FairTax Treatment of Renting versus Home Buying

This morning my inbox had a well thought out and written email with some concerns about how the FairTax will affect low-income renters. There is still a lot about this facet of the FairTax proposal that I need to learn, but read on for my initial stab at responding to the concerns:

I earn about $15,000 per year and have no hope of owning a home. (I cannot conceive of any economic scenario under which I can buy a home.) In this context, I look at proposed legislation with an eye toward how I, as a renter- for-life, would be affected, and the FairTax troubles me.

I see the FairTax as imposing a large and explicit tax penalty on those unable to buy a home. First, renters pay more for housing (median monthly payment) than do homeowners, even though they "consume" much less housing. (At my previous address, I paid more to rent a small upstairs apartment than my next door neighbor Bob paid to own a 2BR home: did I consume more housing than Bob?) Second, rent is fully taxed, including components (such as embedded property taxes and the principal reduction afforded by the rent payment) not taxed when a homeowner pays them. Third, property tax rates are higher on rental prop than on owner-occ primary residences in many states - here, the FairTax would represent a tax on top of a tax on top of a tax. Fourth, renters would also face a stiff tax penalty whenever they pay interest, since renters generally face much higher interest rates than do homeowners (think 18% credit card vs 6% mortgage or HELOC). Since cost reductions historically have not translated to rent reductions, e.g. California's Proposition 13 - (as an economist might say, rents are 'sticky') - I do not expect a rent reduction under the FairTax.

Because at least a substantial portion of a homeowner's housing payment will be exempt from FairTax, it will be possible for a homeowner to spend more and consume more than a renter, while paying less tax. How, exactly, is this Fair?

My response:

Thank you for posing your concerns and questions to me. I am a big fan of the FairTax, however, I am not an expert. I want to say up front, that I do not have all the answers.

That being said let me address your concerns as best as I can. Let me start with some bullet point gut reactions to my first reading of your email.

  • Renting currently is at a disadvantage with regards to taxation. For whatever reason, when I was renting (I was a renter for 3 years before I bought my current home), I could not deduct the interest on the mortgage that my landlord was carrying and paying with my rent. Nor could I deduct the portion of property taxes that my rent was covering.

  • Renting is a lot cheaper. When you look at the total cost of ownership it definitely is cheaper. When I rented, I didn't have to mow my yard, didn't have the fix the plumbing, make repairs from storms, and other general maintenance items that I am CONSTANTLY spending money on now that I owning, instead of renting, property. In addition, my utilities are quite a bit more (I doubled my square footage when I moved into my house from the apartment, however, the utilities tripled).

  • Renting is a choice, not a requirement. Whatever money one is paying in rent now, could go towards a mortgage payment. I finally quit renting myself because I got sick of my landlord getting the breaks on taxes and being the one building equity in property with my money. In fact, my monthly mortgage payment is higher than my rent payment -- and it stays the same every year because I got a fixed mortgage. My rents would go up yearly.

  • Prebate checks are sent to everyone with a social security number and these checks will cover the cost of a month's worth of necessities for a given family size. Therefore, the FairTax is the ONLY tax reform proposal that totally eliminates the tax burden on the poor.

  • As far as interest rates go, I don't use credit cards or HELOC. I am in the process of paying off my one car loan and then attacking my mortgage to be debt free. Debt helps no one, especially the poor.

  • Since the costs of owning a home (e.g. all the maintenance stuff mentioned above) is much higher than the renter (virtually zero maintenance costs), the taxes on those costs will only be paid and felt by the homeowner and not the renter. I don't know numbers and figures to draw comparison, but while on one hand you make the claim that the homeowner is getting all the tax benefits under the FairTax plan, I see this as a huge taxable burden that the homeowner faces that the renter is free from.

I have noticed your posts on other FairTax blogs and forums that are very similar to the concerns outlined here. I hope that I helped to address some of your concerns. If you still have disagreements or questions, please do not hesitate to let me know.

Patrick

This was cross posted at The FairTax Blog.

A couple additional thoughts:

  • The landlord's spending on maintenance items will incur sales tax which would rightfully be collected either in the form of higher rent, or in collecting the renter's portion of that tax. This is something that definately needs to be dealt with properly to make sure that all is equitable.

  • The rent that is paid under the current system has built in costs passed on to the renter to account for the corporate income tax that the landlord pays on the rental income he/she receives from the renter. This would go away with the FairTax thus lowering the cost of rent.

[UPDATE 9/26] I received these notes the other day in reference to this post and I thought it would be useful to add for others to read.

As a landlord, I would expect to get enough rent to cover my expenses. If my expenses include income tax, my renter will pay that tax for me. If that expense goes away, I will either make more money on the unit or I can reduce the rent. Probably not the later. However, I would probably not raise the rent as soon as I would have had the income tax continued.

Not only will the landlord not pay income taxes on his profits from renting, he will probably be able to get a lower rate mortgage on the property and thus save even more. Again, the renter may not see a drop but it may prevent an increase from happening as soon. It all depends on what other landlords are doing. Unless there is a shortage of rental units, a landlord must compete for renters. If there is a shortage of rental units, new unit can be built under the FairTax for less money than under the present tax. Lower construction costs may not be passed on to the renter but again it depends on the competition.

From the renter's angle. Let's say that he pays 15% in payroll taxes and 10% income tax. To pay $75 rent, he must earn $100. Under the FairTax he will earn $100 and receive $100. His rent is still $75 but now has the sales tax (29.9% exclusive) added. 1.299 x $75 = $97.425. However, at $15,000 annual income, most if not all of that sales tax would have been prepaid and is not money out of the renter's pocket. To look at it another way, he now has to work x hours to get $75. After the FairTax is law, he will get $100 for the same number of hours. That is one-third more money to spend. Apply that extra money to a credit card and get out from under the interest a whole lot faster.

Will the home owner do even better? Maybe but does that matter? A person who buys second hand goods and raises most of their own food will do better than the someone spending a million dollars a year. If both the poor and the wealthy are better off, who lost?

- Richard

Richard wish to remain anonymous so I have removed his email address and last name from this post. However, I thought it worthwhile to include the viewpoint of a landlord on this topic.