Thursday, January 22, 2015

Housing Tax Policy, A Series: Part 1 - I was wrong. The mortgage deduction is just the tip of the iceberg.

I've been yammering on about housing policy lately.  I referenced this study that claimed mortgage tax deductions amount to nearly $100 billion annually.  Additionally, the capital gains exemption for owner-occupiers is worth probably even more.  But, I have been missing the full implication of the largest tax benefit - the fact that owner-occupiers don't have to claim imputed rental income as taxable income.  I can't believe that I didn't think about what that means.  I'm going to model this out, because I think this is going to be significant.  What I am finding is that this is very complicated, and the magnitudes of many of the implications dwarf the mortgage interest deduction.

To begin, we basically have three tax advantages to home ownership.

1) The mortgage tax deduction.  This became more important after the Tax Reform Act of 1986.  Before that, all personal interest expenses were deductible above a minimum level.  After that, mortgages carried a tax advantage to other forms of debt.  The effect on the housing market is limited, however, because the marginal tax savings only kick in for a household once itemized tax deductions exceed the standard deduction.  Thus, most of the potential tax savings is unused.  The study mentioned above references work that puts the effect on home prices of 3%-6%.  In my models here, I am using 3.5%.  That looks about right to me. This amounts to an annual transfer from renters to owner-occupiers of about 0.5% of GDP.  I won't get into this here, but if we broke out households more finely, we would find that within the homeowner group, most of that transfer would be going to upper-middle class households who have mortgages large enough to capture the benefit.  So, an unfortunate redistribution of income, but not a significant distortion in the housing market.

2) The capital gains tax exemption.  This was significantly strengthened in the Taxpayer Relief Act of 1997, which made the availability of exemptions on real estate capital gains much more universal.  I should have concentrated on this more in my previous posts.  I am surprised this isn't more of a focus in general.  Here is a comparison of home prices and homeownership rates in the US.  Note that while homeownership rates seem to have reacted to the 1994 passage of the Community Reinvestment Act, price appreciation kicks into gear in 1997 along with the capital gains tax exemption.

I have been defending home prices in the 2000s as being a reasonable reflection of the effect of low real interest rates.  I might have to walk a little of that back.  (I don't know.  This is going to be really complicated before I'm done.)  But, in general, this does still point to my general intuition that while home prices do react to changing demand from more universal access, most of the change in home prices is a reflection of the changing intrinsic value.

In terms of its effect on the housing market, if we assume a 20% capital gains tax rate and 75% utilization of the exemption, the value of a home increases by about 10% at today's interest rates.  Since owner-occupier rent represents about 14% of GDP, this amounts to an annual transfer of about 1.4% of GDP from renters to owners.

Keep in mind, in aggregate, the capital gains taxes on real estate are largely a tax on inflation effects.  My preference is to avoid this distortion by eliminating all capital gains taxes.  The effect here is to create a dislocation between owners and renters.  And the effect is very sensitive to inflation.  So, even though this effect may have been very strong, the low inflation environment we have been in has greatly diminished this distortion.  The 10% effect on home values is based on 2% inflation expectations.  In a 4% inflation environment, the capital gains exemption would create a 20% price distortion.

3) The tax exemption of  the rent income itself.  As far as I know, this has always been the policy.  This is surely a reason why homeownership rates were nearly 50% even before the mortgage deduction, capital gains exemption, and low income homeownership programs were in place.  In effect, this is the opposite issue that two-earner families face.  If a second parent joins the labor force, there is a tax penalty that arises from the fact that much of the household value that had been provided by a full time homemaker is now filtered through additional household cash income, which is taxable, to payments for child and home care services, which are frequently not tax deductible.  Homeownership is sort of the capital version of labor's household production.  Owning a house allows a household to consume its own production in a way that doesn't trigger a public transaction.

This is a case where it is important to separate forms of ownership (debt and equity) from the returns to the asset itself.  We need to start here with a comparison between a landlord who owns an unleveraged house and an owner-occupier that owns an unleveraged house.  When we keep focused in this way, this is a very simple concept.  Let's assume an income tax rate of 25%.  If a landlord has, say, a $300,000 house that has a market rental rate of $1,000, then his post-tax monthly return is $750 on that property.  Since an owner-occupier doesn't pay that tax, she would be willing to pay 25% more for the same property.  At those different prices, both home owners - the landlord and the owner-occupier - would be earning the same after-tax return on investment.

