Did Tax Reform Raise the Cost of Owning a Home?

There is some fascinating analysis just released by the New York Federal Reserve Bank (by economists Sonia Gilbukh, Andrew Haughwout, Rebecca Landau, and Joseph Tracy) that shows how President Trump's tax reform has raised the cost of owning a home in high tax states.

First, the economists set the scene:

Effective starting in 2018, the TCJA [the Tax Cut and Jobs Act of 2017 ] substantially increased the standard deduction. For married couples filing jointly, the standard deduction increased to $24,000, almost double the $12,700 figure of the year before. For individuals and heads of households, the deduction increased to $12,000 and $18,000, respectively. For many taxpayers who itemized in the past, taking the standard deduction has become more attractive.

For taxpayers who itemize, the TCJA also limits the deductibility of state and local taxes (SALT) as well as mortgage interest. SALT deductions, previously uncapped, are now limited to $10,000, and the ceiling on mortgage interest deductions was lowered from $1 million to $750,000. These changes interact with a large reduction in the Alternative Minimum Tax in complex ways that make the effect of the law difficult to analyze.

Because of the limits on deductibility and the increase in the standard deduction, many tax filers will no longer itemize their deductions. The Brookings-Urban Tax Policy Center estimates that the increase in the standard deduction will induce a decline of more than 50 percent in the number of itemizers, with many either moving to take advantage of the increased standard deduction or rethinking itemizing because of the caps on SALT and mortgage interest.

Then they do some calculations:

To understand the way these tax changes affect the relationship between rents and prices, we adopt the standard user cost framework that reflects the opportunity costs of owning a home. From the user cost expression defined in the previous post, the price-to-rent (P/R) ratio is a measure of the (inverse) user cost. 

To examine whether any effect of the TCJA is detectable in the data, we calculate P/R ratios using property-level data from the Multiple Listing Service (MLS); we obtain these data from CoreLogic. Our idea is to create unit-level price-to-rent ratios by estimating, for each owner-occupied unit that sold in a particular place in a particular year, what that same property would have rented for in that time and place. 

The result:

In the...chart, we categorize states by tax regime, with high-tax states defined as the top ten in terms of total taxes collected per capita. We then compare the P/R ratios in high-itemization areas of high-tax states with those in low-tax states...  

Our high-tax states include California, Connecticut, Massachusetts, Minnesota, New Jersey, and New York. The other high tax states—Vermont, Rhode Island, Maryland, Washington D.C., Illinois, and Oregon—are not represented in our MLS data. 

 P/R ratios are generally higher in high-tax, high-itemization areas, but that difference has been declining since April 2018.

The preliminary conclusion:

Overall, the country has seen a narrowing in P/R ratios between high- and low-tax states since the tax changes that started taking effect at the beginning of 2018. In level terms, the ratios in high-tax, high-itemization areas have stopped moving higher while the ratios in the rest of the country have continued to rise. We will continue to monitor these trends in P/R ratios for further insight into housing market dynamics during 2019. 

-RW