Statement of Mark Kalish, Executive Vice President
Michael T. Rose Associates
Presenting the Testimony of
C. Kent Conine, Owner, Conine Residential Group, Dallas, Texas
on behalf ot the National Association of Home Builders
Before the Committee on Ways and Means
Hearing on Savings and Investment Provisions in the Administration's FY 1998 Budget Proposal
Mr. Chairman, members of the committee, my name is Kent Conine and I am a home builder from Dallas, Texas. On behalf of the 190,000 members of the National Association of Home Builders (NAHB), I want to thank you for the opportunity to testify before the Ways and Means Committee today. At the outset, let me state that NAHB has been a long supporter of the tax cuts the Committee is discussing this morning. We are particularly appreciative, Mr. Chairman, of your long-standing support of broad based capital gains relief and we thank you for your continued efforts over the years.
As you know, the home building industry is comprised mostly of small businessmen and women. Over 50 percent of NAHB members build less than 10 houses per year. Approximately 15 percent build more than 25 houses per year and less than two percent build over 500 houses per year. Further, about 80 percent of our members are family owned businesses. Unlike many other industries, home builders are affected by all three of the provisions that have been addressed by this morning's hearing. The exclusion of capital gains on the sale of a primary residence, an expansion of Individual Retirement Accounts and a modification to the estate tax all directly impact the ability of builders to provide affordable housing.
HOUSING-ITS ECONOMIC IMPACT
Housing construction contributes jobs, taxes, and economic activity to the U.S. economy. Each year, nearly 3 million jobs are created in the construction of new homes. These jobs create $98 billion in wages and $45 billion in federal, state and local taxes on that wage and business income. Even greater economic activity is created as the income generated in the construction, manufacturing, and sales jobs spread throughout the rest of the local economy.
NAHB estimates that housing, including new construction, remodeling, repairing and maintenance, and the value provided by existing homes accounts for 13 percent of the U.S. economy. The on-going benefit provides most American homeowners and renters with decent, safe affordable housing.
Table 1. Number of Workers Needed to Construct 1,000 HousesandTotal Wages by Major Industry
| Single Family | Multi-Family | |||
| Number | Number | |||
| of |
Wages |
of |
Wages |
|
| full-time | full-time | |||
|
Industry Group |
jobs (1) | (millions) | jobs (1) | (millions) |
| All Industries | 2,448 | $75.5 | 1,030 | $31.9 |
| Construction | 1,125 | 34.1 | 428 | 13.0 |
| Onsite | 957 | 29.0 | 376 | 11.4 |
| Offsite | 168 | 5.1 | 52 | 1.6 |
| Other industries | 1,323 | 41.4 | 602 | 18.9 |
| Manufacturing | 597 | 20.9 | 279 | 9.8 |
| Trade, transportation, and services | 675 | 19.3 | 304 | 8.7 |
| Mining and Other | 51 | 1.2 | 19 | 0.5 |
(1) Full-time, year round jobs.
Source: Number of workers: NAHB estimates from Bureau of Labor Statistics surveys of labor inputs in residential construction. Wages: NAHB estimes from Bureau of Economic Analysis data.
Table 2. Tax Revenue Generated from Constructing 1,000 Homes:1994 U.S. Averages
| Single Family | Multi-family | |
|
Tax by Source |
(Millions) |
|
| Total | $37.0 | $15.8 |
| Federal Taxes | 26.9 | 11.3 |
| Personal Income Tax | 6.9 | 2.9 |
| Corporate and Business Income Tax | 8.4 | 3.5 |
| Social Security Tax | 11.6 | 4.9 |
| Employee share | 5.8 | 2.4 |
| Employer share | 5.8 | 2.4 |
| State & Local Taxes and Fees | 10.1 | 4.5 |
| State & Local General Sales Taxes | 3.3 | 1.4 |
| State & Local Personal Income Taxes | 1.7 | 0.7 |
| State Corporate and Business Income Taxes | 2.1 | 0.9 |
| Local Real Estate Taxes and Fees (1) | 3.0 | 1.5 |
| Property transfer tax | 0.5 | 0.2 |
| Building permits, approval and impact fees | 2.5 | 1.3 |
(1) Excludes ongoing local property taxes of $1.7 million on 1,000 single family homes and $0.9 million on 1,000 multifamily homes.