Now, I know, there are costs to owning the home that need to be deducted from the rent, etc.  I will make these adjustments as I work through this issue.  But, I think the value of this factor is pretty clear.  And, unlike the mortgage and capital gains tax factors, utilization does not mitigate this factor.  For most households, if imputed rental income was taxable, their taxes would rise with the first marginal extra dollar of income.  This factor is nearly 100% utilized.

If we assume that all homes are fully owned with no leverage, a model of home values that accounts for costs of ownership, with a 25% income tax rate, ascribes a 20% increase in the home value due to this factor.  That amounts to an annual transfer from renters to owners of about 2.9% of GDP.

The relationship between the income exemption and the mortgage tax deduction

This is where the mortgage tax deduction comes into play, and before I have thought through it this way, but I hadn't fully appreciated the value of the income tax exemption separate from the mortgage deduction.  A cash homeowner receives the full advantage of the income exemption.  But, if we assume that a homeowner is fully leveraged 100% on a home, with a perpetual interest only loan in a zero inflation environment, we can imagine that they might have $1,000 in monthly income that is untaxed, but also $1,000 in monthly interest expense that is not deductible.  They would have no net benefit from homeownership.  (Differences between rent expense and interest expense for actual homeowners are effectively a product of inflation and duration exposures they are taking due to the different characteristics of the mortgage and the home.)

So, in an economy where household real estate is leveraged to roughly 50% in the aggregate, this means that owner-occupiers claim roughly 50% of the income exemption benefit - which would account for a 10% increase in intrinsic home values and a 1.4% of GDP annual transfer from renters to owner-occupiers.  The mortgage tax deduction is, effectively, a way for leveraged home owners to also capture this benefit.  But, since the utilization of the mortgage deduction is so low, leveraged home owners only capture about 1/3 of the benefit.  (As stated above, the mortgage deduction might increase home values by 3.5%, compared to my estimate of an additional 10% increase that homeowners would see if they had 100% equity instead of 50%.)

Here is a summary of the effects.  (Keep in mind that these are broad estimates, which interact with one another and also change slightly in scale as interest rates and other assumptions change):
The capital gain exemption is proportional to expected inflation.
(assumed to be 2% here)

<**Edit: Vivian Darkbloom has talked me down a bit in the comments.  After considering her input, I would revise these numbers to: 3% + 5% + 7% = 15% of home values and 0.4% + 0.7% + 1.0% = 2.2% of GDP.  The Cap Gains numbers may still be high, but for a number of reasons having to do with the relationships of the factors in the model, the effect on the modeled price is higher than the effect we might estimate simply by accounting for this year's expected real estate gains.  This factor may turn out to be lower in many contexts.>

<Edit #2:  These estimates are bound to change some more as I continue to review data and concepts.  I am purposefully kind of thinking aloud.  So please check on follow-up posts in the series if you are interested in these estimates.>

Over the next few posts, I expect to show that the actual increase in home values may be much less than 23.5%.  But I expect to demonstrate that this transfer to owner-occupiers exists regardless of the total effect on nominal home prices.  The conclusions I have reached so far have been pretty shocking to me, and I may continue to be shocked as I work through the models to complete the remaining posts, so my conclusions may differ from what I currently expect.  (I am proceeding as I work this out, so you might see my errors as I proceed.  And, this will get complex enough that I might end up reaching the limits of my analytical tools.)  At the point where I am in my analysis now, I believe that if these factors are not manifest in higher nominal market prices for homes, then the potential increase in home values coming out of these policies is a sort of risk-adjusted deadweight loss on our economy.


  1. LOL! Kevin Erdmann not noticing this subsidy is like Fred Astaire tripping over his own feet and falling down the stairs. (I had never noticed the subsidy either, but I am a terrible dancer, and typically only barely able to follow your analysis, let alone match it.)

    I've always been a fan of consumption taxes instead of income taxes. It seems like switching to a consumption tax would eliminate distortive effects such as the one you've identified here, assuming the consumption tax treats owner-occupied housing as the owner consuming the imputed rent. Does that seem right?

    1. Thanks, Kenneth. I agree about the taxation. Good question. My initial reaction is that the consumption tax could probably apply to new homes, but not re-sales, just like we would apply it to other durables like automobiles.

