Friday, September 14, 2012

Debating Housing Subsidies in the Tax Code -- Against Myself

-- Posted by Neil H. Buchanan

I am in Boston, attending the American Bar Association Tax Section's Fall CLE Meeting. Because this is a joint meeting with the Real Property, Trust & Estate Law Section, the Teaching Tax session is devoted to a debate about the Internal Revenue Code's treatment of home ownership.

When I say "debate," I really mean a debate. The session's organizer, the University of Pittsburgh's Tony Infanti, had a fun idea to organize a formal debate, adapting high school and college debate formats to create a real two-sided debate, complete with cross-examination. What Tony did not know when he invited me to be one of the debaters is that I spent most of my youth (and much of my early adulthood) involved in debate competitions. From October of my 9th Grade year until the Spring of my tenth year out of college, I was a debater or a coach in standard high school "on topic" debate and college "parliamentary debate." (Lincoln-Douglas debate was actually introduced the year after I graduated from high school, and I never coached that style of debate.) I promised not to revert (too much) to my debate geek days -- not, for example, "spreading" (and if you do not know what that means, count your blessings) -- so they let me stay.

Because Professor Infanti wanted to include more people in the debate, and because he had three broad subjects that he wanted us to discuss, we adapted the format to create three-person teams. (The usual formats are either one- or two-person teams.) Unfortunately, one of the negative team members ended up having to withdraw, so we had the idea that I would debate on both sides, as the First Affirmative and then as the Third Negative. Being able to take either side of an issue is one of the skills/pathologies that debate instills in young people, so I did not feel any compunction about contradicting myself. (I argue with myself all the time, after all.) It is, however, unique to have the same person debate on both sides in the same debate. This will be fun.

This was evidently not quite complicated enough, because one of the Affirmative team's debaters became ill on Wednesday and had to withdraw as well. We did not decide to revert to a two-on-two format, however, because of the three subjects that we were planning to debate. So, I am now the First Affirmative, and UC Davis's Dennis Ventry is now both the Second and Third Affirmative. Florida State's Steve Johnson is the First Negative, Chris Christensen (a practicing attorney) is the Second Negative, and I am the Third Negative. Confused? I am sure we will be.

So much for form. What about substance? As regular readers of Dorf on Law know, I am actually in a state of mind where I can comfortably debate both sides of the question. (The formal resolution, by the way, is: "Be it resolved that the United States should make the Internal Revenue Code neutral with respect to home ownership.") Not only have I recently bought a house, after years of suggesting that doing so is not a good idea, but I have also been rethinking my original categorical opposition to subsidies for home ownership.

Interestingly, one of the major reasons I have become less dogmatic about this issue is that Professor Lily Kahng's work has convinced me that there are some serious distributional problems with housing tax policy that are realistically best solved by expanding the tax benefits of home ownership to lower middle-class people (a group that is, not coincidentally in the U.S., disproportionately people of color). After hearing Professor Kahng's arguments in June of this year, I have started to develop some thoughts about the class issue as well.

To make today's debate even more confusing, Professor Kahng is the person who was scheduled to argue on the Affirmative side (that is, against tax subsidies for housing), even though she is the one who made me reconsider my opposition to tax subsidies. Again, this is going to be fun (though probably chaotic).

The three issues that we plan to discuss today are: the (nontaxation of) imputed income from owned housing, the mortgage interest deduction, and the exclusion of income on the sale of a home. Professor Ventry has done some important work arguing against the mortgage interest deduction, and I am looking forward to his comments. Professor Johnson apparently agrees with the Affirmative side on many of today's issues (which means that he will fit right into the mishegas), but he will argue against taxing the imputed income from owned housing.

That latter issue (on which I will take the Affirmative position) is probably the least familiar of the three that we will discuss today. My economics training explains why I find it so seductive, but my legal training (to say nothing of my status as a human being) makes me doubt the economic argument.

The basic idea, in any case, is that a person who owns a house can either live in it or rent it to someone else. If she rents it out, she receives money that must be included in income (offset by appropriate deductions for maintenance, etc.). If she lives in it, she avoids having to pay rent to someone else. So, the house is -- even if she is not actually renting it out -- providing imputed income that would be taxed under a consistently applied income tax system. If a house could be rented out for $2500 per month, for example, the person is receiving $30,000 per year in housing "services," which another person would have to buy using after-tax income. Failing to tax that $30,000 in income is thus a subsidy to home ownership, compared to renting.

As I said above, the economist in me loves this argument. The underlying logic is right. There is no question that there is a horizontal inequity created by the failure to treat owner-occupied housing as generating income. Moreover, the agencies (staffed by economists) that compute the various measures of national income -- most importantly, Gross Domestic Product -- include the estimated value of housing services in their measures, not actual home sales.

And then there is reality. Other than the national freak-out that would inevitably follow any proposal to tax owner-occupied housing, one cringes to imagine how to administer a system that would try to apply this new tax rule fairly. I cannot wait to hear what I say this afternoon when I try to argue in favor of this rule!

