the real place where the tax code provides a subsidy for owner-occupied housing is not by allowing mortgage deductibility, because if you or I were to borrow to buy other assets — for instance, if we bought a portfolio of stocks and we borrowed to do that — we’d be able to deduct the interest on that asset purchase, too. If we bought a rental property, we could deduct the interest we paid on the debt we incurred in that context. What we don’t get taxed on under the current income tax system is the income flow that we effectively earn from our owner-occupied house, what some people would call the imputed income or the imputed rent on the house. The simple comparison is that if you buy an apartment building and rent it out, and you buy a home and you live in it, the income from the apartment building would be taxable income, but the “income” from living in your home — the rent you pay to yourself — is never taxed. This is the core tax distortion in the housing market: the tax-free rental flow from being your own landlord.
Pointer from Timothy Taylor. The interview covers other topics, all interesting.
He goes on to say that it is unlikely that people would accept being taxed on a made-up number representing this “rental flow from being your own landlord.” However, people do accept being taxed on the appraised value of their property, which is arguably also a made-up number. It seems to me that you could tax homeowners on a made-up “appraised rental value” just as easily. Or just tax them a percent of the appraised value, as is done now.
Let’s go with the notion that the goal is to tax owner-occupied and investment property identically. Then my thought is you should just exempt landlords from paying tax on their rental income. But I find the whole notion of how the tax system should and should not work to give me a headache. Even if you start with the idea of a consumption tax, do you want to include the use of housing as consumption? Presumably you do, and then you are right back into these conundrums of rental vs. owner-occupied, are you not?
The average Joe would be crazy to net borrow to net invest…which is also to say the average Joe is crazy if they are nudged to do that today.
The Average Joe does just that if he invests in the stock market. He becomes part owner of companies which issue debt against themselves in order to invest in assets.
For doing so, he is not considered crazy. He is considered crazy if he does not — or if, say, he points out this fact on a blog. 🙂
Well, this is why I added the “net” weasel words. Net leverage is pretty darn low if Joe is adequately diversified. But right now Joe probably is crazy for being in the market at peak profit margins and peak buybacks.
Also, there is the semantical considerations of when “invest” becomes “speculate.” Presumably corporations are borrowing against a fairly predictable stream of revenues as opposed to speculating on asset prices, buybacks aside.
I do not think it is all that different from buying a house with a mortgage. Package deal of assets + liabilities in both cases. Usually assets > liabilities in both cases, so you have equity on net.
However, with something like an FHA loan, you can have very little equity & therefor very high leverage — all subsidized by Uncle Sam! Not much in the stock market compares…(or maybe I’m being naive…)
Also, I suspect revenue streams for your average corp. Is not much more secure than the ‘imputed rent’ of living in your own house.
(Might I point out that I also mentioned this imputed rent thing back on the Investment Advice for Bryan Caplan post… but then, nobody cared. Maybe if I had a really cool name like Poterba…)
I cared.
Although note that any taxation of capital income, of which imputed rent is one form, is distortionary. The problem is not so much that government fails to tax imputed rent as that it taxes all other capital income.
It could be a culture thing. The UK tried to tax imputed rent but it was very unpopular. But several other European countries, e.g. Switzerland, have taxed imputed rent for a long time and it seems to work just fine for them. The Swiss rental rate is also higher, which is what one would predict in the absence of the tax distortion.
Property taxes can be considered a surrogate for an imputed income tax. Landlords also have an advantage not available to owners. They can deduct losses against other income (though the amount is capped). They don’t need not to pay tax on rental income as they typically don’t have any to pay on but have a deductible investment expense. Housing is both consumption and an income expense for who can work without a place to live? The difficulty is coming up with measure of that; it isn’t well covered by existing exemption levels.
Great points, Arnold.
Well a Land Value Tax is probably the best answer I would think.
Revenue Neutral – so that any increase is on average offset by corresponding decreases in say Income Tax or other deadweight taxes. The trick as with many taxes is how to tease out the economic “bad” – rents – from the economic “good” – entrepreneurialism, innovation, investment, hard work, efficiency, competition, etc. With housing those imputed rents are captured in the LVT.
Also recommended for it’s ability to avoid evasion – since you can’t hide it offshore, etc.
Nicely progressive also if we want that.
Lots of winners and losers disparity though so it would have to be introduced gradually I would think. Maybe decades. And also probably works best at the local level.
I sympathise with Arnold Kling here though. I get these same headaches, same as I do when I “redesign” welfare. Or Healthcare. Or Education.
