Will tax reform sink the housing recovery?

Tuesday, January 02, 2018 from Floor Covering Weekly

By Kermit Baker

Without a doubt, the 2017 Tax Cuts and Jobs Act (tax bill) will dramatically transform the U.S. economy for many years to come. What’s unclear is how the economy will be transformed, particularly for industries related to the construction sector. Reshaping the construction sector, after all, was not one of the key objectives of the legislation. Regardless, construction decisions will certainly be affected by these changes. For nonresidential building activity — commercial, industrial, and institutional facilities — we can expect that changes ultimately will be quite favorable on net. Lowering corporate tax rates will provide incentives for businesses to invest, and investing in structures is one of the expected outcomes.

Owner-occupied housing, in contrast, will likely land on the other side of the gain/loss ledger. Several of the tax preferences for homeownership specifically, and for housing investment generally, will be reduced or disappear under the tax bill, and this is coming at a critical time in terms of the elusive recovery in the single-family construction market. The overall result is likely to be a modest reduction in the demand for homeownership, some downward pressure on house prices, fewer tax preferences for undertaking home improvement projects, and less overall home building activity as compared to what we would have expected prior to tax reform. While the tax bill is unlikely to sink this housing recovery, it certainly looks to be at least a speed bump.

Several provisions in and expected results from the tax bill are of concern for the housing outlook:

Reduced preferences for homeownership
Moving forward, the maximum amount of mortgage interest that can be deducted by future homebuyers will be reduced, thereby limiting the value of this tax preference for high-end owners. Additionally, a cap is set on the deduction of local property tax payments. Since the standard deduction is increased for all households, the benefit of deducting mortgage interest payments and local property taxes is reduced for many, meaning than fewer owners will be advantaged by from these deductions. With owning and renting being equivalent from a tax perspective for most households, the net result is that is that fewer households will decide to own their home.

Reduction in benefits for home improvement investments
Interest payments on home equity loans will no longer be deductible expenses for federal income taxes. Surveys have shown that home improvements are the most popular use of home equity loans, so financing home improvements will become costlier with the tax bill.

Higher federal debt levels and resulting higher mortgage rates
The tax reform package is projected to add almost a trillion dollars to the federal debt over the coming decade. Higher levels of debt means increased federal borrowing, which will cause interest rates to rise more than they would without this additional debt. Higher borrowing costs will mean that purchasers will buy less housing, thereby decreasing construction levels.

Independent analysis suggests that the reduction in preferences for homeownership will modestly reduce home prices nationally compared to prior federal income tax provisions. Realistically, the national homeownership rate is unlikely to fall very much as a result of the tax bill, which may not be that comforting since the homeownership rate is almost six percentage points below its precession high and near its lowest level of the past 50 years. Critically, though, these concerns regarding the housing outlook will be felt differentially across the country, as areas with higher house prices and higher household incomes will bear the brunt of these changes.

Kermit Baker is the senior research fellow for the Joint Center of Housing Studies at Harvard University. He may be reached via e-mail at [email protected]

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