Wednesday, December 6, 2017

The tax bill devastates homeownership



The tax bill devastates homeownership

Question:  The tax law makes three major changes to the tax code impacting homebuyers.   First, it substantially increases the standard deduction.  The current levels of the standard deduction are $6,350 (single filers) $12,700 (married filing jointly).   The proposed standard deductions in the Senate bill are $12,000 (single filers) and $24,000 (married filing jointly).

Second the proposed bill eliminates the tax deductibility of state and local taxes.  

Third, the proposed bill eliminates the tax deductibility of interest on student debt.

Table one below contains information on median household income, median home value, median listing price, average student debt and average state and local income tax in Alabama and in New York.



Table One: Economic Variables
in Alabama and New York
Alabama
New York
Median household Income
$45,182
$61,311
Medan Home Price
$126,000
$303,700
Median Listing Price
$192,000
$339,000
Average student loan debt
$27,850
$32,200
Average State and Local Income Tax
$682
$2,699

How does the tax bill impact potential buyers in these two states?

What policy change has the largest impact on the rent versus buy decision?

What state is the rent versus buy decision most affected by the proposed tax changes.

Short Answer:   The tax bill will have a devastating impact on homeownership in both states.


Analysis:

The top part of table two lists expected deductions under current law for a potential home buyer in Alabama and a potential home buyer in New York.   The bottom part some financial calculations.


Importance of Three Policy Changes
Expected Deduction
Alabama
New York
Deduction for State and Local Taxes
$682
$2,699
Deduction for Student Loan interest
$951
$1,099
Deduction for Mortgage Interest
$7,029
$12,411
Total Deductions
$8,662
$16,209
Single Filer Deduction
Current Law
6,350
6,350
Senate Bill
$12,000
$12,000
Single Filers Itemized Minus Standard
Current Law
$2,312
$9,859
Senate Bill
($4,971)
$411
Married Filers Deduction
Current Law
$12,700
$12,700
Senate Bill
$24,000
$24,000
Married Fliers Itemized Minus Standard
Current Law
($15,338)
($7,791)
Senate Bill
($16,971)
($11,589)

The student loan interest deduction estimate is interest paid in the fourth year of 10-year student loan where the mount of the loan is state average.  The assumed interest rate is 5.5%.  The mortgage interest deduction assumes interest paid in the first year of a 30-year FRM, interest rate 4.1 % and an initial balance equal to 90 percent of the median state listing price.



Observations on Analysis:

The mortgage interest deduction is much larger for these hypothetical taxpayers than student tax deduction or state and local tax deduction.

The increase in the standard deduction has a much larger impact on whether these taxpayers take standard deduction or itemize deductions.

Under the Senate bill the gap between itemized deductions and standard deductions is smaller (a larger negative number) in Alabama than in New York.


Implications of Analysis:

Both the Senate and House tax bill will basically eliminate the tax advantages associated with purchasing a home for most home buyers purchasing a house at the median price.  

The impact of the tax bill on incentives to purchase or rent a house is larger in Alabama than in New York.

The analysis presented here actually understates the impact of the tax bill on housing in markets where the rent to mortgage ratio is low.   People who can no longer itemize will aggressively consider the possibility of taking near-term savings from renting by increasing contributions to 401(k) plans or health savings accounts to reduce taxes.  

The proposed tax bill will increase the number of years it takes to breakeven by purchasing rather than renting because there are now short-term tax savings from renting.

The Senate and the House tax bills will drastically impact first-time homebuyers.   The impacts will ripple through the entire market because people need the capital gain on their first home to buy their second home. 


Authors Notes:   I am consolidating my economics and finance blogs and am slowly moving to WordPress.   The post above has a link to useful Excel Spreadsheets which can be used to estimate the impact of student debt on the amount of mortgage a person can qualify for.  



I expect to publish a lot of interesting articles on this site.  

Readers interested in this material should pleas subscribe to the blog through the pop-up memo.


















Monday, November 27, 2017

President Trump’s Approach to Student Debt

President Trump’s Approach to Student Debt

The Trump Administration is pushing forward a broad range of policies that will impose substantial financial costs on student borrowers.   The policy levers include changes to the tax code, changes in rules governing student loan programs, and reduced consumer protections for borrowers.

Proposed Policy Change and Actions
  

The Elimination of Subsidized Student Loans

Currently, subsidized student loans are available for low-income students. The government pays all interest on subsidized loans while a student is still enrolled.  The Trump Administration’s budget proposes the elimination of all subsidized student loans.  As a result, low-income students will accrue interest even when in school.

