Global Warming: A "Taxing" Solution?
by Lawrence Yun, Vice President, NAR Research

 

A major issue for both real estate professionals and their clients – the nation's homeowners – is the mortgage interest deduction (MID). The NATIONAL ASSOCIATION OF REALTORS^® has defended, and continues to defend, this provision in the tax code. The deduction is not a subsidy, as many opponents of the deduction argue – rather, it is a vital factor that helps drive homeownership in the this country. Homeownership has been determined to provide immense social and economic benefits. But sometimes attacks on the MID are disguised as a solution to another problem. Recently, repealing the deduction for some homeowners has been couched as a cure for global warming.

The Price of Going Green
The impact of our lifestyles on the environment is an important issue. The current trend of "going green" is influencing how our homes, offices and other structures are built. NAR has taken environmental concerns into account itself – the NAR Building in Washington, DC is a certified "green" building. But how far should those environmental concerns go when it comes to our homes? Recent proposals introduced by Rep. John Dingell, D-Mich., chair of the House Energy and Commerce Committee, would basically institute a "carbon tax" by eliminating the mortgage interest deduction for owners of homes larger than 3,000 square feet.

The proposal reflects the widely held view that carbon emissions contribute to global warning, and that larger homes use greater amounts of carbon fuel. Though some of the goals of the proposal are noble, there are costs that need to be seriously considered.

Eliminating the mortgage interest deduction on larger homes would result in more than just a higher tax burden to many homeowners. It would also lead to lower home values.

The Largeness of it All
Based on data from the American Housing Survey, there are 10.4 million single-family homes at least 3,000 square feet in size out of 74 million owner-occupied homes in the United States. Though this number of large homes comprises just 14 percent of all homes, a conservative estimate is that they account for 27 percent of the total value of all owner-occupied homes.

A Heavy Burden
In 2005, $414 billion of mortgage interest was deducted from tax returns. Since the average homeowner is in the 28 percent tax bracket, the total MID tax benefit was about $116 billion. That means the current MID provision lessened the tax burden for all homeowners in 2005 by $116 billion. Owners of those larger homes (more than 3,000 square feet) reaped a benefit of $31 billion (27 percent of $116 billion). Since we know that outstanding mortgage debt has grown by 10 percent since 2005, eliminating the MID on large homes would add a tax burden of $34 billion to all the nation's homeowners in 2007.

The Value Proposition
But eliminating the MID on larger homes would result in more than just a higher tax burden to many homeowners. It would also lead to lower home values. Let's say you are a potential home buyer. In order to take advantage of the MID, you would likely limit your choice of homes to those smaller than 3,000 square feet. Consequently, the demand for those larger homes would ebb, causing their sales price to decline. Because the housing market is competitive – one home for sale competes with other homes for sale -- a lowering of value in one segment of the market (large homes in this case) would also impact the value of smaller homes. NAR estimates that the bottom-line impact will be a national home price decline of 3 to 4 percent under the most optimistic scenario should the MID be eliminated for large-home owners. The price decline would be on all homes, not just on the larger ones.

The Foreclosure Factor
The price declines could be steeper if one considers the "snowball effect" as home price declines lead to higher foreclosure rates; and higher foreclosures in turn lead to a further lowering of home prices. Recent research from First American Core Logic indicates that a one-percentage point decline in home prices would lead to an additional 70,000 foreclosures. A 3 to 4 percent price decline would, therefore, lead to an additional 210,000 to 280,000 home foreclosures. (That is in addition to the anticipated rise in foreclosures from the subprime loan resets scheduled to occur in 2007 and 2008). Such an impact would be felt more sharply in those local areas with struggling economies. Ironically, the effect could be particularly devastating in a state like Michigan (Congressman's Dingell's state), where job losses have continued for the past six years and home prices have declined by about 10 percent in the past 12 months.

Other Ways to Achieve a Noble Environmental Goal
If the goal is to reduce carbon emissions, there are other options. Taxing utility usage, rather than home size, would spur owners of all homes (regardless of size) to install "green" features in their home that would lower their utility usage – thus reducing carbon emissions. Higher utility taxes could then be offset by reductions in other taxes to achieve revenue neutrality in the tax code. Tax incentives for "building green" is another option that would likely help drive demand for home buying and thus keep home price appreciation at healthy levels. Eliminating the mortgage interest deduction for one group of home owners – even if you call it a "carbon tax" – would do neither.