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National Sales Tax Would Be a Setback for Housing
While replacing the current federal income tax system with a national sales tax would increase economic growth over the long run, that benefit for home builders would be far outweighed by the negative impact on for-sale and rental housing and residential remodeling, according to a recent paper by NAHB tax economist Robert Dietz.
The paper examines the impact of the “Fair Tax” introduced by Rep. John Linder (R-Ga.), which would repeal almost all existing federal taxes and replace them with a 23% tax for all sales or exchanges of new goods from a business to an individual.
The Internal Revenue Service would be abolished over a three-year period, although new or existing government agencies would be needed to administer the new tax system, and only existing federal excise taxes on products such as alcohol and tobacco would remain in place.
“H.R. 25 would in general tax all sales transactions from a business to an individual,” says Dietz. “Individual to individual sales would be exempt. Note that this would exclude sales of existing homes. Sales from an individual to a business, such as labor, would generally be exempt from tax. Investment and payments to capital would be exempt. By not taxing investment and productive business activities, a national retail sales tax encourages economic growth.”
However, he notes, the legislation “would be harmful to housing.” All new home sales would be taxable, including improvements and remodeling services. For multifamily rental property, all rental payments made by tenants to property owners would be subject to the sales tax. The service provided by a bank or other financial institution in making a loan would be taxed. On all but student loans, a portion of the interest payments would be taxed above a benchmark interest rate, most likely the rate on the 10-year Treasury bond. This means that a portion of every mortgage interest payment would be taxable.
And other financial services — including fees from brokers, Realtors®, mutual fund managers and loan originators — would be subject to the Fair Tax, which “would thus increase the cost of selling or buying a home for both new and existing housing.”
NAHB contracted Tax Policy Advisers (TPA) to analyze the complete set of Fair Tax impacts and also determine what tax rate would be required to keep the proposal revenue-neutral.
The models at TPA found that the tax would need to be higher than the 23% rate specified in the legislation — in the range of 26.1% to 27.7%. Other economists have said that the rate would need to be even higher to avoid a loss in federal revenue, which would produce less economic growth and reduce the benefits offered by the tax reform proposal.
On the economic side, TPA determined that the new tax would have these impacts, using the range it found would be revenue-neutral:
- It would increase growth in the gross domestic product by an average 2.1% in its first five years and 3.1% thereafter.
- After-tax wages would be 17.4% higher in the first five years and even higher after that, although today’s average income tax rate is 21%, so before-tax wages would actually fall.
- The dollar volume of investment in non-housing businesses is 8.9% higher in the year of reform and 8.3% higher five years later.
- After five years, interest rates would be 1.1 percentage points lower, but the after-tax interest rate would remain about the same.
- Prices of non-housing goods would fall 0.2% in the year of reform and they would be 0.5% lower after five years.
- The value of existing assets and wealth would fall significantly. After the reform, non-housing related asset prices would fall by 14.5%. After five years, those pre-reform assets would still be worth 12.1% less in terms of real purchasing power.
Impacts on housing include:
- The user cost of owning a home — including tax benefits and expected appreciation — increases by 4.6% five years after the reform because of the repeal of tax housing preferences and the taxation of mortgage costs and other housing-related items. “Because the after-tax cost of owning housing is higher, the demand for owner-occupied housing as a form of investment is lower relative to other forms of investment.”
- Home prices on average are 10.1% lower in the year of reform. The price decline eventually dissipates over a six-year transition period.
- In the year of reform, investment in new construction and remodeling of owner-occupied housing would fall 18.6%, a decline of $94 billion. After five years, investment is still almost 2% lower.
- Due to the sales tax on new housing, sales fall by 18.6% — from a baseline of 1.053 million to 847,000. Sales remain lower five years later, with total annual volume of 1.006 million.
- Due to the sales tax on rental payments, the before-tax price of rental housing falls as housing demand declines. In the year of reform, before-tax rents fall by 0.2%. After five years, the price is 0.5% lower and it continues to fall thereafter.
- The average value of rental housing businesses falls by 25.6% in the year of the reform. After five years, the value of these businesses remains 21.8% lower. However, investment in rental housing increases as a result of the tax policy change — by 12.9% in the first year of reform and 10.5% after five years.
- Residential fixed investment falls from a baseline of 32.4% of total investment in the economy, or $672 billion, to 28.2% or $600 billion after the tax policy change, and it then grows to a 30% share two years after reform and 30.6% after five years.
- Total housing starts decline by 13% in the year of the reform, with single-family starts down by 18.6%, offset by the increase in multifamily starts.
- The homeownership rate declines from a baseline of 68.8% to 68.6% after two years, 68.1% after five years and 67.7% over the longer run. “This is a function of the relatively higher user cost of owner-occupied housing. The decline in the homeownership rate translates to a less favorable market for new home sales.”
Dietz says that a national retail sales tax could hypothetically be beneficial for housing. But “for this to be the case, at the very least, sales tax exemptions for new home sales and mortgage interest payments would be required.” That, however, would be unlikely because the loss of the tax revenue from housing would require the tax rate to be increased — to 30.4%, according to TPA.
 Want to Know the Housing Forecast for the Top 100 Metros?
Find out in HousingEconomic.com’s 2008 to 2009 Metro Forecast (free preview).
Get the metro forecast with in-depth analysis, overviews and downloadable Excel tables.
To learn more, visit www.HousingEconomics.com.
 Free NAHB Kit Gives Builders Back-to-Basics Tips to Navigate the Slowdown
What was once expected to be a relatively mild housing slump following three years of record new home construction and sales has given way to a significant downturn.
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