Sources: Table II-4, U.S. Department of the Treasury, Internal Revenue Service, Statistics of Income Bulletin, Summer 1994; and U.S. Department of Commerce; Bureau of Economic Analysis, Survey of Current Business, July 1994 and February 1995; U.S. Advisory Commission on Intergovernmental Relations, Significant Feautres of Fiscal Federalism; 1993, Volume I; National Apartment Association and NAHB estimates.
HOME OWNERSHIP - IT'S IMPACT ON OUR SOCIETY
Homeownership truly is a fundamental part of the American Dream. Getting a good education, working hard, practicing thrift so that home ownership can become a reality, has been a motivating force for millions of Americans. NAHB's surveys show that 80 to 90 percent of all Americans want to become home owners. Recent studies by Fannie Mae have demonstrated the goal for home ownership is strong among all age and income groups. Homeownership not only allows families to establish roots in their communities, but it strengthens neighborhoods, expands participation in civic, religious, and community activities -- it is what ties our neighborhoods together.
Financial security is another benefit of homeownership. A home is the largest single asset of most Americans. For millions it represents a nest egg for retirement which has provided the elderly a strong supplement to social security. Many point to the low rate of per capital savings in the United States. However, if the equity in the homes of individuals were calculated, our per capita savings rates would be dramatically higher.
The tax base for our public schools and community services results from homeownership. It provides a safe haven, a sanctuary, a secure place for families to live, grow and prosper. This environment is essential for the development and growth of our children. How can a child study properly, develop family values, excel and expand their goals and dreams without the proper environment Homes are what provide that secure, protected and nurturing environment for millions of Americans. We should strive to do what is possible to provide the opportunity of homeownership for more young families, and that Mr. Chairman is what expansion of Individual Retirement Accounts (IRAs) and the penalty free withdrawal from IRAs for first time home purchases will do.
EXPANSION OF INDIVIDUAL RETIREMENT ACCOUNTS
NAHB supports expansion of tax-deferred retirement savings and use of IRA deposits for down payment on a first home. The proposal currently before the committee would create a new IRA, and allow the penalty-free distribution of funds from that account and from existing IRAs for first-time home purchase. NAHB supports this proposal and suggests modifications to better accomplish its stated purposes. Specifically, NAHB believes that any legislation should also allow the tax free withdrawal of funds in addition to penalty free withdrawal sand and affiliated individuals (e.g. parents and grandparents) should be allowed acess to retirement savings for a first-time home buyer.
Accumulating the down payment for the purchase of a first home is the primary barrier to home ownership for many young households. Even with lower down payment requirements under FHA and special affordable housing programs from Fannie Mae, Freddie Mac, and the Federal Home Loan Bank System, first-time homebuyers find it difficult to accumulate the cash necessary to make the leap into homeownership. The U.S. Census bureau and the Harvard Joint Center for Housing Studies have reported that down payment remains a serious barrier to home ownership for young renters.(1) Approximately nine-out-ten young renters cannot afford to purchase even a modest home in their area.
Increasing housing costs add to the housing affordability problem in this country. From World War II until 1980 home ownership rates in the U.S. increased. Since that time home ownership rates overall has declined. Particularly hard hit are those in the prime home buying age of 25-34. The home ownership rates of those in the age group 25-29 dropped from 43.1% to 34.4% and those in the 30-34 age group dropped from 62.2% to 53.1%. This trend is of significant concern.
Table 3. Homeownership Rates (Percent)
| 75 | 80 | 85 | 90 | 94 | 95 | |
| <25 | 20.4 | 21.3 | 17.0 | 15.7 | 14.9 | 15.9 |
| 25-29 | 43.1 | 43.3 | 37.4 | 35.2 | 34.1 | 34.4 |
| 30-34 | 62.2 | 61.1 | 53.8 | 51.8 | 50.6 | 53.1 |
| 35-39 | 69.0 | 70.9 | 65.3 | 63.0 | 61.2 | 62.1 |
| 40-44 | 73.9 | 74.2 | 71.2 | 69.9 | 68.2 | 68.6 |
| 45-54 | 77.0 | 77.6 | 75.4 | 74.9 | 74.9 | 74.8 |
| 55-64 | 77.0 | 79.2 | 79.2 | 79.3 | 79.3 | 79.5 |
| 65-74 | 71.8 | 75.2 | 77.8 | 79.3 | 80.4 | 80.9 |
| 75+ | 67.3 | 67.8 | 69.2 | 72.3 | 73.5 | 74.6 |
| All | 64.7 | 65.6 | 63.9 | 63.9 | 64.0 | 64.7 |
There are many factors that contribute to the housing affordability problem we are facing in this country. Certainly a factor has been increasing housing costs. Higher mortgage interest rates and general economic inflation have also been factors. The National Association of Home Builders believes government over-regulation is a significant contributor to increased land development and housing costs. The Kemp Commission on "Removing Barriers to Affordable Housing" identified numerous government regulations that add to the problem. We strongly urge Congress to make an aggressive review of these regulations and eliminate or change those that are unnecessary, costly and counter productive.
