20061113

The "Fair Tax" and Home Ownership

In the recent past, I came to the conclusion, and stated the conclusion, that I could live with the so called "Fair Tax" (a plan for replacing the current tax code with a national sales tax) as long as a progressive income tax was continued for those in higher income levels.

While bumping down the road, I continued to give the "Fair Tax" further thought. What would the impact be on a big part of the American Dream for the middle class, that of home ownership, I asked myself.

I have come to the conclusion that the results will be disastrous. It still might not lead to a collapse of home values, however it might make home ownership a stupid investment for many homeowners. How is this so? Let us examine how the "Fair Tax" would impact a significant portion of middle class home owners today.

Let us say a young family purchases their first starter home. Since they have not yet met anywhere near their peak income, they start off modestly with dreams of a bigger castle for themselves held back until their income increases. They choose a modest home that the seller is asking $100k for (in many, if not most of America's housing markets, $100k will indeed be a modest home). However in addition to what the seller wants, Uncle Sam now demands the 30% Fair Tax and the price increases to $130k.

But what happens when the home buyer walks into the bank asking for a mortgage? The banker is going to ask the buyer if he has a minimum of $30k just to even qualify for a "no money down" loan. If the buyer wishes to escape PMI (mortgage insurance) he will have to have $40k. Why the minimum $30k down? Even if the bank is willing to risk a 100%, no money down mortgage, the amount they will be willing to finance is only $100k since this is the maximum amount that they could be expect to receive if they were forced to repossess and sell the property even if they received exactly the same price the home buyer paid.

Strike one: The first time home purchaser is going to be forced to come up with an unrealistic down payment for his starter home.

Now let us further examine the future for this home buyer. A significant portion of home buyers do not buy their first home and then live in it for the rest of their lives. Due to needing to move to other areas of the nation, family growth, or just increased income and being able to afford a nicer home, they might sell it and move up after only a few years.

Let us examine what happens to investment decision of this first time home purchaser if they choose to sell their starter home after only having lived in it for 5 years. 5 years might not be totally typical, but it is the time period investment advisers typically use when advising whether or not it is wise to refinance when interest rates are dropping.

In five years, using an amortization table with a 6% interest rate, we'll find the homebuyer would have paid down $6945.64 in principal. Now let us assume that appreciation of home values only follows the CPI (Consumer Price Index) which will have risen by about 3.3% for fiscal year 2006. I'll use this figure to compute appreciation. The homebuyer can expect his home will have appreciated in value by $17,625.52 in five years.

$6,945.64 in principal reduction + $17,625.52 in appreciation = $24,571.16 meaning the homebuyer will have LOST $5,428.84 for having owned his own home. This does not factor in any further expenses due to maintenance expenses, or having to pay a realtor the commission (thousands of dollars) for helping to sell the home.

Strike two: This young family loses money on their investment even while they deal with the headaches of home ownership.

Let's say this young family experienced a healthy increase of income and purchased a home marketed for $200k. With the Fair Tax added in, they will pay $60k immediately to Uncle Sam once again before they ask the bank to finance the remainder. This means our not untypical family will have paid $90k to Uncle Sam over a period of 5 years for the right to lose money for daring to own a home.

Strike three: No further explanation required.

For many middle class home purchasers, purchasing a home is going to become downright stupid. It will be financially wise for them to just rent, and what the heck, let the landlord deal with the headaches.

The only thing that will prevent a catastrophic collapse of property values will be all the investors that will be circling like sharks as sellers try to market their properties at fire sale prices. The middle class is still going to need a place to live after all, it is just that they are now going to increasingly become tenants instead of home owners. But investors are not going to be willing to invest unless they see a profit to be made.

Remember, one of the things driving current property values is the significant tax benefits obtained from itemizing due to mortgage interest.

Property values are going to decline significantly, particularly on the types of property the middle class can afford. And the American Dream of home ownership for the middle class is going to frequently be a nightmare.

19 Comments:

Blogger Lethal_Poison said...

Owning a house would be no more ignorant then owning a vehicle which you are upside down in the loan. Why doesnt everyone just lease vehicles? Oh yeah, because its stupid most of the time. You own nothing at the end of the day, and your payments are comparitable, if not higher then they would be to own.

I rent now, obviously, and if I had the option of purchasing a house for the same amount Im renting for now, Id gladly take that deal, even if I had to be upside down for a while.

Renting has its own handful of headaches. The only difference is you have to depend on a landlord to deal with the headaches, because you are dissuaded from dealing with them because its not yours. Some landlords are better then others, and some landlords dont give a damn at all as long as their check is showing up.

The only difference is now the government wouldnt be subsidizing property owners.

This would reduce the house that most people could afford, initially, that is true, and home prices may fall slightly, that is also true, although they would be floated by a significant reduction in prime interest rates.

So what?

