By: Mark Glennon*
On two key points, it doesn’t matter whether the bottom line on homeowners’ federal tax bill would go up or down under tax law changes Washington is considering.
Under both the House and Senate proposals now pending from Republican Congressional majorities, Illinois home values would drop and anger over high property tax rates would intensify. Huge, unintended consequences of doubling the standard deduction are being overlooked.
In other words, set aside other important issues like who would benefit most from the tax cuts, effects on growth and whether tax breaks for home ownership ever made sense to begin with. Let’s look at just two issues for now — effects on home prices and the property tax problem because, as you’ll see, they are largely independent from the other issues.
Home ownership is subsidized and prices propped up in many ways, but the two biggest are tax deductions for mortgage interest and property taxes. Both would disappear for the vast majority of Illinois homeowners, regardless of whether they get an overall tax cut:
Mortgage Interest Deduction
The Senate proposal would leave the mortgage interest deduction fully intact. The competing House proposal would limit the deduction to interest on mortgages up to $500,000. (Currently, that cap is $1 million.)
“No effect,” you might therefore conclude, if the Senate prevails or even if the House prevails on most homes because most mortgages are under the cap.
That’s because both the House and Senate proposals would roughly double the standard deduction for a married couple to $24,000, making the mortgage interest deduction irrelevant to most Illinois homeowners. For all but a few, in other words, the mortgage interest deduction would no longer be an incentive to buy a home.
A study this month by a Zillow economist has the data. The number of itemizers would drop dramatically under either the Senate or House bills.
For example, about 51 percent of homes in Cook County are worth enough under current law for mortgage interest to be sufficient for a homeowner to take the mortgage interest deduction instead of the standard deduction. Under the House bill, just 11 percent of homes in Cook Country would itemize instead of taking the standard deduction. Under the Senate bill, only 4 percent would.
It’s a similar story for all counties surrounding Chicago, though some counties already have virtually no itemizers. Here are the data on other Illinois counties:
Property Tax Deduction
Illinois has the highest property taxes in the nation, with effective rates over 3%, 4% and even 5% in many communities — several times the national average. That burden is currently softened by deductibility of property taxes for federal income tax purposes. Most married homeowners have marginal tax rates ranging from 15% to 33%, which means their true property tax burden is reduced by that percentage if they are itemizing (and most are now itemizing in Cook and surrounding counties, as shown in the data above).
But the Senate bill would entirely eliminate that deduction and the House bill would limit the amount to $10,000.
The impact might be particularly harsh on pricey homes. Let’s say a married couple makes $120,000 each, which puts them in the 35% federal tax bracket. They own a home worth $800,000. A property tax rate of 2.5% or $20,000 per year would be common in many Chicago suburbs. Under the Senate bill their effective, after-tax property tax bill would increase from $12,000 to $19,000 per year, or $583 per month. (I am including the 5% tax credit on Illinois income taxes that presumably will stay in place.)
Even under the House proposal, their annual, after-tax property tax bill would increase by $3,500 or about $290 per month.
They won’t be happy. They’re likely already fuming about their property tax bill.
For the majority, who aren’t in homes that expensive, the property tax deduction would become irrelevant because they wouldn’t be itemizing, as shown in that Zillow data. So, again, they may get their federal tax bill lowered but the property tax deduction will have disappeared as a tranquilizer for high property tax rates.
Decide what you want about the two pending proposals overall, and keep in mind there are many other issues pertinent to it and to the nation’s overall policy on housing. Both proposals may indeed cut federal taxes for most Americans, as proponents claim. That would partially offset the negative effect on home prices because people would simply have more money, some of which would probably go into homes. It’s clear, however, that both proposals would end or drastically reduce two tax policies that now prop up home prices.
Many may see that as a good result. They may also see this it as a welcome, last straw in our Illinois’ property tax mess that will finally induce comprehensive reform of some kind. If that doesn’t happen, however, more communities will approach death spiral property tax rates that we’ve written about before since both proposals will lower property values and increase effective, after-tax property tax rates. Once rates pass three or four percent new construction and property, improvements become irrational and the incentive to reduce assessed values increases. That drives values down, feeding the cycle further.
Realtors are livid about both proposals, as you’d expect. The National Association of Realtors says we should expect a 10% drop in home prices nationally if they become law.
For Illinois, I’d say that’s optimistic.
*Mark Glennon is founder and Executive Editor of Wirepoints. Opinions expressed are his own.