The president's Advisory Panel on Federal Tax Reform will present its proposals tomorrow, and the bipartisan commission seems to have reached the following conclusion about how to improve revenue collection: Screw the blue states.
In the name of simplification and fairness, the panel is proposing to do away with the dreaded Alternative Minimum Tax, a pernicious levy that effectively increases taxes on millions of people each year by robbing them of some deductions for property taxes and state and local income taxes. According to the Treasury Department, some 4 million Americans will pay the tax in 2005. If Congress doesn't extend a law that limits the reach of the AMT, it could hit 21 million people next year. Abolishing the AMT would seem to be good news for blue-staters, since it falls largely on people who live in Democrat-dominated areas.
But to do away with the AMT, the reformers must replace the expected $1.2 trillion in revenue it would throw off over 10 years. And, as David Rosenbaum reported in an Oct. 19 New York Times article (which you now have to pay to read online), the panel came up with two simplification plans. Both would severely limit the size of the home mortgage deduction. Now the deduction applies to up to the first $1 million of a mortgage. The panel's plans would cut it down so that it would only apply to loans that are the "maximum that the Federal Housing Administration will insure." The sum varies by market, but the maximum is $312,895 and the national average is $244,000. Both plans would eliminate deductions for interest on home-equity loans or mortgages for vacation homes. And both would eliminate the deduction for state and local taxes paid, including property taxes.
On the one hand, gutting the mortgage-interest deduction seems progressive, because the deduction now favors the well-off: The mortgage deduction gets more generous the more expensive the home you buy, and the more income you have. And property taxes are generally a function of home size and value. On the other hand, regional variations in home prices and state and local taxes would heavily skew the burden of these tax changes onto blue-staters. Who has the most to lose if the mortgage deduction is capped at $313,000, and if you can no longer deduct local taxes from your taxable federal income? People who live in places where (a) real estate is expensive; (b) states and/or cities tax income; and (c) property taxes are high, to support local schools and services. In other words, people who live in California, Seattle, the entire Atlantic seaboard from Maryland up to Maine, and well-off suburbs of Chicago. If you live in a $300,000 McMansion in a state with no income tax, like, say, Texas or Wyoming, these changes aren't likely to affect you at all. But if you just bought a $700,000 house in Takoma Park, Md., you're screwed three ways.
Many of the people writing and talking about these issues suffer from one of two kinds of myopia. There's blue-state myopia. Classic sufferers: Moneybox, Moneybox's editors, many of Moneybox's readers. These are people who think you have to pay seven figures to get a nice house with a nice yard in a nice suburb, or who think its normal to borrow $800,000 to buy a two-bedroom condo in a dicey neighborhood.
Then there's red-state myopia. Connie Mack, the Republican ex-senator who is co-chairman of the tax advisory panel, is a classic sufferer. When asked by the New York TimesMagazine whether limiting the deduction could "hurt the middle class and discourage people from buying, say, a $500,000 house?" he responded: "It depends on how you define middle class. I don't think that there would be a large percentage of middle-income families that would have a $500,000 house." Mack has obviously never spent much time in Staten Island, N.Y., where Vito Fossella, one of the few remaining Republican members of Congress in the Northeast, has already come out against the panel's ideas. In the high-population, high-income states—the states that, by the way, produce a disproportionate share of federal income taxes—plenty of middle-class people live in $500,000 homes.
In both instances, the myopia can be cured by a simple exercise. Go to Realtor.com, punch in your ZIP code and a price point, then punch in another ZIP code in a different part of the country and the same price point, and check out the astonishing difference in what you get.
To a degree, the AMT payers have only themselves to blame. People choose to live in places that have high property values and higher taxes, and for some pretty rational reasons. They like the beach. Schools tend to be better in places where property taxes are high. There may be a wider variety of high-paying jobs available. What's more, they've generally chosen to back the wrong horses over the last several years. Bush didn't seriously compete on the Atlantic seaboard or on the West Coast in 2000 or in 2004. And the Republicans who remain—feeble moderates like Lincoln Chafee in Rhode Island and Rep. Chris Shays in Connecticut—aren't part of the in crowd. Is it any surprise that the changes recommended by a commission appointed by the president would probably have the worst effects on Democratic areas?
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