      We do have property taxes, which I will probably get into during this series. Property taxes could be another way to address consumption taxation regarding real estate. I have some conceptual work still to do here, but so far, in the story I expect to unfold over the next few posts, I see some advantages from using property taxes.

    2. Good one! I think your mistake is thinking of me a Fred Astaire.

      Think of it more like Buster Keaton. The mess of complexity we call finance is like the Windy Day, and when I start on these thought experiments, I'm just hoping that I'm standing within the window frame when the wall collapses around me.


  2. Marginal price theory: prices are set at the margin, not based on average position. If the marginal (not the average buyer) buyer is willing to pay the most, and is in a situation of full tax deductiability (etc etc), how does that change their incentive for price setting, and the flow on distribution impacts vs renters vs 'average' position buyers vs 'equity funding' buyers?

    1. You're right. This post was a broad first brush at the topic. I hope to address some of your points in follow up posts. But, I'm not an economist, so I might get some things wrong even when I try to address them. This gets even more complicated when you start factoring in non-financial benefits of owning and risk premiums for non-diversification. Looking forward to your input.

    2. Cheers Kevin - I really like how you are approaching this from trying to identify the value transfer and dead-weight losses that are occuring. I suspect applicatino of 'marginal' thinking, and/ or application of my other thoughts on DCF values (again as applied to the 'marginal' buyers incentive) is going to highlight that the distortions you recognise here are going to be much greater than this first cut. I look forward to seeing more!

  3. Further - valuation via DCF/ NPV analysis. I am Australian, so not totally familier with the US tax system, and Australian tax incentives are different. But valuing a house via DCF/ NPV type analysis (either as an owner-occupier or investor-to-rent, and compared to the DCF of paying rent instead) can be instructive. Doing that DCF type analysis, the impacts of the Australian tax system on incentives for debt-gearing can be shown that the tax system structure could be easily be adding +40% to the 'fair value' DCF value of a house. Note, this is just taking into accuont a financial-cashflow perspective, ignores the 'qualitative' values of owning a house, which many people do value (eg pride, ability to change things without permission etc). Your quote/ link above to 3.5% value distortion would seems way to low versus an 'dcf' anlysis for Australia, and I suspect (but don't know) would be shown to be too low vs a DCF type analysis of housing in the USA too.....

    1. 40% seems steep. I have fairly arbitrarily chosen a 25% income tax rate. That could be one difference. Even in the US, I could be off. I suspect that coming up with a typical landlord income tax rate is difficult even for those with trade knowledge. Also, I am not reinvesting the subsidy. A model that treated the relative gains as if they were reinvested in the property could suggest a much stronger effect.

    2. Maybe it's an Australia-vs-USA tax difference, eg Australian top marginal income tax rate at ~49.5% (effective). Again though, marginal thinking -> your 25% selected tax rate seems like an "average" income tax rate, rather than the tax rate the marginal buyer with the most incentives/ distortions faces.

    3. The real world is very complicated. A private landlord very quickly needs to be doing this through a corporation or trust, depending on his long term ambitions. I think a modestly wealthy person would be able to set up a handful of units in trusts such that their after expense rental income is passed through at their marginal long-term capital gains rate, not their income tax rate.
      A very wealthy person would easily be able to do this, and probably far more!

  4. Great analysis Kevin!
    I have always sensed that there was some "hidden benefit" of home-ownership vs. renting and I think you may have captured it with this and earlier analysis.
    The mortgage interest tax relief system was ended here in the UK a few years back - I don't recall there having been any significant change in prices that were attributed to it at the time, but I could be wrong. I'm pretty sure that landlords can't claim tax relief on mortgage interest either.
    Also, former Labour chancellor Alistair Darling was on TV a few weeks ago stating that capital gains tax on primary homes was simply politically unacceptable hence stamp duty, etc. Wealth transfer indeed!
    Keep it up - oh, and then put an excel app thingy on your site so that I can put in rent, costs, etc. and it will tell me exactly what to do!!

    1. I will post it somehow before I'm done. There will be conceptual complexity, but I think the basic spreadsheet will be very simple.

  5. Seriously? You propose to tax owned assets as if they were generating income? So, my computer, here on my desk, would be generating imputed income just by sitting here, and I'd have to pay tax on that? And on the imputed income from my car? The furniture in the living room? Your thinking about this is bass ackwards.