If there is blog-worthy material in today's debate (which seems highly likely), I will write a follow-up post next week. In the meantime, there is no need to wish me well. I am guaranteed to be on the winning side this afternoon. And some chump named Buchanan will be one of the losers. I'm gonna clean his clock.


Michael C. Dorf said...

One thought for the discussion of imputed income: The IRC does not tax imputed income from personal property. E.g., if I buy a lawnmower, I'm not taxed on the value of the services I provide myself using that lawnmower, even though it saves me the cost of hiring someone to mow my lawn (and pay taxes on the income he derives from his lawnmower). In this example, note that I'm also not taxed on the imputed income of my labor in mowing my own lawns. The same is true of cooking my own meals, etc. So one way to frame the imputed income question would be whether there is any reason to think that imputed income from owning real property ought to be treated differently from imputed income from other sources.

Good luck in the debate!

Michael C. Dorf said...

That should be lawn (singular), not lawns--although I suppose we could say I have two lawns: a front and a back. Anyway, back to work . . . .

David Ricardo said...

Okay this does look like an interesting session. And thanks for clarifying the position of imputed income for home ownership.

To address the imputed income issue, one must note that the principle applies not just to home ownership. Under the imputed income argument there is imputed income to every assets that an individual owns. A person who buys a car has imputed income in the sense that they are avoiding the cost of renting a car.

However the real argument against taxing imputed income is that it is looking at gross income, and we don’t tax gross income in this country, we tax net income. The $30,000 a year cited in the example is gross revenue, the taxable income would be net income, the $30,000 after expenses including maintenance, repair, interest, depreciation etc. (which Mr. Buchanan does mention). So examined in this light the entire argument for taxing gross imputed income falls apart. As for taxing net income, well there may not be any as new homeowners rapidly discovers.

The other two issues, the interest deduction and the exclusion of gain are also more complicated. The interest deduction, for example only applies for those who itemize deductions, and it exists only at the margin. A family with $6,000 in mortgage interest but with only $9,000 in total deductions does not get any benefit from the mortgage interest deduction. That same person with $14,000 in itemized deductions gets only partial benefits.

So the mortgage interest deduction is biased towards high income, high deduction taxpayers. (Hence the unstated but implied position of Mr. Romney that he would remove the mortgage interest deduction from the code as a way to offset revenue loss to high income tax payers from his tax rate reductions). The same logic exists for the deduction of property taxes.

Also, is it truly possible for the tax code to be neutral with respect to homeownership? One assumes this means no provisions for home ownership, but that may not be neutral. For example if an investor buys a home and rents it out, the interest on that loan is deductible as a business expense, but the burden of that interest falls at least in part on the renter who gets no deduction for the interest payment. On the other hand, to not allow this deduction for the investor/owner/lessor violates the principle of taxing net rather than gross business income.

The reality is that a neutral tax code with respect to residential housing, or anything else is simply not possible. That is, it is not possible enact a tax code that does not change behavior from what would occur in the absence of a tax code. So the issue here devolves into one of welfare economics. Is society and the economy better off with more rather than less home ownership, and if so, is the tax code the way to encourage this, and if so, are the current provisions in the tax code the most efficient, effective and fair way to do this. That, I think, is the real subject of the debate.

Paul Scott said...

Imputed income re: labor.

I don't think this is right, Mike. You are taxed on the benefit you provided to yourself. What has essentially happened is a wash. You worked on your lawn and paid yourself $X. That $X dollars you "earned" by mowing the law is off-set by the same $X you paid, resulting in a net income of $0.

So, I think the IRC treats income earned from services to yourself in exactly the same way it treats income earned by services to others.

It certainly does treat other personal property differently. The lawnmower or cooking supplies, for example, are not deductible expenditures associated with your cooking and lawn-care "businesses." That is, if you were providing cooking or lawn-care services for others, you would be able to offset that income earned by the costs of those supplies and equipment. For whatever reason (though maybe its just that no one has tried - I'll run it by my accountant next year for sure!), when you sell those services to yourself, you don't get to count the costs.

In fact, the mortgage interest deduction is really the only reason there is imputed income from renting a house to yourself. That is, if the IRC treated everything alike, the interest on the mortgage would be among the costs you would deduct from the income you received for renting yourself a house. For most people, at least for a significant portion of the time lived in the house, this is probably a wash that avoids enforcement and transaction costs.

Michael C. Dorf said...

Hi Paul,

I don't think that's right. Suppose that I pay my neighbor $20 to mow my lawn and he pays me $20 to make him dinner. Each of us has $20 of taxable income, even though that's also a "wash." Likewise with imputed income. If the law taxed imputed income, then when I mow my own lawn, I don't get to deduct the $20 I pay myself, just as nobody gets to deduct anything in the hypothetical case.

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