Mortgages

For most homeowners, their mortgage payment is their largest single expense.  Housing prices in most coastal states are rising far faster than wages.  Low interest rates allowed buyers to borrow more than they'd been able to borrow at higher rates — and the beneficiaries were not the buyers, but rather the sellers (who had a monopoly good to offer — a home in a certain location — and could leave town with a windfall which would support them in comfort in a less desirable part of the country), the real estate brokers (who collected 6% of a higher transaction amount) and the mortgage lenders.

Further, with the value of coastal-state properties rising, those who owned those properties could borrow at low interest rates against the land equity, allowing them to spend money their work hadn't earned.  Meanwhile, those in middle America and those without valuable land equity are relegated to payday loans and credit card borrowing, which takes a terrible toll on their lives, if they find that their expenses exceed their wages.

When one buys a home, one agrees to a price with the seller, then seeks a mortgage lender to pay them the portion of the purchase price one doesn't have in hand. At one time, a 20% down payment was typical, and some people tend to think in terms of buying the land "outright" and using a mortgage for the house itself. But today, with the exception of new houses on the fringe, a residential property is likely to be at least 50% land value if it is in one of the major metropolitan areas, and in some, more like 75% land value. [See the 2006 Federal Reserve Board study on the Price of Residential Land.] So one is borrowing a significant portion of the value of the land.

Should the mortgage lenders get the interest on the land value, or should we use the capitalized value of the land to finance our common spending? That is the question. We can guess what the mortgage lenders think. What do you think? Which is better for our children? Which is better for a society dedicated to the proposition that all men are created equal, that none should be subject to others, that none should be privileged to privatize what we all together create?

Michael Hudson and Kris Feder: Real Estate and the Capital Gains Debate

1 Introduction THE CAPITAL GAINS CONTROVERSY | WHAT IS MISSING FROM THE CAPITAL GAINS DEBATE?
2 Depreciation and Capital Gains
3 How Mortgage Debt Converts Rent into Interest
4 Capital Gains Taxation in Real Estate
5 Government Statistics on Real Estate Asset Gains
6 The Political Context of Real Estate Taxation
7 Policy Conclusions
DO NOT REDUCE CAPITAL GAINS TAXES ON BUILDINGS.
DO NOT PERMIT BUILDINGS TO BE DEPRECIATED MORE THAN ONCE
DO NOT REDUCE CAPITAL GAINS TAXES ON LAND
IMPROVE THE QUALITY OF STATISTICS AND REFORM NIPA ACCOUNTING PRACTICES
... very little of real estate cash flow is taxable as ordinary income, so the capital gains tax is currently the only major federal levy paid by the real estate industry. CCAs and tax-deductible mortgage interest payments combine to exempt most of real estate cash flow from the income tax. This encourages debt pyramiding as it throws the burden of public finance onto other taxpayers. ...

Our second major conclusion is that, at least until re-depreciation of second-hand buildings is disallowed, a capital gains tax cut would be unlikely to stimulate much new investment and employment from its largest beneficiary, the real estate industry. Depreciation allowances and mortgage interest absorb so much of the ongoing cash flow as to leave little taxable income. Mortgage interest payments, which now consume the lion’s share of cash flow, are tax-deductible, while CCAs offset much of what remains of rental income. On an industry-wide basis, in fact, NIPA statistics reveal that depreciation offsets more than the total reported income. As Charts 2a, 2b, and 2c illustrate, real estate corporations and partnerships have recently reported net losses year after year. ...

How Mortgage Debt Converts Rent into Interest

Depreciation rules are not the only reason why the real estate sector declares little taxable income. Out of their gross rental income, landlords pay state and local property taxes, a tiny modicum of income tax, and interest on their mortgage debt. A large proportion of cash flow is turned over to lenders as mortgage payments. Since the early 1970s, interest paid by the real estate industry has been much larger than the figures reported for net rental income. As Charts 3a, 3b, 3c, and 3d illustrate, real estate investors and homeowners have become the financial sector’s prime customers. According to the Federal Reserve Board, 1994 mortgage debt of $4.3 trillion represented some 46 percent of the economy's $9.3 trillion private nonfinancial debt, and a third of the total $12.8 trillion U.S. debt.27 NIPA statistics indicate that about 70 percent of loans to business borrowers currently are made to the real estate sector, making it the major absorber of savings and payer of interest.