NAHB urges Congress to pass legislation expanding IRAs to create an incentive which will promote savings and encourage homeownership. Mr. Chairman, this proposal will make it possible for thousands of young working families to obtain the American Dream of home ownership. In turn, the construction of their homes will create jobs and the expansion of our economy. Equally important the expansion of homeownership contributes to the social/political stability of our society.
IRA Savings for a Downpayment
IRAs could be a useful resource to assist in first-time home purchase. IRAs already have substantial deposits. Total assets held in IRAs and Keogh plans (retirement plans for the self-employed) reached $773 billion at the end of 1992. Another $230 billion is invested in salary reduction plans (401(k), 457 and 403(b) tax deferred employer and employee contribution retirement plans) and $304 billion is invested in the federal government retirement plan for civil servants(2). Collectively, these retirement plans could provide up to 1.3 trillion dollars.
A number of proposals have been made to increase the potential use of retirement accounts for first time home purchase down payments. Proposals for use of existing "front-end" accounts typically propose penalty-free withdrawals of funds from the IRA for specified purposes. However, the tax that was deferred when the deposit was originally made must be paid at the time of withdrawal. Accordingly, withdrawal would be relatively expensive, especially if the funds were deposited at a time when the taxpayer's marginal tax rate was lower.
To this end, the "Savings and Investment Incentive Act of 1997", S. 197, introduced by Senators William Roth (R-DE) and John Breaux (D-LA) in the Senate and the House companion bill sponsored by Representative Bill Thomas (R-CA), restores the IRA deduction and adjusts the $2,000 deductible amount for inflation. It would also create nondeductible tax-free IRAs called "IRA Plus" accounts. Under the provisions of S. 197, distributions may be made free of penalty if used for first-time home purchase by the individual, their spouse, child, grandchild or ancestor. NAHB urges the Committee to consider these bills as it begins drafting legislation on expanded IRAs.
Mr. Chairman, NAHB encourages you to make the rules for IRA use as flexible as possible. For example, if the legislation requires that the funds be maintained on deposit at least 5 years prior to withdrawal, the impact on home ownership would be minimal. First time home buyers are typically in their early 30s and currently have small account balances in tax-deferred retirement accounts. The long waiting period coupled with the first-time purchaser's paucity of funds defer and diminish the stimulative impact of the proposal. Although with such a rule there would still be an increase in the incentive to save, resulting in greater participation, the likelihood of generating substantial savings is small.
NAHB also suggests that the current proposal be modified to allow home purchase withdrawals to be made from parents' and grandparents' accounts. This modification is important because those very individuals this proposal is targeted to assist, young working families who are recently out of college trying to pay off students loans, or finance a car, have precious little left over for a retirement account.
In designing a successful proposal for using retirement funds for down payments, there are three important components: 1) The use must be considered an alternative investment rather than a withdrawal; 2) Eligibility must be open to parents and grandparents of first time home buyers as well as the buyer; and 3) Eligible plans must include IRAs, Keoghs, 401(k) and other salary reduction plans, and the federal government retirement system. In the alternative, an attractive and economical proposal would allow down payments for first home purchase to be treated as an investment for tax deferred accounts rather than as a penalty-free withdrawal. Withdrawing the funds also subjects the taxpayer to implicit penalties in that the account holder's investments in tax deferred assets are reduced. From the point of withdrawal on, interest on withdrawn funds would be taxed at current marginal tax rates, again often higher than those anticipated during retirement. Treating the down payment as an alternative investment would avoid both explicit and implicit penalties.