Too many people as it is are depending on that crutch to get into houses they really cant afford, and are driving the prices up exponentially for everyone else who are not willing to pay 75% of their net income in a house payment, as the interest savings multiply as the value of the house rises.

11/16/2006 09:41:00 AM  
Blogger Little David said...

I am saying that the loss of the tax advantage will reduce the incentive to buy a home. I also showed where someone could actually lose money after having owned a home for 5 years.

Some people do lease vehicles. Some people who would have bought a home will no longer do so, because, for them, it would be then be stupid to do it.

11/19/2006 08:05:00 PM  
Blogger Lethal_Poison said...

1. I am saying that the loss of the tax advantage will reduce the incentive to buy a home. I also showed where someone could actually lose money after having owned a home for 5 years.


Reply- It is true, you would lose money, on paper, for a while, until the value of the house appreciates higher then the total for the amortization schedule.

I ask you again, so what? The only people who would get hurt are the ones who want to move around every few years.

If someone who was planning on moving in 3 years was stupid enough to take out a conventional loan, I blame them.


2. Some people do lease vehicles. Some people who would have bought a home will no longer do so, because, for them, it would be then be stupid to do it.


Reply- Why wouldnt someone buy a house? I could care less if they are "losing money" on paper. Its still much better then renting, where you dont own squat.

Even if you were backwards for a while in a loan, Id rather pay $1200 a month and say I owned it, then $1400 a month, and be throwing good money after bad on nothing.


Again, regardless of how its set up, at the end of the day, you have a house. When you rent, you dont have a damn thing.

11/20/2006 10:49:00 AM  
Blogger Little David said...

Take a look at yourself.

If you are ever going to realize the American Dream, you are going to have to start at a home that is less then your ulimate dream. Later, hopefully, your income will increase so that you can achieve something better.

I rest my case.

I do not want to penalize you for attempting to seize as much of the American Dream as possible now, and striving for a larger portion later.

11/20/2006 12:49:00 PM  
Blogger Lethal_Poison said...

1. I do not want to penalize you for attempting to seize as much of the American Dream as possible now, and striving for a larger portion later.


Reply- What is this "penalized" notion? How are you being "penalized" by having your priveledge revoked? Im not sure how that is a "penalty". The only people who are penalized by proxy are those who rent, who dont receive the land owner tax breaks, yet still pay equivalent or higher monthly payments.


Should we also give out interest breaks on car payments not related to business expense? After all, driving my car takes the burden off of public transportation, and hey, it would give those "broke asses" on the bus motivation to get off the bus........

11/20/2006 01:14:00 PM  
Blogger Little David said...

Actually, at one point consumer interest (including on car payments and credit cards) was an income deduction for those who itemized. I think this was to avoid double taxation. Whoever received the interest had to report the interest as income and pay taxes on it, so having the consumer also pay income taxes was double taxation. Somewhere along the line this was changed.

However nowadays the Republicans are putting forth that taxing businesses on profits and then taxing the investors again when these profits are realized through either dividend payments or capital gains amounts to double taxation and they claim this is unfair.

Seems to some it is OK for ordinary consumers to be double taxed but we can not allow this to happen to the investor.

I think of the pursuit of the American Dream, which includes home ownership, as a right, not a priveledge. This right might not be enshrined in the Constitution, but it can be enforced at the voting booth. Grin.

11/21/2006 06:28:00 AM  
Blogger Lethal_Poison said...

1. However nowadays the Republicans are putting forth that taxing businesses on profits and then taxing the investors again when these profits are realized through either dividend payments or capital gains amounts to double taxation and they claim this is unfair.


Reply- Do you know what a "capital gain" is? Do you know the difference between dividend distributions and capital gain?


2. Seems to some it is OK for ordinary consumers to be double taxed but we can not allow this to happen to the investor.


Reply- This I agree with. Why is it ok in some instances for things to be "double taxed" but others its not. I say, either everything, or nothing. Double standards in the tax code are a serious problem in my opinion.

11/21/2006 09:43:00 AM  
Blogger Little David said...

Yes I think I know what a "capital gain" is. You buy stock at $1 a share and you later sell this stock for $2, this would be a "capital gain", correct?

Yes there are problems with the tax code. However my observations are that you seem motivated only to correct the tax code so that it is advantageous to you in your present situation. You do not even look forward to your own future prospects.

11/21/2006 01:50:00 PM  
Blogger Little David said...

I went and checked Merriam-Webster for the definition of "capital gain" is. According to Merriam-Webster: the increase in value of an asset (as stock or real estate) between the time it is bought and the time it is sold.

So I see that it does in fact mean what I thought it meant.

Now a question for you, what made you think I did not know what it was? Was it solely because I have never been to college or something?

11/21/2006 01:55:00 PM  
Blogger Lethal_Poison said...

1. Yes I think I know what a "capital gain" is. You buy stock at $1 a share and you later sell this stock for $2, this would be a "capital gain", correct?

Reply- Right, so, how is that "double taxation"? A capital gain is influenced by market forces, not income.