Sigh.
“because if you or I were to borrow to buy other assets — for instance, if we bought a portfolio of stocks and we borrowed to do that”
Is that right? I don’t think so, except in the case of someone that is doing it as a trade or business.
That is the basic gist of my comment above. Just trying to keep track of who these jacka politicians are trying to cross-subsidize gives me a headache.
But saying average Joe is an inveatment business is scary and saying his home is a direct analogy to business should tell everyone we are doing it all wrong.
Margin interest is deductible if the borrowed money is also invested.
Is that a big problem?
I don’t know if it’s a problem or not. The question was “Is that right?” And the answer is: yes it is.
Interesting. I didn’t know that.
Would making rent on a primary residence tax-deductible address this?
Why stop at houses? Why not tax “imputed rent” on everything a person owns that might be rented – today you can rent cars, clothes, computers, and furniture, so why not tax the imputed rent on them too?
This whole discussion misses one key thing.
Vast numbers of people have built vast dependencies on things working how they have worked in the past – they have paid for their houses and property taxes are relatively limited. Changing that will tend to be very damaging to many people, and probably the economy as a whole. (If the mortgage interest deduction disappeared tomorrow how many people would default or be driven into bankruptcy?)
Indeed, it would seem that the entire notion of any tax upon property is terrible erosion of the very idea of property.
Nothing will/should be done “overnight.”
Incremental change over time would allow for market adjustment.
But it won’t happen: the residential real estate industry (realtors, appraisers, lenders, loan brokers, et al.) won’t let it.
The tax code is all about distinguishing between business and personal; ask those who have had problems deducting housing expenses when working from home and all the other mixes of personal and business.
If a personal residence is going to be considered an income producer, one should then be able to deduct the expenses. Ha! Hear me now and believe me later; those expenses are going to be more than any feeble imputed rent.
The problem here is expecting a unified and internally consistent set of tax laws. Ours is anything but that.
Homeowners also cannot deduct many things a rental property owner can deduct. Estimating *net* imputed rental income would have to factor all those expenses in, plus depreciation. Net imputed rental income could quite plausibly be negative for many homeowners.
Another factor that would into play, along with offsetting expenses against [imputed] income, and depreciating the property over its expected lifespan, is that, as the law is now, a landlord may report the loss on sale of his rental property and use it to offset other income.
A homeowner is taxed on realized gain on sale of his residence (but up to $250k [$500k for married couple] is excluded), but may not report a loss realized on said sale.
To give a home residence tax treatment similar to a rental property, solely for the purpose of equalizing some ephemeral preference that homeowners have over renters, would prove far more difficult to do well than I think you may realize.
“You” being Arnold, not David N.
No, no, no, no, no!
I am not a homeowner, but I have seen this argument before and it is a horror show! The whole point of ownership is that you get to use the thing that is owned, without having to pay for it again! Rent is what you pay to use something you do not own. The idea of pretending that someone is paying rent for something they’ve already bought and paid for, amounts to saying they don’t really own it at all.
The idea of imputed rent on owned property essentially means there is no such thing as ownership. It means we must all impute rent on our cars, our furniture, our electronics, heck, on the cash in our bank accounts (after all, if we didn’t own it, we’d have to borrow it and pay interest). But, then, to whom do those things belong? Who is forgiving us the rent we aren’t paying?
The distortion, of course, is the tax deduction for a non-business use. The tax deduction on a rented property is at least an allowance against the income for that property: it recognizes that a portion of the rent is simply a pass-through of the loan interest, just as a portion is a pass-through of maintenance costs. But when we own a thing to use it ourselves, it is consumption use – and then the deduction isn’t appropriate. We don’t deduct loans for cars, or furniture, or computers in our homes – but we can for our businesses.
Please, please don’t start us down the – ultimately communist – path of arguing that owned property has imputed rent, and isn’t really owned at all.
As an aside, yes, real property gets taxed. Of course, real property is called “real” because the state has not yet entirely accepted the idea that people should own it: the word “real” in “real estate” does not mean “as opposed to surreal” but rather has the same root as “royal”: the state owns all the “royal estate”, and “ownership” is really more in the nature of an open-ended lease on whatever terms the state chooses to impose – which is why we tend to have property taxes, i.e., land rent, on real property. The property belongs to the state – but economics tells us that state ownership of all that property is a bad, bad plan. So, again, please, stop it with the “imputed rent” fallacy: the direction we want to be going is exactly the opposite (and brings elimination of the homeowner’s deduction).