  6. The homeowner and the landlord in your example are not equivalent. The landlord still has to live somewhere. By renting out the home, he now has to pay rent somewhere else, or buy another home.

    1. This is not relevant. Imagine there are 100 households and 100 houses. some people own their own home and some others, others rent. All are creditworthy but have different wealth and income. The distortions Kevin describes combine with interest rates and inflation expectations to determine how much each renter should be willing to pay to get out from under the rent, and at what price the owners should be willing to sell.

    2. He's describing ownership as an income-generating activity. It isn't: it's ownership. As a general rule, ownership of useful assets is not taxed. That's not a distortion, and it's not a tax break.

      What he's observing is that there's a tax disincentive to being a landlord, because a landlord is effectively lending the price of the property to the tenant, and the interest the landlord receives is taxable (the rest of the rent covers the landlord's costs: his "income" is the after-tax opportunity cost of capital).

      Yes, any economist worth his salt can tell you that taxes on returns to capital are distortionary: they promote consumption over investment. That's not unique to housing. The way to minimize the distortion is to minimize the tax rate. When you decide to "fix" the distortion by adding a second distortion, you are well on your way to economic hell.

      Consider, for example, the idea of imputing income to housewives and weekend handymen-husbands (the human equivalent of imputed rental income, and one we can easily relate to). Would you base the tax on what they actually do, or on their income-earning potential? If you base it on what they actually do, they'll do less, and that's distortionary. But, following the theme here, you'd impute income based on what they could earn, i.e., on their income-earning potential. So a housewife who had taken a break from an engineering career to raise children would have to pay taxes as if she still had her engineer's income. Now we have new distortions: first, some people who would have liked to take a break will instead continue to work, because they need the money to pay the tax; second, some people who would have studied engineering will not do it, because the lifetime imputed income tax associated with doing so is so large (think of it as a steroid-enhanced version of student debt, one that by definition takes a lifetime to pay down). To fix that, the salaries of engineers would have to go up, relative to what they would have been otherwise - another distortion - and that increases the lifetime value of that tax obligation for students... Distortion upon distortion.

      Meanwhile, we have a name for people who must pay for the right not to work: slaves.

      Taxing economic activity is distortionary. Taxing economic inactivity is the road to hell.

    3. He's describing how our actual policies impact asset valuations in a simple model to try and better understand asset valuation in the real world.
      Yes, any economist can tell you taxes are distortionary--but trying to find the effects and magnitude in the real world is difficult.
      Sorry but I don't want to argue with you about slavery! It doesn't matter if you don't like the politics surround this stuff. You can read this analysis and decide it's imperative that we stop taxing rental income to overcome the distortion. Fine! You can read it and say 'I don't care about changing the transfer effect bc justice'--We still want to estimate how big it is and how it will alter valuations going forward.

    4. He's describing the non-taxation as a "tax benefit" and you're describing non-taxation as a "transfer". This language is not simple neutral analysis: it's advocacy, and it's advocacy for property rights and personal rights that date from before the Enlightenment. And no, I don't care for a return to the economic structures of pre-Enlightenment Europe.

  7. As a homeowner and landlord I can't decide if this is a Herculean task or a Sisyphean task. Good luck.

    1. Ha! Both, I'm afraid. Probably a little bit Laputan, too.

    2. "I referenced this study that claimed mortgage tax deductions amount to nearly $100 billion annually."

      I did not see that figure in the study you referenced---for an estimate of the tax cost of the mortgage interest deduction, you should go directly to the Joint Committee on Taxation. The latest estimate for 2014 was $71.7 billion (federal) for the mortgage interest deduction.

      "Additionally, the capital gains exemption for owner-occupiers is worth probably even more."

      Actually, per the JCT, the value is much less than for the mortgage interest deduction--"only" about $25 billion.

      The JCT does not do tax expenditure estimates for the deemed rental value of principal residences. However, the following references a 2006 estimate by OMB (about $29 billion).

      It is not clear the methodology used by OMB for this estimate; however, to be theoretically consistent with the idea that one's home generates "rental income", it would strike me as logical to offset deemed gross income by actual expenses to put this on par with comparable (actual) rentals to unrelated tenants. That would mean an offset for repairs and depreciation (as well as taxes and mortgage interest). The result is, of course, income (positive or negative) and not the tax cost (or benefit).