2. Yes there are problems with the tax code. However my observations are that you seem motivated only to correct the tax code so that it is advantageous to you in your present situation. You do not even look forward to your own future prospects


Reply- Ok, step out of the "me, me, me" right wing box. I dont give a DAMN about myself. I care about society on a whole. As hard as that is to understand for someone so clearly influenced by the right wing, it is possible.

Myself, just happens to be in the demographic that I happen to do the most advocation for.

11/21/2006 02:31:00 PM  
Blogger Lethal_Poison said...

1. Now a question for you, what made you think I did not know what it was? Was it solely because I have never been to college or something?


Reply- No, it was this comment

"....when these profits are realized through either dividend payments or capital gains amounts to double taxation and they claim this is unfair...."

Most capital gains, those recognized through share sales, are never subjected to double taxation.

The only convoluted argument that capital gains are subjected to double taxation, is that when assets are sold at a corporate level, that profit is taxed as a capital gain, and then taxed again if distributed as a share.

Then again, the way your argument as worded stated, is that capital gains are somehow "taxed" for a second time when they are realized by investors, which is just bularkey.

11/21/2006 02:44:00 PM  
Blogger Little David said...

Look at it this way:

The corporation earns a profit and pays tax on the profit. The corporation then invests these after tax profits.... hang on a second... these investments would be deducted from "before expense" profits and never subjected to the tax.

I think I understand where you are coming from now.

11/21/2006 03:51:00 PM  
Blogger Lethal_Poison said...

1. The corporation earns a profit and pays tax on the profit. The corporation then invests these after tax profits.... hang on a second... these investments would be deducted from "before expense" profits and never subjected to the tax

Reply- here it is very simply

A corporation makes income, deducts its expenses, and ends up with net income before taxes. Of course thats very simple, but its a general overview. Then it pays taxes.

It then has the choice of paying dividends and/or closing that income to retained earnings, which are "supposed" to be plowed back into the company, and become "owners equity". The "owners" (shareholders) do not pay any tax on this increase in equity. In reality, that "equity" is pretty much just "paper equity" anyway, as it doesnt mean much at the end of the day.

So, if the company dumps out non qualified dividends, the shareholders are going to pay income tax on it. If Im not mistaken, some certain dividends are qualified to be taxed at capital gains rates, but dont quote me on that.


Since Bush took down the capital gains taxes, companies have pretty much stopped paying dividends at all.

The hope is, that plowed back retained earnings, will increase asset value, and corresponding income, increase the bottom line, and increase share prices, which would constitute capital gains for a share holder.

That said, that net income has NO connection to the shares gains (capital gains). That gain is set in the market place, and is often more influenced by some stupid speculation then any hard core financials.


The only capital gain that may be taxed twice, is if the company buys a building, it appreciates, they sell it, and then realize a capital gain, which they will pay tax on.

That will eventually filter down into net income available to shareholders, and if it is distributed as shares, it will be taxed again when it hits the shareholders hand.

11/21/2006 04:25:00 PM  
Blogger Little David said...

I am aware of the ideas behind just about everything you stated.

To help you, unqualified dividends from corporations are taxed at the recipients ordinary tax rate. Qualified dividends are taxed at the same rate as capital gains, 15%.

11/21/2006 04:37:00 PM  
Blogger Lethal_Poison said...

This comment has been removed by the author.

11/22/2006 09:02:00 AM  
Blogger Lethal_Poison said...

1. To help you, unqualified dividends from corporations are taxed at the recipients ordinary tax rate. Qualified dividends are taxed at the same rate as capital gains, 15%.


Reply- Yeah, after I wrote the comment, it hit me about what is and isnt a qualified dividend, and I didnt bother to redo the whole post to fix it. I was aware of the different tax rates, it just momentarily slipped my mind about the definition of what is and isnt one.

C-Corps are pretty much the only ones that dump out qualified dividends, and of course, these are the only ones "double taxed", since a non qualified "dividend" is basically just an income filter through used in S-Corps and LLC's.


Oh, by the way, the capital gains tax rate is a max of 15%, it isnt neccessarily ALWAYS 15%.

11/22/2006 09:17:00 AM  
Blogger Little David said...

Yeah, but the only ones who qualify for the lesser rate are lower income earners correct?

I seem to recall that qualified dividends are taxed at only 10% if the recipients income is low enough.

11/22/2006 10:11:00 AM  
Blogger Lethal_Poison said...

1. I seem to recall that qualified dividends are taxed at only 10% if the recipients income is low enough.


Reply- Im no tax expert, and without looking Im pretty sure it can go all the way down to 0% depending on income.

11/22/2006 10:36:00 AM  
Blogger Little David said...

Yes, I think you are correct, it could fall to as little as 0%. It is just that qualified dividends are at times taxed at below the recipients top, ordinary income tax rate.

11/27/2006 11:32:00 AM  

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