Taxes and Housing Prices
The combination of the recently-passed health care legislation and the President’s proposed rollback of the Bush tax cuts for upper-income taxpayers would sharply boost tax rates on the wealthy. This is great news for the high-end real estate market.
It may seem counterintuitive, but raising taxes on those in the top brackets could increase urban house prices by as much as 10 percent, and even more in east and west coast cities where homes are most expensive. The drivers of this windfall: higher top rates on ordinary income and hikes in capital gains taxes. Obama’s proposal to limit the benefit of itemized deductions to 28 percent could more than reverse this housing windfall, but that measure is unlikely to win congressional approval.
Let’s start with the President’s proposal to restore the 36 percent and 39.6 percent rates on income. This would increase the value of owning a home, since as tax rates rise, so does the value of the mortgage interest deduction. (For example, if a taxpayer’s marginal tax rate rises from 33 to 36 percent, the value of $1 deduction increases from 33 cents to 36 cents.)
The role of the capital gains taxes is less obvious, but high rates also drive up house prices. Here’s why: Taxpayers who sell homes at a profit probably won’t pay any taxes due to the $250,000 exclusion ($500,000 for married taxpayers) for gains on the sale of a home. While the President wouldn’t change this exclusion, he does support higher capital gains tax rates for wealthy households. The health bill increased those rates by 3.8 percentage points starting in 2013 and rolling back the Bush tax cuts would increase the top rate from 15 percent to 20 percent next year.
As capital gains taxes go up, so does the value of the capital gains exclusion on housing. (To put it another way, if capital gains and dividend tax rates were 100 percent, all investors would put their money in tax-favored investments like housing and municipal bonds.) Like the increase in ordinary income tax rates, a higher capital gains rate makes housing more valuable.
In recent research, I’ve found that increases in rates on both capital gains and ordinary income would boost metropolitan housing prices by between 7 and 10 percent, with larger hikes for cities on the coasts.
By contrast, the President’s proposal to limit the tax savings from itemized deductions to 28 percent would depress urban housing prices. The limitation on itemized deductions—including mortgage interest and local property taxes paid—would decrease the tax savings from homeownership, making home-owning less attractive. And with this limitation in place, the increase in ordinary income tax rates won’t affect housing prices. My model of the President’s policies suggests that—relative to current tax policy—this proposal would drive down median long-run metropolitan housing values by between 12 and 16 percent, and even more in most coastal cities.
These results come with lots of caveats, but the lessons are clear. One, limiting itemized deductions might not be the best idea while the housing market is still struggling. And two, higher tax rates might just be a much-needed shot in the arm for our anemic housing market.