Comment on Proposal to Eliminate Subsidized Student Loans: Subsidized student loans are only available for lower-income students.   The build-up of interest payments while a student is in school will have the largest impact on students who fail to graduate on time.   This provision may discourage students who leave school after their freshman or sophomore debt to reenter school later in life.   This provision will also have a large impact on low-income students in complex fields (medicine, science and law) because interest will accrue for years prior to the initiation of repayment.

The Modification of the Income Based Replacement Loan Program:

The Trump Administration is proposing a uniform set of rules for Income Based Replacement Loan programs.   People with an undergraduate education would pay more annually but would be able to receive loan forgiveness after 15 years rather than 20 years.   However, debt incurred in graduate school would not be forgiven until after 30 years.

Comments on Income Based Replacement Loan Programs:    The current IBR program has many flaws.   The modifications proposed by Trump worsen the program. 

Many people enrolled in the IBR program because they temporarily have low income and they are trying to prevent a loan default.  These people pay more under iBR than under a 10-year loan plan. Many people who enroll in IBR fail to receive any debt relief because obtaining debt relief requires that a person stay in the loan program every year.

Many borrowers will be unable to make the new annual IBR payment.   These borrowers may default or may sign up for a 20-year loan, which will cause them to pay more student loan interest over their lifetime.  It is highly likely that a substantial number of student borrowers will select 20-year repayment options because of higher debt totals and the increases in the annual IBR payment.

The Elimination of Public Loan Forgiveness Programs:

Current law provides loan forgiveness to borrowers who have been certified to work in a public service job after 10 years of on-time payments.   President Trump’s budget proposal would end public loan forgiveness for loans issued after July 1, 2018, except for loans needed to finish the current program.   Current law provides loan forgiveness to borrowers who have been certified to work in a public service job after 10 years of on-time payments.

Comment on Abolishing Student Loan Forgiveness Programs:  Some economists including staff at the Government Accountability Board have forecasted large costs for the current Public Service Loan Program.  Around 500,000 people have enrolled and many jobs are potentially covered by the program.   I believe the number of people receiving public service loan forgiveness may be lower than anticipated because people who leave public service employment prior to ten years do not receive any loan forgiveness.

This program will encourage some people to stay in a public service job even when more productive opportunities exist elsewhere. Proposals providing partial loan forgiveness for people serving in public service jobs for a period smaller than ten years should be considered.

Denying Access to Enrollees in Public Loan Forgiveness Programs Prior to the Elimination of the Program:  

The Department of Education under Betsey DeVos has denied student borrowers with existing loans access to the public loan forgiveness program.   This administrative change is being applied to people who have already taken on debt and are currently working.  A law suit is currently challenging these denials and claims that the Administration has arbitrarily changed eligibility requirements for the public service loan program.

Comment on Denial of Access to Public Service Loan Programs:  The Trump Administration position favors taxpayers over students.   The savings to the taxpayer may be smaller than anticipated if many people do not stay 10 years in a public service position.

Consumer Protections:

Reducing Protections for Defrauded Students:

Under President Obama, the Department of Education put into place rules that provided defrauded students debt relief.   Betsey DeVos stopped work with the CFPB on student loan fraud efforts, proposed changes to the Obama-era rule that would limit the amount of debt relief given to defrauded borrower and delayed applications of debt relief until the new rule is finalized.

Comment on Reduced Protections for Defrauded Students:   The Trump Administration appears to oppose most regulations of for-profit colleges evens when there is documented abuse.

Enforcement of IBR loan application rules:

The CFPB recently found that loan servicers were illegally denying students access to Income Based Replacement loan programs. The CFPB ordered loan servicers to improve procedures to guarantee

Comment on CFPB Ruling:   The Trump Administration and many Republicans oppose the existence of the CFPB.   The Administration named an interim director who opposes the agency.   

The lack of regulation of applications to the IBR program is important because applications must be renewed annually and no debt relief is offered to debtors who do not remain continuously enrolled.


Taxing free tuition waivers, ending the tax deductibility of student loan interest and other student loan tax preferences.  

The House tax bill, which has been supported by President Trump, proposes to treat tuition waivers for graduate students and sons and daughters of university employees as ordinary income for tax purposes. The House bill also eliminates the tax deductibility of student debt, the exemption from tax for lifetime learning, and exemption from tax for employee tuition assistance.


Most of these proposals were removed from the final tax bill, which was enacted into law.  


Links to Articles Documenting These Policy Changes: