David R. Henderson  

Huge Marginal Tax Rates in Bush-Obama Housing Bailout

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Friedman vs. Bernanke... Windbags and Modernity...

Implicit Marginal Tax Rate Could be 131 Percent

University of Chicago economist Casey Mulligan, in his latest NBER piece, finds greater than 100 percent marginal tax rates across a large swath of the U.S. population. How so?

From his NBER piece, "Means-Tested Mortgage Modification: Homes Saved or Income Destroyed?" NBER Working Paper 15281 (gated) [un-gated is here.]

The FDIC-HASP [HASP stands for "Homeowner Affordability and Stability Plan] plan massively distorts the supply of income-earning efforts, because its mortgage modification is large and means-tested: its formula implies that an action taken by a borrower to increase his income would increase his housing payment by 31 percent of the income increment. If the affordable payment (i.e., the payment that would comprise 31 percent of income) were re-evaluated monthly, this would amount to a 31 percent marginal tax rate in each month that a modification could occur.
Standard practice determines an affordable payment based on the most recent year's income, and puts that payment in place for five years (recall the Citigroup practice cited above). Thus, a marginal dollar earned in the base year raises mortgage payment obligations by 31 cents in each of the following five years. If, say, 2009 income were used to calculate an affordable payment for the years 2010-14 and the interest rate wer zero, then the marginal tax rate would be 155 percent for 2009 (5 times the formula's 0.31 limit on the payment to income ratio) and zero thereafter. Hereafter I assume an annual interest rate of 6 percent, which means that the marginal tax rate would be 131 percent for 2009. (italics his)

In other words, if you're in the federal government's program for mortgage modification and you make an extra dollar, you pay an extra 31 cents in mortgage payment. This sounds like an extra 31-percentage-point increment to your marginal tax rate, which is bad enough. But wait; there's more. If, as he says above, that extra dollar of income this year causes you to pay 31 cents more in mortgage for the next five years, then the present value of that extra 155 cents in mortgage is, at a discount rate of 6 percent, 131 cents. Implicit marginal tax rate: 131 percent. And that's on top of a marginal tax rate that's probably (with federal, social security, Medicare, and state income taxes) about 35 to 40 percent.

And note his next three sentences:

Moreover, underwater mortgages are ubiquitous enough that FDIC-HASP mortgage modification could produce distortions that are large enough to be visible in the national employment data, or at least visible in the employment data of the worst hit states. Means-tested mortgage modification has created a massive implicit tax that is significant even from a macroeconomic perspective.

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CATEGORIES: Taxation



COMMENTS (6 to date)
Burk writes:

Shame on you for ginning up one-year data points into five years of taxes. Why not call them "death taxes" while you are at it? "Mort taxes" might be even better!

Sounds just like the illness Krugman was diagnosing in his recent NYT magazine piece. Could you folks get with the program and propose a better way to do mortgage modifications where benefits flow to all participants- holders who don't lose their shirts in foreclosure, residents who keep a roof over their heads, and the economy as a whole? My bet would be some form of conversion to rentals.

John Thacker writes:
Shame on you for ginning up one-year data points into five years of taxes.

Shame on you for not reading. It's the mortgage modification program that bases the next five years of payments on one year's income:

"Standard practice determines an affordable payment based on the most recent year's income, and puts that payment in place for five year"

The paper simply notes the obvious incentive to depress your income during the one year used to determine your next five year's payments.

ryan yin writes:

Shame on you for ginning up one-year data points into five years of taxes.

Burk, did you read the post (including the quoted bits)? Mulligan is pointing out that actual practice is to use current income to determine payments for the next 5 years; in other words, in this particular case, earning one more dollar this year would imply 31 cents of extra payments for 5 years, regardless of what future income is. So the only way to calculate accurately the marginal tax is to include all five years.

Steve writes:

Burk: Could you folks get with the program and propose a better way to do mortgage modifications...

This question comes from a paradigm that we have trouble escaping from. Burk requests that the policy experts, economists/technocrats, propose a way for mortgage modifications to work. If there are 15 different companies doing this in 15 different ways, then the public doesn't perceive that "anything's being done about it." Once the spotlight shines on an issue, people are blind to changes that don't occur as a direct result of a top-down dictate.

Hayek (someone please correct me if I am mis-characterizing his argument; I take this thought from his views on the developing world here: http://www.cato-at-liberty.org/2009/05/08/hayek-and-development/) argued that one cannot create a free system; rather, it must emerge spontaneously. Thus, proposing a "better way to do mortgage modifications" is fruitless at best if not destructive.

Russell writes:

Does not that increase in mortgage payment have some effect on how quickly the mortgage is paid off? If so, it's not a tax, but debt payment. Something very different.

aaron writes:

It would make a lot more sense for the fed to lend to people who have overvalued properties in general at a lower rate rather than through the legislative branch by means.

It makes a lot more sense to lend to people who actually generate an income than to lend to the Treasury and well connected people and institutions at a fantastically discounted rate. Until interest comes down for people in overvalued properties, things won't improve. Too much income is tied up in interest and taxes. People are tied down to contracts that are too long (never underestimate the power of herd mentality and cultural norms). People can't move.

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