My friend Mike asked me what I thought about the possibility of his buying a house. I said that not only was I not optimistic about real estate prices simply because of the current price levels, but I am also concerned that there is risk to the deductibility of mortgages, especially for an expensive house.

The President's tax commission recently came back with two relatively weak and spineless proposals, both of which aim for a slightly flatter and simpler tax structure...not nearly as flat or simple as we should have.

The National Association of Realtors have now put out two papers outlining the tax panel's proposals regarding real estate...and they're all ugly from the point of view of someone who does or wants to buy a house.

You can read the article, titled "Tax Reform – Impact on Housing and Homeownership" at
http://www.realtor.org/reioutlook.nsf/pages/MarketIntelligence?opendocument

and "To Figure, or Not to Figure, Tax Reform Into the Housing Outlook"
http://www.realtor.org/reioutlook.nsf/pages/forecast?opendocument

All of the real estate provisions in the proposals are bad for housing prices, and especially for houses above the FHA loan limit.

Quoting from the first article:

Tax Reform Panel Proposals
There are four major components recommended by the Advisory Panel on Tax Reform that could significantly impact residential housing:

* Convert the mortgage interest deduction from the current $1 million mortgage loan to a 15% tax credit only up to the FHA loan limit (which ranges from $172,000 to $312,000 depending on locality).
* Elimination of the mortgage interest deduction for home equity loans and mortgages on a second home.
* Elimination of the local property tax deduction.
* Raising the capital gains tax-free allowance to $300,000/$6000 from $250,000/$500,000 (single/married).

The NAR's first article focuses on the impact of removing deductibility of property taxes. Their "baseline" case, i.e. neither optimistic nor pessimistic by their thinking, is that such a change would reduce the value of residential housing by $780 billion, more or less immediately. This means over $10,500 for each homeowner, or about 5.4% drop in home prices.

Of course, this price burden would not be distributed equally; states with high property tax rates like New Jersey would get hit very hard, with the NAR estimating a drop of over $28,000 in the average home price in the state under their "baseline" scenario!

Keep in mind that these numbers are ONLY for removing the deductibility of property tax.

In the second article noted above, the NAR discusses the potential effect of all the tax panel's proposals: a loss of 10% to 15% in home values, which would be between about $21,000 and $31,000. Again, the areas with high taxes and high home values would be hurt the most.

HOWEVER, I agree with the NAR that the chances of these proposals passiing are very slim. There is some chance that Congress, especially given the horrible performance of Republicans on fiscal matters this year, might go along with reducing deductibility of interest or taxes for people above a certain income or houses above a certain value or mortgage size. That would be the worst of all worlds...and thus maybe the most likely given our legislators' inability to understand the economic and moral folly of "soaking the rich".

Although lower-end housing will probably not be touched directly, if the high end of housing takes a price hit the low end will be effected too. Given what I think is a clear top in the housing market anyway, this extra political risk makes me even happier to be a renter at this time.