will be lower."

Who's right? Stay tuned for future flat-tax flap updates. And don't be shocked if you see housing advocates come out swinging against both Republican and Democratic proposals.

Kenneth R. Harney is a syndicated columnist. Send letters car of the Washington Post Writers Group, 1150 15th St. N.W., Washington, D.C. 20071.

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