Most cash flow now ends up neither with developers nor with the tax authorities, but as interest paid to banks, insurance companies and other mortgage lenders. In fact, mortgage interest now absorbs seven percent of national income, up from just one percent in the late 1940s. In 1993 (the most recent year for which NIPA statistics are available) the real estate sector generated some $326 billion in interest payments, more than it contributed in income taxes and state and local property taxes together. Meanwhile, over the past half century, net declarable income plus capital consumption allowances and property taxes have been cut in half as a proportion of national income, from over ten percent to less than five percent. Thus interest is the real estate industry’s major cost, and as such, has helped to minimize the real estate industry’s income tax liability.

One effect of favorable depreciation and capital gains tax treatment is to spur debt pyramiding for the real estate industry. The tax structure provides a distortionary incentive for real estate holders to borrow excessively, converting rental income into a nontaxable mortgage interest cost while waiting for capital gains to accrue. This, alongside financial deregulation of the nation’s S&Ls, was a major factor in the over-building spree of the 80's.

Sometimes, of course, no capital gains accrue. In some highly conspicuous cases, landlords have walked away from their properties, leaving their mortgage lenders holding the bag. This is what led to the $500 billion FSLIC bailout by the Reconstruction Finance Corporation. Many smaller real estate parcels likewise were abandoned in central city areas from New York to Los Angeles. Indeed, this process was part of an international phenomenon, extending from Canary Wharf in London to Tokyo’s Bubble Economy of 1985-1980. Nevertheless, holding onto properties by paying off their mortgage loans is made easier by favorable tax treatment. Indeed, nominal tax losses during 1984-91 enabled building investors not only to earn a rising cash flow, but to gain tax credits to shelter their otherwise taxable income earned in other sectors.

Real estate is pledged to mortgage lenders as collateral in case the promised interest payments fail to materialize. Capital gains have been collateralized into new and larger loans decade after decade, increasing the mortgage burden that transforms rental income and depreciation allowances into interest payments. Ultimately, the financial rentiers end up with most of the cash flow which landlords -- and government tax collectors -- relinquish.

Tax-deductibility of mortgage costs does not impair government revenues if mortgage lenders pay taxes on their interest income. Moreover, lenders may be able to shift part of the tax burden to borrowers by charging higher interest rates.29 Actually, however, much interest income manages to avoid taxation, such as that of banks adding to their loss coverage funds (or otherwise offsetting their income) or individuals with tax shelters. The insurance and financial industries have long obtained virtual tax exemption for their income. ...Read the whole article

Alanna Hartzok: Earth Rights Democracy: Public Finance based on Early Christian Teachings

Enormous sums are currently accruing as unearned income to a relatively few individuals, families and corporations who are holding large amounts of land, very valuable and well-located land, and natural resources as their own exclusive private property. These enormous land values and resource rents are also accruing as unearned income to banks holding mortgages based on exploitative compound interest rates. It may be of interest to note that the word "mortgage" means "dead hand." Truly, when one must work so many years of one's life to pay off a mortgage, one productive hand is as if dead in terms of producing for oneself, as the labor of that hand pays the mortgage. For the 33% of citizens (40 million people) in the United States who are renters, there is not even equity ownership to look forward to after a life of labor. For the more than three million homeless people in American and the multi-millions who are homeless around the world, what Henry George said in 1879 holds true today:

Our primary social adjustment is a denial of justice. In allowing one man to own the land on which and from which other men must live, we have made them his bondsmen in a degree which increases as material progress goes on.[19]

Not only is the land ethic of Old and New Testament prophets and Henry George virtually the same, the policy approach of "resource rent for revenue" also known as "land or site value taxation" has its corollary in the approach called for by the ancient rabbis in their discussions about the finer and little known details of Jubilee....   Read the whole article

  Louis Post: Outlines of Louis F. Post's Lectures, with Illustrative Notes and Charts (1894) — Appendix: FAQ

Q14. How would you adjust mortgages to the single tax scheme?
A. Mortgages are modified deeds, and mortgageors are landowners in degree. I would make no adjustment, but would warn mortgageors and mortgagees to adjust their interests as they see fit when they make their mortgages, just as I would warn buyers and sellers of land to guard their interests as between themselves by their contracts. Full notice has now been given that as soon as possible and as fast as possible we propose to induce the people to bring about a condition in which land values will be taken for public use and improvement values be left for private use. People who in the face of this notice neglect to protect themselves in their contracts have no one else to blame if when the change comes they suffer pecuniary loss in the re-adjustment.

... read the book