WASHINGTON, November 27, 2012 – Again, there’s not much to say about this morning’s markets. Everything is in a holding pattern awaiting the outcomes of minor matters like Greece and the Euro-mess (allegedly “solved” once again), America’s “fiscal cliff” (genuinely scary, at least to the ten citizens or so who are still paying attention), and the 64-Year’s War (dating from 1948 and counting) that may yet achieve its diamond jubilee year over in the Middle East if the players don’t incinerate the planet first.
Front and center today, however, is that fiscal cliff, as one must attend to one’s home fires before starting conflagrations elsewhere, fiscal or otherwise. The latest hot idea in Congress for raising revenue is to slash the tax deduction for mortgage interest. But for exactly whom? Nobody is saying, but it’s probably you and me, so don’t say you weren’t warned.
The attack on the mortgage home interest deduction
Initially included in Simpson-Bowles, messing around with the mortgage interest deduction is not necessarily a bad idea. But the way in which it’s executed just might be. A little history:
Back in the day when the Maven was still a registered representative (i.e., a stockbroker), he was able to offer retail clients the range of stocks, bonds, and options investments/trades. But in addition, he could also market any number of tax-sheltered, closely held limited partnerships. Sold in units, these creatures were interesting vehicles, allowing the average investor to participate in large real-estate developments (apartments, office buildings and the like), oil drilling partnerships, cable TV franchises (the now absorbed Jones Intercable was one), and even B-grade motion pictures.
The appeal of these investments to a certain class of retail investor was obvious. First, they were sold in relatively bite-sized units, usually multiples of $5,000. Second, they offered immediate and generous tax writeoffs based largely on initial depreciation. Third, if they were successful over a 5-10 year period, they could start throwing off some decent income.
The downside: since these were private placements, units were quite illiquid, so you had to plan on not receiving money back for years. And, of course, success was never guaranteed.
Most retail investors who purchased such vehicles were initially in it for the tax writeoffs and didn’t need current income. Individual tax rates were higher back in those days (the early 1980s), and such deductions noticeably increased take home pay for investors in the higher tax brackets—middle-middle to upper-middle class individuals for the most part. Therefore, the likelihood of some eventual real losses was of considerably less importance than it would have been to investors in lower income brackets.
But alas, all good things must inevitably come to an end, particularly when they give middle-class taxpayers the same kinds of tax advantages generally only available to the genuinely wealthy. The Reagan Era tax reforms, while cutting marginal tax rates, also virtually eliminated the ability of the middle-class to invest in these tax-sheltered investment vehicles, in exchange for future budget cuts that the Democrats magically never allowed to happen.
Thus, Reagan did win half the battle (cuts in marginal rates plus the indexing of taxation to the rate of inflation); but he effectively lost the war, as Congress continued to bolster government giveaways while creating new ones as well. As a result, the middle-class was largely left with only one remaining choice when it came to coming up with a tax break: the mortgage interest deduction.
Over the years since then, it’s not difficult to see why real estate became the effective lynchpin of the American economy. Not only was the ideal of home ownership already well-ingrained in the American psyche. It was also the only way to acquire a capital investment and get a big tax deduction at the same time. There was no limit on the deductibility of mortgage interest on Form 1040, so this encouraged better-off middle-class and upper-class homebuyers to buy bigger and more extravagant houses, the better to increase the writeoff.
Additionally, this enabled the average middle-middle and above homeowner to acquire a deductible second, or vacation home, plus gain a certain amount of deductibility for second mortgages on these properties under certain easy-to-fulfill conditions.
At the present time, given the current economic mess, the mortgage interest deduction as it currently stands is the last refuge of the middle-middle and upper-middle class taxpayer desirous of avoiding current and future Federal tax increases. And now Congress, always lustful after more revenue, is eager to scoop up this potential tax windfall as well. Proposals are currently being floated that would max out the home interest tax deduction beyond a certain yet-to-be-designated point; that point to be determined by either the actual amount of interest paid or by the income level of the individual involved. There is additional talk of eliminating the deduction of interest on second homes as well as interest on second trusts. It’s all on the table. And we’re not sure how many of the intended victims of this gigantic middle-class tax increase are even aware of it.
The Maven issues a warning to the middle class
The Maven has always thought that allowing unlimited deductibility of home mortgage interest has, over the years, led to foolishly extravagant overbuilding of McMansions and infill dwellings that have blighted town and country alike. Tax policy is, after all, first and foremost a tool for social engineering, and like any such tool, folks will take advantage of it far beyond its original intent should they have the means to do so.
But aside from this, any elimination of deductions in this sector will likely result in real pain for middle-class taxpayers, slashing their last generally available deduction while likely leaving the huge deductions for the Warren Buffetts of the world entirely intact. Thus again will the rich grow richer and the poor grow poorer—and more numerous as middle-class taxpayers are relentlessly pushed down the economic ladder rather than up.
Any mortgage interest limitation that’s enacted will likely need to be paired with equal and opposite reductions in Federal spending. But this is a sticky wicket, too. Just as the Democrats in the Reagan Era gamed the Reagan tax cuts by “promising” budget cuts in the out years, that’s what we’ll see again if the mortgage interest deduction is put on the phase-out road. Any Republican who doesn’t insist on immediate offsetting budget cuts for any of this deserve to be defeated in 2014.
Out-year budget cuts, which never happen, are a classic leftist game with a historically provable long-term conclusion. Anyone who falls for this again, no matter what kind of intimidation, slanders, and outright thuggery is brought to bear against them by this Administration’s Chicago Gang, deserves to be removed from Congress.
The time for stopping this kind of blanket tax-increase-for-the-middle-class is now. The wealthy and the poor are clearly waging economic warfare on the shrinking middle-class in this country. It’s time for those in the middle-class who yet remain to wake from their collective slumber and fight in favor of keeping this key mortgage interest tax deduction, at least for themselves, lest they, like Joe Sixpack, be consigned forever to the ash-heap of history just like anyone else who stands in the way of the Federal tax juggernaut.
The wealthy will still get to keep all their toys. Why should we let them have ours, too.
All this will have a profound effect on the markets in the weeks and months ahead, so keep your powder dry.
Disclaimer: The author of this column maintains several active trading and investment portfolios and owns residential and investment real estate. He is currently long IAU, SLV, MCP, and bits and pieces of Schwab ETFs as the occasion may warrant; and continues to hold medium term corporate and municipal bonds.
Positions mentioned above describe this author’s own investment decisions and should not be construed as either buy or sell recommendations. The current market is highly treacherous and all investors travel at their own risk, so caution should be exercised at all times.
Illustrations, charts, commentary, and analysis are only the author’s view of current or historical market activity and don’t constitute a recommendation to buy or sell any security or contract. Views, indications, and analysis aren’t necessarily predictive of any future market or government action. Rather they indicate the author’s opinion as to a range of possibilities that may occur going forward.
References to other reporters, analysts, pundits, or commentators are illustrative only and do not necessarily represent an endorsement of such individuals’ points of view. If specific investment vehicles are mentioned in any article under this column heading, the author will always fully disclose any active or contemplated investments in said vehicles.
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