Wednesday, October 12, 2005

Tax Panel Says Popular Breaks Should Be Cut.

Tax Panel Says Popular Breaks Should Be Cut.
Author Agrees and is Equally Unpopular.
Author’s Dog and Cats Still Like Him.

There is a story about Harry Truman and a one-handed economist. The story is probably apocryphal. And it could apply equally well to a lawyer or an honest policy advisor.

Truman was reported to have said he wanted to hire a one-handed economist. When asked why, he responded, “An economist will explain something to you and you will find yourself understanding what he says and being in complete agreement. But in the next breath, the economist will say ‘but on the other hand . . .”


Sometimes being a credible and accurate analyst requires bucking conventional wisdom and cutting “sacred cows”[i] down to size. The Author was not the first to jump on these sacred cows, but will eagerly dogpile upon them.

Yesterday, President Bush’s tax advisory commission proposed cuts in the popular home mortgage interest deductions and employer-paid health insurance. These ideas will never see the light of legislation, but they do have merit and should be considered. Here is why:

Tax treatment of a transaction alters the cost of a transaction. These altered costs affect the conduct of individuals. And what is the effect of this conduct? Socially or economically good, bad, or merely indifferent? Let’s look at some extreme examples to winnow down the analysis:

1. Imagine that the US Tax Court issued a decision that computer hackers could deduct the “ordinary and reasonable costs” of hacking networks, OBDCing databases looking for credit card information, the cost of their T-1 lines, development costs of viruses, ECT. Such a tax policy would encourage more hackers to get into the “business”. A tax deduction would have the effect of lowering their cost of hacking activity by 20-40%, the value of their new business tax deduction. Most everyone would agree, with the possible exception of computer security consultants[ii], that encouraging hackers is a bad thing.

2. Congress passes, and the president signs, a tax law that gives taxpayers a tax deduction for putting up bat boxes. Bats are voracious insect eaters and rarely fly into women’s hair.[iii] They have lost a good deal of habitat and bat boxes are the bat version of birdhouses. So this tax policy reduces the cost of bat boxes by 20-40%, encourages natural insect reduction and ensures better Halloweens.

These examples are extreme, of course, and would not have broad effect. But two proposals from the tax commission would have massive affects upon American taxpayers.

First, this commission proposes capping the home mortgage deduction at the maximum mortgage amount that the Federal Housing Administration (FHA) will insure. This amount varies from county to county. The high is $312,895 and the average is about $244,000. Thus, you could only deduct the amount of mortgage interest paid on the principal amount up the FHA limit. Any interest paid beyond that is nondeductible.


The effect of such a tax move would be to raise the interest expense on larger home loans 20-40% (again, the lost deduction). House prices would fall and building activity would slow. In the Author’s opinion, this would have a salutary effect. It would deflate the housing asset bubble, decrease the building pressure on infrastructure and open land, and slow suburban sprawl. Tough arguments to overcome, unless one step outside one’s self and one’s private interests. Or work in the tax-favored housing industry.

The next proposal is to limit the employer-paid healthcare tax deduction to the average cost of the premium that the federal government pays for federal workers. That is currently about $11,000 per year.[iv] Between a third and one-half more than the cost of a comparable family's healthcare in other developed world countries. And these countries provide universal healthcare, unlike the US.

Since the cost of an American worker’s healthcare is not taxable, the cost paid by the worker through employee premiums and wages they would otherwise receive if their employer did not pay healthcare premiums is reduced by the tax benefit. Americans consume more healthcare because the tax code encourages the consumption. This nondeductibility would slow that consumption.

Healthcare economics was the Author’s driving interest through the 1990s. But having spent at least five years away from healthcare, the Author fears to slip back into the abyss that is American healthcare finance and delivery. So he will stop here.


[i] Most readers are probably unaware that the Author is a vegetarian. So take this as extremely metaphorical.
[ii] Read the Author’s Profile, if you have not already.
[iii] Except perhaps in Texas, where “big har” is the ubiquitous female equivalent of the mullet.
[iv] To put this average healthcare premium cost figure of $11,000 into some Dickensian perspective, the yearly wage for a minimum wage worker is $10, 712.00. “Are there no workhouses? Are there no prisons? And the Union workhouses are they still in full operation?”