      Vivian Darkbloom

    3. Thanks for all the input, Vivian!

      Mortgage Deduction: I was probably a little loose there. "Nearly $100 billion" is a little sloppy. I will shade my estimated value down a bit, from 3.5% of home values to 3%, (or from 0.5% of GDP to about 0.4%) which gets us near the value you reference. In either case, I agree that this is a minor subsidy.

      Cap Gains Exemption: This one is difficult. If those numbers are based on actual returns, the numbers right now would be very low because many homes are being sold at a loss. If we just take the current total real estate value $23 trillion x 2% annual appreciation x 20% tax rate = $92 billion annual subsidy if all potential cap. gains tax subsidies were utilized. That is lower than I estimated above. This is because my estimate is based on the effect it has on intrinsic value, which I currently peg much higher than market values. That point is certainly arguable.
      In my model this subsidy is expressed as a deduction in the discount rate. Possibly there is a better way to handle it. Treating it this way means that the modeled amount is dependent on several other variables. I noted this above when I noted that it would be higher in a high inflation context. But, I overlooked the fact that it is also higher in a low-real rate context, which is what we are in now. So, I may be overstating the case a bit in my introductory remarks here. I think this might get worked out as I work through it over the next few posts. The main way to correct this issue would be to correct either my estimate for the tax rate (20%) or the utilization of the exemption (75%). I think my estimated tax rate of 20% is probably too high. This is the top end of the statutory long term rate. On further reflection, a rate of 10% is probably a closer estimate of the effective rate landlords pay after managing their asset base for tax efficiency. $23 trillion x 10% rate x 2% inflation x 75% utilization = $34.5 billion subsidy, which is a little higher than the current reported level, but I think in the realm of reason, considering the deferred nature of the exemption and the current flavor of the housing market. That cuts the total benefit down substantially from my estimate, but still puts it larger than the mortgage deduction.

      Imputed Rental Income: I don't see how this could be so low. My back of the envelope estimate of aggregate imputed rent, net of costs, at a 25% tax rate, is somewhere near $200 billion annually. The only explanations I have is that they are using reported landlord income as the benchmark, which includes depreciation and possibly other non-property standard deductions, and would counter much of a typical landlord's cash profit. But, of course, depreciation doesn't eliminate the taxability of the rental income so much as it defers it. That still has value. I think it is roughly reasonable to treat this income as if it would be taxed at the marginal rate. However, I will estimate the tax deferral value at about 30% of the present value of the tax paid. So, I will lower the income tax rate from 25% to 18%, pending more input from readers.

      Thank you for the thoughtful input and good links, Vivian.

    4. Just as a quick follow-up on the imputed rental income issue. Owner rent is about 24% of the CPI basket, or about 14% of GDP, which puts it at $2.5 trillion, annually. I just don't see how the realistic economic value of this tax exemption could get adjusted down to anywhere close to $29 billion. That's barely 1% of the imputed gross income.

    5. Re: the capital gains tax exemption.

      Your estimate seems to assume that all (potential) capital gains from (principal) home sales and potential sales are currently exempted. This is not so. Current law exempts (only) $250K for single taxpayers and $500K for married taxpayers. Believe it or not, this does not exempt all gains.

      Also, a lot of gain is exempted under the estate tax rules in which exempt built-in gains at death and give heirs a step-up in basis. JCT would have counted the latter under a separate category (see their menu of estimates in the link I provided, but this lumps all gains at death in one category).

      Your tax rate also seems much too high. You seem to assume that all gains are taxed at 20 percent. The maximum *marginal* rate today is about 24%, but below that capital gains are also subject to preferred lower rates. But, here, you are combining the tax cost not only of exempting some gains completely from tax but also the preferred capital gains tax rate (JCT would include the latter in a separate category). If you think that being taxed at ordinary rates on built-in inflation is a "benefit", that's an entirely different discussion.

      If you think that the estimates are currently low due to a depressed real estate market, it would be easy to go back to the link I provided (and prior annual estimates by the JCT) to judge current estimates by historical ones. Of course, it is a matter of some discussion whether real estate prices are currently depressed, or whether they were previously elevated above "normal". The Treasury Department does its own estimate of the "cost" of tax expenditures and you may want to compare their estimates against the JCT's.

      This tax expenditure estimating is not a precise science; however, the basis for the JCT estimates are indeed actual tax return information extrapolated for economic forecasts, etc. They have a large and professional staff with sophisticated models. It is not perfect, but is most likely the best out there. JCT estimates are incorporated by CBO for budget purposes.


