February will likely be remembered in our industry for a seismic
response to the Obama administration’s launch of a campaign to generate support
for regulations governing fiduciary behavior in the advising of retirement
savers. We certainly have our own
thoughts on the matter, as we have expressed in the past and most likely will
again.
For that reason, some may have overlooked the release by the
Congressional Research Service (CRS) of a report on the largest individual
income tax breaks for fiscal year 2015, which CRS has historically described as
“tax costs.” This is something the CRS
has been doing for many, many years, but it is especially relevant at a time
when those in Congress and in commerce have their eyes on possible major tax
reform. There is virtually no way to
substantially lower individual and corporate tax rates without cutting into
some of these tax provisions that now save citizens billions in federal taxes
each year. “Cutting into,” in plain
terms, could potentially mean reducing the benefits of some – or all – of these
and other individual tax breaks.
The lineup in this top-five roster of so-called tax costs is
projected to be as follows for the 2015 fiscal year: 1) home mortgage interest deduction, $74.8
billion; 2) state and local tax deduction, $59.2 billion; 3) charitable giving
deduction, $45.6 billion; 4) state and local real estate tax deduction, $34
billion; and 5) retirement savings deduction, $18.3 billion.
It is a bit like stepping through a mine field to make comparative
judgments about the value or importance of federally-delivered benefits,
whether it is an entitlement like a social welfare program, or a tax break like
a deduction for a Traditional IRA contribution.
Each has its advocates, and credible arguments can be made for many of
these benefits. Favoring one while
questioning another exposes a person to accusations of partisanship. But it’s part of our responsibility as
citizens to make value judgments, and grapple with issues where there may not
be answers written in black or white, or answers that will be universally
popular.
It is not my intention to step on any toes, but I do happen to feel that there
are differences in the relative importance to our society of some of these tax
benefits. Differences, too, in which
actually result in a loss of tax revenue.
One of the true “sacred cows” in American tax law is the home mortgage
interest deduction for one’s principal residence. We are generally allowed to reduce our
taxable income by this amount of interest paid when we file our individual
income tax returns. This is especially beneficial
in the early years of home mortgage payments, when a high proportion of that
payment represents interest, and a much lesser proportion represents
principal.
Many, if not most, Americans grow up with the admirable goal and expectation of
owning a home. For some, the tax benefit
of a mortgage interest deduction might
be a deal-breaker when it comes to when – or whether – they will become home owners. To date though, I haven't seen anything that would show that this would be
the case for a majority of citizens. Certainly
the housing industry, and the associated professions of real estate broker,
mortgage banker, contractor, insurance provider and numerous others, benefit from
robust activity in home buying.
But are tax incentives that make home ownership easier for an
increment of Americans more important than preparing us for security in retirement?
A value judgment to be sure but one that at some point will likely have to be made. The annual “tax cost” estimated by CRS for
home mortgage interest deductions is four times the estimated cost in lost
revenue as a result of IRA deductions and contributions to employers’
retirement plans. Furthermore, citizens who
reduce their taxable income via the home mortgage interest deduction do not pay
this tax benefit back to the U.S. Treasury at some future time. Contrast this with deductible IRA contributions and pre-tax
amounts deferred into 401(k) plans which are eventually taxed when a retiree
withdraws them for financial support in retirement. Contrary to the way these retirement benefits
are often characterized, they are not a permanent “cost” to the federal tax
revenue stream. Again, I do not mean to imply this tax benefit does not serve a valuable benefit but rather want to point out that comparing this to retirement benefits, is not an apples to apples comparison.
Next after the home mortgage interest deduction as a tax
cost are deductions for state and local non-business taxes paid. This amount is three times the so-called
annual tax cost for retirement contributions, and is never recovered. Charitable giving comes next on CRS’s list,
and is almost two-and-one-half times the retirement number. I have no quarrel with the importance to our
society of tax incentives for charitable giving and in fact strongly believe they serve an important purpose. But perhaps we should not impede the average
American’s ability to provide for their own security in retirement – helping to
insulate them from the need to rely on social programs – by reducing their tax
incentives for saving, in order to deliver maximum tax benefits for charitable
giving.
The same can be said for CRS’s #4 cost, from deductions for
state and local real estate taxes paid.
This is twice as large as the price tag for retirement saving incentives. Like the others, it too is a permanent tax loss,
whereas most retirement saving pours back its tax “cost” when amounts are taken
from these savings arrangements and included in income.
The administration’s fiduciary campaign cited at the start
of this blog has been criticized for a lack of perspective. Perspective is also needed when lawmakers
consider the relationship between an imagined cost of retirement tax benefits,
and the real and painful costs of having a retiree population unprepared for
that stage of life. 