The ability to use tax deferred retirement accounts for a down payment must be open to parents and grandparents because few young people have sufficient retirement savings to be useful. Table 1 shows participation rates by age of employee in employer pension plans. Table 2 shows account balances by age for salary reductions plans, chiefly 401(k) plans. Employees between 25 and 30 years old have the lowest participation rate in retirement plans and an average account balance of $5,185. A 10 percent down payment and associated closing costs on a median priced existing home sold would require cash in the amount of $13,000(3).
On the other hand, the parent of a potential first time home buyer is at least 45 years old, with an average IRA balance of approximately $16,380. Grandparent IRAs are most likely to have sufficient balances to provide down payment support in that workers between 60 and 64 years old have average IRA balances of $25,011.
Under current law, IRAs are primarily alternative forms of retirement savings when the savers' employer does not offer a retirement account, the saver is not self-employed, or the saver's income is under $40,000. About 20 percent of all workers have IRAs compared to 53 percent who participate in some employer pension plan. In order to have any sufficient impact, the first-time home purchase provision should also apply to other retirement accounts.
Expanding the eligible investments of a tax deferred retirement account to include qualified first time home purchase will have very little impact on federal tax receipts in the near term. The transfer of funds across investment opportunities is already a frequent occurrence and has no federal tax implications. The ability to use retirement funds for first time home buyer assistance may increase the desirability of saving in this form, both for potential first time home buyers as well as their parents and grandparents. Any increase in tax deferred in tax deferred savings because of the expanded options would decrease federal tax revenues over a longer period of time as deposits increased.
Therefore, NAHB recommends that such use (by either the buyer, parents or grandparents of the buyer) be deemed an eligible investment of the IRA. Roughly 15 percent of potential first-time home buyers have invested in IRAs and another 9 percent have invested in 401(k) plans(4). NAHB estimates that allowing a first-time home buyer's purchase to be a qualified investment within the plan would create 20,000 jobs and generate 36,000 additional home purchases.
CAPITAL GAINS
with respect to real estate, a capital gains preference would increase investors and owners incentives to purchase, rehabilitate and operate rental housing. part of the total return to investors who own rental housing is property appreciation. the greater the owner's after-tax income from the appreciation portion of their return, the less income required from rents to achieve the same earnings. reducing capital gains tax rates will reduce residential rents. since much of the appreciation in housing is due to price inflation, adjusting the gains for inflation will reduce rents even more.
we must insist however, that any capital gains incentive include real estate. just as real estate serves as the engine to lead the economic recovery, so it must be included in any capital gains reduction in order to maximize the dynamic economic impact of the proposal. indeed, inclusion of real estate effectively rebuts any argument that a capital gains tax cut would favor only wealthy taxpayers. mr. chairman, i know this has been a long standing position of yours.
depreciation recapture
There is a technical aspect of the capital gains issue relating to the taxation of business and investment real estate which could have strong negative economic impact on our industry. If, as was considered in 1996 budget talks, depreciation rules are altered so that only gain in excess of depreciable real estate's original costs would qualify for a new lower capital gains tax rate, three out of five (60 percent) of investment and business real estate sales would effectively be excluded form a capital gains tax cut. Real estate, therefore, would be disadvantaged vis-a-vis other investments, such as stock, further slowing additional recovery in the nation's still fragile real estate markets.
Depreciation deductions for real estate are intended to reflect the inevitable costs associated with the deterioration of a long-lived structure and its many components, such as the roof, heating, ventilation and air conditioning units, plumbing and electrical fixtures, etc. Sale of real estate for more than its adjusted basis is therefore likely the result of the combination of a number of factors -- such as, inflation, appreciation in the value of the underlying land and market conditions.
In 1964, Congress required that a portion of the accelerated depreciation on real property be recaptured as ordinary income. Subsequent amendments to the tax law have required that the entire amount of accelerated depreciation on real property be recaptured as ordinary income. However, any depreciation taken to the extent allowable under the straight-line method is generally not recaptured as ordinary income, but rather creates capital gain.
The theory behind depreciation recapture is that to the extent depreciation allowances reflect real economic depreciation, there is no ordinary-income tax benefit to recapture, only a capital gain. Also, to the extent that depreciation allowances exceed economic depreciation, there is an ordinary-income tax benefit which should be taxed at ordinary-income tax rates.
