Between 1944 and 1958, adjusted gross income grew 139 percent, the amount of itemized deductions, 468 percent

The higher a taxpayer's income, the more likely is he to itemize. The percentage of taxable returns itemizing deductions in 1958 were:

Adjusted gross income under $2,500---

$2.500 to $5,000.

$5,000 to $10,000....
$10,000 to $20,000.

$20,000 and over..

Percent

The types of itemized deductions in 1958 were (by number of returns in percent of all taxable returns):

In

Taxpayers with below-average income who pay neither real estate taxes nor mortgage interest seldom have allowable deductions which exceed the 10-percent standard deduction. They rarely itemize unless they have incurred unusually heavy medical expenses, casualty losses, or capital losses. On the other hand, homeowners-unless their property is of very low value-are much more likely to itemize particularly if they carry a substantial mortgage. Homeownership reached a new record of 61 percent (of all nonfarm dwelling units) in 1958. the same year, 41 percent of all taxable returns listed taxes as an itemized deduction, 33 percent listed interest payments. This does not necessarily mean that 67 percent of all homeowners listed property taxes and 54 percent mortgage interest as deductions. Some of the income tax returns with itemized deductions came from business partnerships, some from taxpayers in high brackets who are tenants, others from farmers, etc. But it appears likely that close to one-half of all homeowners now itemize and that most of those do who own homes valued at or above average or carry a substantial mortgage. Taxpayers who do not itemize are likely to fall into one or several of these categories:

(a) Tenants, except those in higher income brackets;

(b) Owners of low-value homes;

(c) Owners of mortgage-free homes;

(d) Taxpayers with few or no deductions besides real estate taxes and mortgage interest (who can claim only minor deductions for other taxes, contributions, medical expenses, casualty losses, etc.);

(e) Taxpayers who are ignorant of the provisions of the tax law; (f) Taxpayers who find the listing of deductions too cumbersome and prefer the convenience of the standard deduction to the effort of listing itemized deductions.

Assumptions:

Value of home.

$10,000

$10,000

$16,000

Mortgage..

$16,000

$22,000

$22,000

9,000

4,000

12,000

6,000

15,000

Real estate taxes..

6,000

140

140

225

225

308

308

Property taxes.

140

140

225

225

308

Mortgage interest.

308

450

200

600

300

750

Other.

300

300

300

600

600

800

800

1 Using the optional tax table. Use of the standard deduction results in a tax liability of $247.20 or $283.20, respectively.

TABLE D-II-Comparison of deductions in illustrative examples in table D-I with deductions actually taken in 1958

(Average deductions actually taken by taxpayers who claimed these deductions in 1958)

(Average deductions of homeowners in illustrative examples in table D-I)

The benefit of nontaxability of the imputed income of their houses accrues to all homeowners who are subject to income taxes, whether or not they itemize deductions. Imputed income from owner-occupied dwellings is taxable in Great Britain, France, Germany, Austria, and, in fact, in most industrial countries with the notable exceptions of the United States and Canada."

The first permanent individual income tax in the United States, enacted by Wisconsin in 1911, taxed imputed income from 1911 to 1917. All other Federal and State income taxes in the United States omit it. Whether taxation of imputed income is constitutional under the 16th amendment has been doubtful since a 1934 decision of the U.S. Supreme Court. But the equity of taxing imputed income is apparent. Home ownership combines two distinct economic activities: (a) The ownership of usable and occupied living quarters which earn a rental income;

(b) The occupancy of living quarters which requires a personal consumption expenditure.

The Office of Business Economics in the U.S. Department of Commerce, in preparing its national economic accounts, correctly includes in the income account an estimate of the (net) rental value of owner-occupied dwellings, and among the consumption expenditures an amount for the (gross) space rental value of owneroccupied dwellings.