    6. Two further thoughts:

      First, you speak of an alleged "transfer from renters to owners" through our tax system. I'm not sure I fully agree with that set-up. It appears to assume that home owners are treated (for tax purposes) more favourably than renters. Let's think about that.

      Renters enjoy tax benefits indirectly through the tax breaks given their landlord/owners (how you want to break that out is debatable, but so is splitting benefits among homeowners, bankers and realtors). Let's list some of the benefits renters (indirectly) get:

      1. Full deduction of mortgage interest (not subject to threshold itemized deductions or the Pease limits);

      2. Full deduction of property taxes (not subject to threshold itemised deductions or the Pease limits);

      3. Full deduction of all repairs as well as various "management" services related to the property;

      4. Depreciation allowances subject to eventual recapture many years later);

      5. Benefit of current tax losses on said properties subject only to passive activity loss rules;

      5. Various additional credits and deductions for low income renters (not including government subsidised rentals through HUD programs).

      You don't think those benefits are worked into rents?

      It strikes me that these benefits might even equal or outweigh those given to homeowners when all is tallied up.

      Second, regarding the tax rates: Per the latest information, the *average* federal income tax rate (not including payroll taxes) has been between 8 and 10 percent since 2002. You may argue that a much higher *marginal* rate should be used, but here again I'm skeptical. Using the marginal rate assumes that if we were to eliminate all existing "favourable" tax provisions for home ownership, all other tax provisions would remain equal (including rates). (You also seem to assume home prices and ownership versus renting would be constant whereas I think a more "dynamic" scoring model is appropriate). I believe that there is a more compelling argument for using something closer to average rates than your (assumed) marginal rate.


    7. Vivian:
      Cap Gains: I have reduced the rate to 10% and income to 18% after reviewing your first comment. Additionally, I apply a utilization level to this. I am currently using 25% before 1996 and 75% after 1996. That could be too high. High transaction costs and other frictions prevent arbitrage in high price areas, so 75% could be too high, although as you say some of this could be showing up as an inheritance exemption.

      I was surprised that the cap gains exemptions levels in the mid-2000s weren't higher.

      In any case, I have made significant downward revisions based on the references you have provided.

      On your second post, I will talk through my framing of this as a transfer as I work through the posts. It is possible that I will talk myself out of this framing. It is also possible that I will feel firmly about it but not convince you. There are facets of my thinking here that I haven't introduced yet. To be honest it's all still a bit of a jumble in my head, as evidenced by the fact that I have a hard time giving my wife the 2 minute pillow talk version. I'm hoping it comes together as I write.

      As for the list of deductions, I believe that I am generally accounting for these in the model (see post 2). I admit that I might be creating some confusing with my framing. I am treating the landlord as the baseline (including the deductions). Relative tax advantages from owning are then added back in as gains relative to that baseline. The idea is that the value of a property to a landlord should cause net rent income before tax to be equal to the nominal yield on a 30 year mortgage. I am using the 30 year nominal rate as a proxy for required returns on real estate. Deviations for various owners build from that. It does make it a little confusing.

      You make a good point about tax rates, but certainly the marginal tax rate for home owners will tend to be much higher than the average rate for all taxpayers. I have reduced the income tax rate exemption level to 18% to account for some of the tax deferral advantages that landlords receive. Maybe I haven't reduced it enough. Eventually, I can apply all of these different values to the model to see what difference it makes.

      Actually, the increasing value of the tax subsidies as household income rises should be an important factor dividing households into renters vs. owners as I think through the issue.

      For instance, I apply the income tax exemption to the equity portion of the owner-occupier's home. But, I only apply a small percentage of the potential exemption to the mortgaged portion, to reflect the limited utilization of the mortgage deduction.

      The property tax deduction for owner-occupiers is an additional advantage which I haven't explicitly included in the model. For now, I will assume this tax advantage is covered by the 18% income tax exemption. But, if I start playing around with property tax levels to see their effects, it would be more accurate to create a partially utilized tax gain that is directly proportional to property tax.

      Thanks again for taking so much time to help me think through this. You have already helped me to make substantial adjustments to my starting assumptions.

