Paying People to Buy; Punishing Them for Saving

buy nowToday the NCPA featured a report summary in its Daily Policy Digest on how taxing capital penalizes saving.   The report, by Alan Viard of the American Enterprise Institute, provides a clear example of how even if the tax rates on labor income and saving are the same, the saver still pays a greater effective tax rate on a dollar earned and saved than the worker who earns her dollar and spends it.

But that comparison just scratches the surface.  Not only does government penalize saving, it subsidizes consumption, especially for home purchases.  For the sake of simplicity, suppose I earn $100, taxed at 25 percent, leaving me with $75 to spend.  I go to the mall and purchase an item that is not taxed at the state and local rates for whatever reason (sales tax holiday or perhaps I live in a state with no sales tax).  No consumption subsidy here.

But suppose I spend my $75 toward the purchase of a $200,000 home.  I take out a 30-year fixed loan at 4.5 percent, and my total interest paid in the first year is $8,861 on a principal amount of $3,300.  So for the first year, every $75 in principal carries an additional $201 in interest.  But wait…that interest is tax deductible!  At a 25 percent marginal tax rate, the first year tax savings on $75 is about $29.  Thus, the buyer receives an additional $4 subsidy for the $75 spent on housing.

Some may argue that tax-deferred retirement accounts provide the same subsidy.  But the difference is that savings in those accounts are limited to an annual contribution amount for all wavers each year.  The mortgage interest deduction, on the other hand, is only limited for the highest income earners.  Because of this the subsidy has a greater impact on middle-income earners, who may be more likely to purchase more house than they can afford.

Two years ago, I published the NCPA report, How Are Baby Boomers Spending Their Money?, that detailed how today’s 45- to 64- year olds are spending their money and why many of them are ill-prepared for retirement.  Compared to the same age group 20 years ago, more of today’s pre-retirees are paying mortgages that will go well into their retirement years.   This may very well be in part due to the fact that homeownership is an overemphasized public policy goal (compared to saving), and the tax system is none to happy to help those who want to buy.

 

Comments (12)

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  1. Miguel says:

    “The report, by Alan Viard of the American Enterprise Institute, provides a clear example of how even if the tax rates on labor income and saving are the same, the saver still pays a greater effective tax rate on a dollar earned and saved than the worker who earns her dollar and spends it.”

    Exactly!

  2. Brenden says:

    “But that comparison just scratches the surface. Not only does government penalize saving, it subsidizes consumption, especially for home purchases”

    It seems as though the government is trying to create an incentive to buy things, so that people will stimulate the economy, but what the government does’t realize apparently is that saving is also necessary for economic prosperity and larger investment in business etc. create more growth then small spending.

    • Pam Villarreal says:

      That’s right. Saving reduces the cost of current and future capital,and also helps people rely less on government when times are tough or when they get into retirement years.

    • Dewaine says:

      Both of you are right on. Appropriate saving and spending (as determined by the individual) are necessary for a progressing economy. When we artificially over-emphasize one or the other we will either suffer in the present or the future. Since it is most common to for us to over-emphasize spending, we suffer in the future.

  3. Lilian says:

    “This may very well be in part due to the fact that home-ownership is an overemphasized public policy goal (compared to saving), and the tax system is none to happy to help those who want to buy.”

    This is definitely true. Just look at the 2008 economic crisis, HUD forced banks to give loans for housing to be people who could never possibly pay those loans back, and that caused (obviously) major problems for the U.S. economy.

    • Gregory says:

      How should the government help people who don’t have houses then?

      • Pam Villarreal says:

        The real question is: Should they?

      • Dewaine says:

        Economics is a delicate balance, when the government “helps” people, it comes from somebody else’s pocket. People voluntarily helping other people with housing would be a much, much more efficient (and helpful) system than government action. The only reason that we don’t see that kind of voluntary behavior taking over the market is that the government is already in that business, crowding-out private parties.

  4. Lewis Warne says:

    The government also subsidizes mortgages in other ways:

    “Fannie Mae was chartered by Congress in 1938 to support liquidity, stability, and affordability in the secondary mortgage market, where existing mortgage-related assets are purchased and sold. Our charter does not permit us to originate loans or lend money directly to consumers in the primary mortgage market.”

    http://www.fanniemae.com/portal/about-us/governance/our-charter.html

  5. Lloyd says:

    The government taxes here and taxes there………….. WE (the responsible financial minded citizens of the United States of America)know that every household needs to develop a budget, control our spending and prepare for hard times, extra expenses, and the future.

    The government needs to take note of this and do the same thing.

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