Let us take an example of two families, both of which have a capital of $10,000. Family A puts it into a savings and loan association and receives $400 annual interest. If its top rate bracket is 26 percent, it pays an income tax of $104 on the interest. Family B uses its capital for an equity in a home. If it rented the home to another family and lived elsewhere, it would receive taxable income from one house and incur an expenditure on another. It could not offset its rental expense against its rental income. But if the family lives in the house it owns, and, in effect, pays the rental to itself (it earns income and consumes it in the form of occupancy), it pays no tax on the rent. It saves $104 compared with the tenant family mentioned above. This places a premium on living in one's own house rather than somebody else's. Basically, it violates the principle of the tax law that personal consumption expenses are not deductible from income. Donald Marsh suggested: "The amount of imputed rent is considered equal to the amount obtainable if the property were rented to others." The space rental value of

Henry C. Simons, "Personal Income Taxation," University of Chicago Press, 1938, Dp. 112 f Helvering v. Independent Life Insurance Co., 292 U.S. 371 (1934). Donald B. Marsh, "The Taxation of Imputed Income," Political Science Quarterly. December 1943. See also: Melvin I. White, "Consistent Treatment of Items Excluded and Omitted From the Individual Income Tax Base," in Tax Revision Compendium, Committee on Ways and Means, House, 86th Cong., 1st sess., 1959, p. 317.

owner-occupied nonfarm dwellings in 1956 totaled $19.8 billion. If we assume that three-fourths of this was absorbed by expenses and that one-fourth constitutes net rent, the owners' income amounted to $5 billion. The revenue loss to the U.S. Treasury of the tax exemption of imputed income on owner-occupied dwellings may be estimated in excess of $1 billion.10

The homeowners' saving from the deductibility of real estate taxes and mortgage interest may be computed as follows:

Real estate taxes on owner-occupied dwellings in 1957 (see table L). Mortgages on 1-family owner-occupied dwellings in 1956 totaled $84,000,000,000 (National Housing Inventory) at a rate of 5 percent, interest amounted to----

Total_

Billion

$3.3

4.2

7.5

If we assume that at least half of the taxes and mortgage interest was itemized on Federal tax returns, and that most of this-if it were taxable-would be subject to rates between 20 and 30 percent, the Treasury's net loss from these deductions may be estimated at $1 billion a year."

It appears then that the combined Federal income tax advantage of homeowners approximated $2 billion in 1956-57. Their total benefits may be slightly higher because State income tax laws parallel the relevant provisions of the Internal Revenue Code. Homeowners' real property taxes totalled $3.3 billion in 1957; about two-thirds of this may be offset by income tax benefits.12

12

Some observers justify and welcome income tax benefits as an expression of a governmental policy which tries, through a variety of activities, to promote and aid the widest possible distribution of homeownership. Homeownership is regarded as desirable in itself and as an avenue toward a better and more stable citizenry. Governmental encouragement and subvention undoubtedly help accellerate the mass migration from the cities to the suburbs. This policy leaves in its wake rapidly decaying central cities, multiplies the public service needs of mushrooming new developments, and creates a virtually insoluble problem of commuter traffic between home and working place.

Some view benefits to homeowners as an indirect means of strengthening the autonomy of local governments, particularly school districts: Federal tax offset enables local authorities to impose heavier property taxes than their constituents would willingly bear if property taxes rested wholly upon owners. Others believe that there are better ways of promoting homeownership or providing local funds than the present system of income tax relief.

13

By and large, the charge of income tax discrimination against the tenant appears highly persuasive. But it could well be not as airtight or as strong as it seems. Spokesmen for the renters state correctly that landlords shift the burden of property taxes and mortgage interest to the tenant. Stephen G. Thompson in his earlier-cited article wrote: "In effect, the landlord is really only an agent or conduit for real estate taxes and interest payments." Bruce Lee Balch said: “*** the landlord can be thought of as a collecting agency for the local government. * * * Again it should be noted that a tenant must pay (mortgage interest) in the form of increased rent to his landlord, although the tenant gets no deduction." " The tenant, of course, gets no deduction for the real estate taxes and mortgage interest paid by his landlord. But the landlord does. We found earlier that the homeowner's net cost of real estate taxes is less than the amount he pays to the tax collector. Is this not equally true of the landlord? The question is: Does the landlord pass on to the tenant his

Survey of Current Business, July 1959, p. 17. The corresponding figure for 1958 is $24,000,000,000.

10 It was estimated at $1,000,000,000 or more by Louis Shere in "Federal Tax Revision To Promote Economic Growth and Stability," January 1957 Economic Report of the President, hearings before the Joint Economic Committee, 85th Cong., 1st sess.. 1957, p. 428; ilkewise by Joseph A. Pechman, in National Tax Journal, March 1957, p. 24.

