(Bloomberg View)—The tax bill seemingly headed for passage in Congress is going to be terrible for real estate, according to Patrick Clark of Bloomberg News:
Even before the GOP Congress forges a compromise bill to send to President Donald Trump, House and Senate plans are unsettling housing markets, especially in high-tax, Democratic-leaning states like California, New York, New Jersey and Connecticut.
Changes to deductions for state and local taxes, property taxes, moving expenses and mortgage interest would lower home values throughout the U.S., according the National Association of Realtors.
The tax bill seemingly headed for passage in Congress is going to be great for real estate, according to Patricia Cohen and Jesse Drucker of the New York Times:
“Real estate does great,” said Daniel N. Shaviro, a professor of taxation at New York University Law School, who as a congressional staff member helped write the 1986 tax overhaul. “It’s hard to imagine what they might have asked for that they don’t have.”
Confused? A better way to put it might be that the legislation is terrible for homeowners -- at least those with expensive dwellings in the "high-tax, Democratic-leaning states" that Clark mentions -- and great for landlords. It's great for landlords mainly because they tend to do business via pass-through entities -- real estate investment trusts, partnerships, limited liability companies, S corporations and sole proprietorships -- that are set to get big tax breaks in both the House and Senate bills.
Pass-through businesses are so called because their income is passed through to the owners and subjected to individual income tax rather than taxed at the company level. It's a reasonably elegant (and Milton Friedman-endorsed) alternative to the double taxation involved in taxing both corporate income and shareholders' capital gains and dividend income. In part because effective pass-through tax rates have generally been lower than effective corporate rates, pass-throughs' share of business receipts and income in the U.S. has risen a lot over the past few decades. If you want to learn more about that, here's a column I wrote about it a few weeks ago.With a big cut in corporate tax rates the centerpiece of their plan, though, congressional Republicans wanted to make sure that most pass-through businesses got a tax cut, too. In the House bill, according to the Joint Committee on Taxation, it's a $596.6 billion tax cut over 10 years; in the Senate bill, it's a $339.7 billion cut. This will transform the current relative simplicity of pass-through taxation into a complicated, likely-to-be-gamed mess that will probably deliver its greatest benefits to very wealthy people and their accountants and tax lawyers, which I've also written about if you want to learn more about that.
But I'm trying to focus on real estate here! The Internal Revenue Service publishes regular (if not particularly timely) reports on pass-through business receipts and income broken down by, among other things, industry. And yes, I also wrote a column going into great detail on that a few weeks ago. What follows is a simplified and updated accounting that shows which industries might be getting most of that $339.7 billion-to-$596.6 billion tax cut. I arrived at it by taking the IRS data on pass-through income from 2013 (the most recent year for which data on every category of pass-through was available), subtracting out industries that will be mostly ineligible for the pass-through tax breaks because they involve the provision of services (doctors, lawyers, accountants, etc.), and calculating the industry shares of the remaining pass-through income.
These percentages are just an approximation of how the legislation's benefits will be apportioned; there are quirks in both bills and in the current treatment of some pass-through income (carried interest for private equity firms being the most obvious one) that complicate the link between net income and tax breaks. Still, it does appear that by far the biggest share of the pass-through tax break is headed straight for the real estate business, mainly owners of commercial buildings and apartments. Landlords, in other words -- including the landlord currently living rent-free in the White House, whose business interests are structured as a multitude of pass-through LLCs.The politics of this seem pretty straightforward: The Republican Party has decided to write off upper-middle-class homeowners in coastal states -- an important part of its base back in the Nixon and Reagan years, but now a mostly Democratic crowd -- and reward business owners across the country. And if real estate and financial types benefit more than any other business owners, that's just fine. The finance/insurance/real estate sector was the biggest donor to candidates for federal office during the 2015-2016 election cycle, according to the Center for Responsive Politics, with the majority of its spending going to Republicans.
The economics are less clear. Some proponents of the pass-through tax break have pitched it as a way to encourage manufacturing. It seems like an awfully inefficient way to do that, especially in comparison with cutting corporate taxes, given that manufacturing makes up a far bigger share of corporate earnings than pass-through earnings. But the legislation's homeowner-vs.-landlord dynamic could have some interesting (and probably unintentional) effects. As someone who's been writing for years about the problems with too-high housing prices and too-little new construction of housing, especially higher-density housing, in and around expensive cities such as San Francisco, I have to acknowledge that they might not all be bad effects. What if this legislation actually did lower home prices in expensive, high-tax areas while encouraging the construction of rental housing? It could turn out to be the Yimby tax bill!
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Justin Fox is a Bloomberg View columnist. He was the editorial director of Harvard Business Review and wrote for Time, Fortune and American Banker. He is the author of “The Myth of the Rational Market.”
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