    8. To follow up, I think the estimated tax value of the imputed rent exemption may be understated because it is adjusted for depreciation and expenses. But, I am already accounting for expenses in my model. Also, I wonder if there is some double counting going on, because the pace of depreciation seems much faster than actual depreciation, especially if a maintenance budget is included in the net rent measure. So, if households had to account for the imputed depreciation when they sold their homes, they would have much higher capital gains.

      Since these items aren't accounted for carefully for tax purposes, I'm not sure if they are being accounted for clearly here.

      That being said, my estimate for gross imputed rent was $2.5 trillion. The Imputed rental of owner-occupied nonfarm housing under Personal Consumption Expenditures by Function (BEA Table 2.5.5) was only $1.3 trillion in 2013. So, I might have had a bad input number that caused my estimate to be high.

      But, still, just as a first pass at it, if home leverage tends to be around 50%, and the mortgage deduction (which has very low utilization) amounts to about $70 billion in tax savings, I don't see how the 50% of the home they own could possibly have de facto net returns so low that there tax savings for imputed rent would be even lower.

      Here is a treasury revenue report for 2014 (page 254, via

      They estimate:
      $101 billion mortgage deduction
      $76 billion imputed rent exemption
      $46 billion capital gains exemption
      $25 billion property tax deduction

      That amounts to $248 billion in tax savings on $1.3 trillion in imputed rent and $460 billion in capital gains ($23 trillion x 2% inflation). That's 14% of total gross annual gains, or a 1% annual tax subsidy on current market values. This is in the ballpark of my total estimates, even with the low (to me) number for tax savings from imputed rent.

      That compares to $25 billion in tax savings to landlords for rental losses, depreciation, and low income housing credits. 2013 landlord rent was $445 billion, plus about $150 billion in assumed cap. gains. So, landlord tax savings amount to about 4% of total gross annual gains.

    9. Kevin,

      Your $248 billion in estimated tax savings is either double counting, theoretically inconsistent, and probably both.

      The $76 billion tax expenditure estimate by the White House is not explained in detail, unfortunately. ( As an aside, it has long been my belief that government agencies should be required to publish their models and that think tanks that receive deductible donations and tax-exempt status should be required to do the same, That would give folks like you the chance to play with them, critique them and improve them. As taxpayers, we should expect no less than that the things we finance should be in the public domain--if there is a compelling case for Rogoff and Reinhardt to do so, there is even a more compelling case for those mentioned above).

      However, importantly, the estimate is of *net* imputed rent. It is therefore most likely that the *net* figure has already taken into account the mortgage interest deduction and the property tax deduction (it is not clear that repairs or depreciation were taken into account). This is consistent with respect to Bartlett's comment at Economic (regarding the "correct" methodology but relating to a different number from the national accounts):

      "Last year, the B.E.A. calculated that net imputed rental income was $284 billion for 2011. That includes depreciation or capital consumption, but does not include an adjustment for routine maintenance, mortgage interest or property taxes, which should be deductible."

      Apropos those deductions, you refer to a low utilisation rate. This is presumably because of:

      1. Threshold hurdles for itemised deductions;
      2. Pease limitations;
      3. The $1.1 million debt limit (applied before Pease).

      (Taking these together, one should understand the housing tax benefits are really for the middle class). Keep in mind that if you want to move to an imputed rent system, these limits should theoretically fall away (increasing utilisation to 100 percent on debt financing). For fun, perhaps you should take that $284 gross BEA figure and calculate against that all the mortgage interest, property taxes and repairs that would be deductible without the existing current limits and then tax-effect the net result!)

      Thus, I believe the maximum (assuming allow properly allowable deductions for imputed rent were taken into account) would be $76 billion, as the study indicated--not $248 billion that you have tallied it all up.

      Similarly, it is not clear to me what you are doing with the capital gains part of it. You seem to be including the $46 billion in total of $248 billion for "imputed rent" benefit, and separately as a "capital gain" item (here, may I assume the 2 percent "inflation" number is intended to represent real gains above inflation times the present value of the owner-occupied housing stock?). Are you proposing a mark-to-market regime?

      Please note that when arriving at these tax expenditure estimates for future years (including capital gains) estimated inflation (and real estimated growth) are already taken into account. The estimates also take into account changes in tax rates (the higher tax rates are, the greater the "benefit" of tax exclusions and deductions). Thus, not only increasing real estate prices, but increasing tax rates would account for some of the growth in post-2013 estimates.


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