11 Joseph A. Pechman (ibid.) estimated the 1956 tax loss from all personal tax and interest deductions at $2,100,000,000. It seems reasonable to assume that about half of this is accounted for by owner-occupied homes.

12 Louis Winnick (as quoted by Stephen G. Thompson in Architectural Forum, June 1958. e-timated that comparable benefits for renters would amount up to $1,000,000,000. Since the space rental value of owners is about twice that of renters, Winnick's estimate agrees with rs of $2,000,000,000 benefits for homeowners.

* On. et.

14 Op eit.

gross outlays or his net cost? If, as Thompson expressed it, the landlord is a "conduit" for real estate taxes, could he not also be a conduit for income taxes? The pricing goal of real estate as well as of industrial enterprises is gross receipts which, after deducting costs and taxes, yield the investor an adequate net return on his capital. If property taxes and mortgage interest were not deductible from the landlord's Federal income tax base, rents would have to be higher to yield a comparable net return. Thus, it seems possible that the benefit of the deduction and the resulting lower Federal taxes accrue, at least partly, to the tenant. Further research would be required to explore whether or to what extent income taxes and savings thereon are passed on to the tenant.

The renter is likely to receive greater benefits from the standard deduction than the homeowner. The 10-percent standard deduction was intended to equal the allowable deduction of the average taxpayer, including property taxes and interest payments. A renter in the low-income brackets seldom has enough allow. able deductions to equal 10 percent of his adjusted gross income. The standard deduction may permit him to deduct from his income twice or three times the amount he could itemize. The owner of a mortgaged home needs few if any other deductions to equal the 10-percent standard deduction. If the deductibility of property taxes and interest payments were eliminated-as has been suggested by those who want to equalize the position of homeowners and renters-the standard deduction would have to be adjusted downward from the present 10 percent. This could well increase taxes for renters proportionately as much as for homeowners.

In summary, then, it appears certain that a substantial part of the residential property taxes is offset by benefits under Federal and State income taxes. It is not certain whether only homeowners enjoy the benefits or whether renters also share in them. The net savings to homeowners approximate, in the national average, two-thirds of their real estate taxes, which makes those taxes easier to bear. Of course, somebody pays for the difference as long as Government maintains its level of revenue. Since homeowning families, as a group, constitute the majority of the American people, and receive about three-fourths of all income in the United States, they probably bear in the end, in some form or other, the cost of the benefits they receive through the deductibility of property taxes, mortgage interest, and nontaxability of imputed income.

(The following letter commenting upon the statement of Mr. Freeman was received prior to the closing of the hearings, and appears at this point by order of the chairman:)

Hon. WAYNE L. MORSE,

MIAMI UNIVERSITY, Oxford, Ohio, June 28, 1963.

B. Senator From Oregon, Chairman, Subcommittee on Education, Senate Committee on Labor and Welfare, Senate Office Building, Washington, D.C. MY DEAR SENATOR MORSE: Just this past week, my attention has been called to the testimony of Mr. Roger Freeman, of the Hoover Institute of Stanford University, presented before your subcommittee on May 27, 1963, and inserted in the Congressional Record of that same date by Senator Goldwater. Since there is specific mention in that testimony of the report of the Commission on Financing Higher Education sponsored by the Association of American Universites, of which I was the executive director, I am taking the liberty of writing you this letter.

Since I have been personally interested also in the possibility of Federal legislation providing grants and loans to institutions of higher education, I trust I ay be permitted at the same time to make certain general observations about Mr. Freeman's testimony.

It is obvious, I believe, that Mr. Freeman has given much attention and carefal thought to the preparation of his testimony for your subcommittee. His point of view has been presented with great effectiveness.

All the way through Mr. Freeman's testimony there are items of misinformation or misinterpretation which each by itself seems relatively minor, but which te total can be quite damaging. For example, the whole discussion of economies it higher education is presented from a very one-sided point of view. Thus, it pears that, unless you have a trimester calendar or a quarter system, you are 14erating on a year-round basis. Mr. Freeman completely ignores the numer of institutions on a semester calendar which also have a summer session.