For Homeowners, the Flat Tax Doesn't Add Up

Brad Sherman is a Democratic congressman who represents portions of the San Fernando Valley and Ventura County

It is said that any idea, no matter how flimsy, can take hold of American political thought if the idea is repeated often enough. It helps if the flimsy idea at least makes a pretense of addressing a real problem.

One such flimsy idea is the flat tax, popularized by billionaire Steve Forbes. When one runs for president, as Forbes did in 1996, it helps to have a clear reason as to why you are running. Forbes had one: He felt he was paying too much in taxes and that the guy who washed his car was paying too little.

Forbes proposed a flat 17% tax rate with numerous business exclusions--a tax proposal that would provide far less revenue than the current income tax.

Of course, we are all in favor of lower taxes, and any new tax system at a low revenue rate appears more attractive than the current taxes at a higher rate. However, to balance the budget under a flat tax with extensive exclusions, we have to drastically slash federal spending, a subject outside the scope of this article. In determining which tax system is most painless, we must compare rival systems that produce the same amount of revenue.

There are real problems with the federal income tax: It is too complicated and the Internal Revenue Service is too intrusive. In fact, there are a number of proposals being considered that would change the manner in which the government collects taxes. Some look at ways to improve the existing system, while others would rewrite that system entirely.

Among the latter is a flat tax plan proposed by House Majority Leader Dick Armey (R-Texas) and based on the Forbes model.

The flat tax solves Forbes' problem--shifting the tax burden from billionaires like himself to working families--but does little to simplify tax law or reduce the compliance burden. Under the flat tax, taxpayers would still have to compute their taxable income. Those who carry on their own businesses would still have to report gross revenues and then deduct the cost of goods sold, advertising and administrative costs, depreciation, etc.

Currently, after computing taxable income, the taxpayer needs to look at a chart to see how much tax is imposed on that amount of income under our progressive income tax. It takes hours or days to compute taxable income and then it takes about 30 seconds to look at the chart to determine the tax applicable to that income.

Under the flat tax, you would still compute taxable income but you would save the 30 seconds it takes to look at the tax chart--and Forbes would save about $30 million. Moreover, the IRS would still audit that gross revenue and those business expense deductions.

Forbes offers rhetoric but not a single suggested action for controlling the IRS.

Simplifying the income tax is a painstaking process. We need to simplify the tax code section by section. Although I do not sit on the Ways and Means Committee, I am working to simplify some aspects of our tax code such as removing the incentive stock option from the alternative minimum tax and providing the same estate tax exclusions to couples who do not hire an attorney to write a 50 page bypass trust as is currently enjoyed by those who do have complex estate-planning documents.

In evaluating the flat tax, I focus on the people I represent in the western San Fernando Valley and the Conejo Valley, areas where home prices are more than double the national average. We in the West Valley and the Conejo have a lot at stake in preserving the deduction for home mortgage expenses and property taxes.

Under the flat tax, business expenses still would be deductible but personal deductions--such as those for home mortgage interest and property taxes--would be abolished. A thorough economic study commissioned by the California Realtors Assn. demonstrated that such a flat tax would reduce California home values by 25%--and by an even greater percentage in the West Valley and the Conejo, where home values exceed even the California state average.

The study shows that while California's homes would decline in value by 25%, homes nationwide would decline by only 15%. The median home value nationally is $127,000 and so the average American homeowner would loose 15% of that amount, $19,050. The median home price in the communities I represent is $307,300, and the loss in value would exceed 25% of that value, $46,095.

When a buyer goes to a Realtor in search of a home, the first step is often to review the cost of paying property taxes and mortgage payments on homes of various values to determine what price home the buyer can afford. Such costs should be computed on an after-tax basis.

Normally, a home buyer spending $1,500 on property taxes and home mortgage payments is actually paying less than $1,000 per month, after the tax benefit is figured in. The degree of savings is even greater for the better-off taxpayer, perhaps making payments of $3,000 per month with an after-tax cost of well below $2,000 per month.

What if you have lived in your home for 30 years, have paid off the mortgage and enjoy low property taxes under Proposition 13? You may not benefit today from the home mortgage and property tax deductions. But whoever buys your home will make hefty mortgage payments and pay property taxes based on the value of the home at the time they purchase it.

Today's prospective purchaser is willing to make payments of $3,000 per month, because the after-tax cost is less than $2,000 per month. Under the flat tax, with no tax deductions, the same purchaser is willing to pay $2,000 per month, which translates into a one-third reduction in the purchase price for your home.

Even if you never own a home, the home mortgage deduction is critical to the economy of the Valley and the Conejo. If every homeowner in the Valley saw their home decline in value by 25% or more, Topanga Plaza would be a ghost town. How many high-tech businesses of the future were formed when a daring entrepreneur mortgaged his or her home? How many people are planning to retire based on the value of their home? In the Valley and the Conejo, most people have most of their wealth tied up in the value of their home. If home values drop by a quarter to a third, our communities would suffer from top to bottom.

Keep in mind that we are not talking about a 25% decline in the homeowners' equity, but a decline of 25% of the value of the home.

Imagine a home worth $400,000 and subject to a $300,000 mortgage. A 25% decline means the home's value drops to $300,000, and the homeowners see their equity drop to zero. Do you think they will be out shopping for a car the next day? It is no accident that the Realtors' associaton is fighting so hard against the flat tax. It is not because Realtors enjoy filling out tax forms. It is not because the Realtors' association is dominated by flaming liberals dedicated to income redistribution. Many Realtors really would not mind if Forbes saved $30 million or even $300 million on his taxes.

Realtors have a direct interest: If California home values decline 25%, no one will sell. And if home values decline by 25% in the 24th Congressional District, it is probably not real good for my career either--especially if the decline results from an action taken by the federal government. When it comes to home values, the adoption of a flat tax would make the Northridge earthquake look like a mere 3.3 tremor.

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