If Congress thought tax reform would be simple, right now these legislators are getting a wake up call from a variety of constituencies who feel cheated in the deal. More importantly, our Congress is missing the bigger picture. The biggest losers will be homeowners, home builders, charities and lower to middle-income taxpayers who give to charities.
The biggest winners in either the Senate or House plan are renters and people who believe that charity begins, and stays, at home.
Let me break it down for you. Our tax system is designed to promote home ownership and donating to charities. Significantly increasing the standard deduction makes it less advantageous for many to do either of those things. In both versions of the bill, the standard deduction increases to $12,000 for single filers, up from $6,350; and to $24,000, up from $12,000, for married couples filing jointly.
The Link Between the Standard Deduction and Home Ownership
Increasing the standard deduction decreases the motivation to buy a home because fewer households will itemize, so the mortgage interest deduction becomes less important. This will result in a decrease in value of homes, which obviously will affect the net worth of most homeowners.
The Senate and House versions of the plan differ on the deduction for mortgage interest. Senate Republicans are leaving this one alone; the House would cap the deduction at $500,000, down from $1 million.
But that difference still misses point for the majority of lower to middle income Americans. Since the mortgage interest will no longer be reducing federal and states income taxes paid, incomes will decrease. Net result: more people to default on their mortgages. Homebuilders will then also be affected because of additional homes coming on the market, thus lowering the value of most homes.
This is basic supply and demand. A decreased demand for home ownership plus a glut of new homes coming into the market will bulldoze the housing industry.
"Tax deductible" is the best sales phrase ever. This phrase will become passé as millions opt for the standard deduction. And since they will no longer be itemizing their deductions they have less of an incentive to contribute to a charity.
The charitable deduction has been around almost as long as the income tax. According to the Tax Policy Center, lawmakers enacted the deduction as part of the War Revenue Act of 1917 because of concerns that a high tax rate might weaken charitable giving.
Fast forward to the Reagan tax reform of the 80s. By the mid-80's, despite the significant amount of tax legislation passed in the first three years of his presidency, the public was still unhappy with the IRS. People saw it as too complex and unfair. Sound familiar? This lead to the 1986 Reform Act that did not renew any charitable deduction to taxpayers who didn't itemize and, as a result, many charities felt the hit.
The Wealthy Will Be Less Affected
To be clear, neither the House or Senate version of tax reform is going to impact the rich as much, given that they have more valuable homes with larger mortgages and real estate taxes. Also, those who give tens of thousands of dollars to charities will be less affected.
The brunt of the damage will be to those who make less than $100,000 per year and have mortgages of less than $100,000 ($200,000 for married couples).
Finally, a third impact of this huge increase in the standard deduction will be to people who live in high tax states (such as California or New York) even if they are not homeowners or large charitable givers. Taxpayers would no longer be able to deduct some or all of their state taxes.
Because our lives are not easy to generalize, taxes can also be complex. In tax reform, Congress needs to remember the big picture and a lesson in tax history wouldn't hurt.