Builders & Buyers Bypass Budget Bullet

The mortgage interest deduction (MID) cost the US Treasury $88.8 billion in 2011, making it the second largest tax break for individuals. That is precisely why the Congress has its sights set on it. However, there is much debate about how to reduce its costs to the Treasury and by how much.
No matter what happens, reducing the MID will lower some house prices. That being said, how the Congress reduces the MID will determine how much how many houses lose value. And since so many of us own a home, sell homes or build homes, the MID will not be singled out for special treatment. Rather, the Congress will cap or phaseout the value of all deductions, and in that way avoid favoring one deduction over another.
While there are several possible approaches, the fiscal cliff compromise bill passed into law on January 2nd of this year phases out itemized deductions for households with incomes over $300,000. While at first blush this may appear to be quite damaging, I think homeowners, realtors, builders, and the entire housing industry have all dodged a bullet and should sleep well for quite a while, or at least until the Congress reopens debate on the tax code sometime in the future
Phasing out Schedule A deductions for couples with incomes over $300,000 limits the impact to buyers of only the most expensive houses. For example, with a 10% down-payment on a $1,500,000 house, mortgage interest would be $54,000/year, property taxes would average $16,500, and insurance would be about $8,000, totaling $78,500 in annual housing-related expenses. To finance that mortgage, the $78,500 should ideally not be more than 30% of gross income, which means qualifying requires having an annual income of roughly $260,000; comfortably below the income level at which deductions start phasing out.
That being said, how much will a house valued at $2,000,000 decline? By very little! In theory it will fall by the one-time lump-sum amount necessary to compensate buyers for the new income taxes they will pay due to their being at or above the phaseout threshold. With interest rates currently at 4%, this means, and trust me on this, every $1,000 in added income taxes reduces the house price by ($1,000/4% or) $25,000. However, in reality, these impacts will be dramatically mitigated by tax avoidance strategies available to the very wealthy including systematically larger down-payments, cash purchases, corporate purchases and so on.
In short, few homeowners will be impacted by the new tax treatment of deductions including the MID. For households with incomes below $300,000, there are no impacts stemming from this change and for those with higher incomes, the impacts will largely be mitigated by tax avoidance behavior. At worst, only homes worth well over a million dollars will be adversely affected.
With huge deficits as far as the eye can see, the tax treatment of deductions is sure to continue to change and evolve. Enjoy the debate, but be aware that next time you may be on the menu.
Elliot Eisenberg, Ph.D. is President of GraphsandLaughs, LLC and can be reached at Elliot@graphsandlaughs.net. His daily 70 word economics and policy blog can be seen at www.econ70.com.