Changing the current depreciation recapture law for improved real property in the manner that has been discussed by the Treasury department would not sufficiently unlock real estate assets and would seriously disadvantage improved real estate to other investments. To be meaningful, a capital gains tax cut must maintain the current depreciation recapture rules.
Capital Gains Tax on Home Sales
Roll-over and One-Time Exemption Provisions
While NAHB remains committed to a broad base cut in the capital gains tax rate, we realize the purpose of this morning's hearing is to discuss the targeted capital gains cut contained in President Clinton's FY1998 budget.
Owning your own home provides a personal satisfaction such as the ability to control your living environment and the feeling of being an integral part of your community. Owning also brings financial gains through appreciation, and tax preferences. One of the tax preferences accorded owning is the ability to postpone and partially or entirely exclude taxation on the appreciation.
The roll-over provisions provide some relief to home owners who wish to trade homes but otherwise may incur a tax liability. The roll-over provisions effectively extend the tax treatment currently accorded tax-deferred retirement accounts to housing. If a taxpayer moves deposits in a retirement account from one asset to another, the activity is not taxed. Since home equity is the single largest asset for most families, equivalent treatment would seem appropriate. Financial and real investments not sheltered in retirement accounts do not enjoy these tax benefits and capital gains tax is normally due when realized. The long-run impact of the proposal enhances housing relative to other investments. To a home owner deciding whether to invest in housing, greater relief from tax on gains in an owned home versus some other asset will tilt the tax decision towards housing.
Magnitudes
There are roughly 65 million home owners currently and most would be likely to incur a tax if they were to sell and buy a less expensive home or decide to rent. After the typical length of stay in one home (15 years), a typical home seller today will have $60,000 in taxable gain if they do not qualify for the rollover or exemption. However, few do pay capital gains tax for one reason or another. According to 1993 IRS statistics, 150,000 tax payers claimed a taxable gain in the sale of a residence in 1992. About 30,000 had no tax liability, and the remaining 110,000 taxpayers claimed an average of $17,200 in gain. The federal government collected an estimated $300 million on these gains.
Estimates have been made regarding the number of home sellers who used the roll-over and the one-time exemption to avoid tax in a particular year. The results have been that only half of all home sellers even file the proper form. Presumably, those that did not file were eligible for deferral and didn't realize they still must file (or they lied to avoid paying tax). Additionally, it is estimated that 62 percent of the gains that are reported are not taxed because the home owner bought or is planning to buy a more expensive home and 33 percent of the gain was subject to the one-time exclusion, leaving 5 percent of the gain taxed. Since these ratios omit the sales not reported, the portion of all gains that is actually taxed is even smaller.
Effect of Change
Increasing the current capital gains exemption for home ownership would increase the incentive to own and to own more house. Allowing repeated use of the exemption after each sale would enhance housing as an asset by removing barriers to trading before and after a certain age (55 under current law). Allowing a repeated exemption will also remove significant reporting burdens now required of home owners. Under current law, a typical elderly home owner who moves to a retirement community must calculate capital gains liability by going back to records of the first home purchased and follow each successive sale and purchase. The record keeping and effort necessary to calculate tax liability is daunting for anyone, and all the worse for an individual who has already paid a lifetime of taxes.
Increasing the amount of capital gains that is exempt from tax will increase home ownership by removing the capital gains reporting burden and by making the financial investment in home owning more attractive than the financial investment in other assets. Raising the amount of home appreciation exempt from tax is also necessary now in order to anticipate future home appreciation that will dilute the value of the current one-time exemption level of $125,000. At current levels of house price appreciation, typical home buyers in 1997 will see $265,000 of appreciation in their homeowning lifetime(5). Increasing the limit now will assure those young households that they will enjoy the same tax advantages of home owning as their parents and grandparents.
"DEATH TAX" RELIEF
Home building is dominated by small firms which very often are family owned and operated. The current estate and gift tax laws operate to destroy family-owned businesses by imposing a tax upon the inter-generational transfer of the business. Moreover, the economic impact of the tax increases from year to year because of inflation. Under present law, estate and gift taxes of up to 55% are imposed on the value of transfers. Although a credit is allowed against estate and gift taxes sufficient to allow a taxpayer upon death to transfer up to $600,000 without paying tax, this exemption amount has not been increased since 1987.
Impact on Housing
Eighty percent of home building firms in our country are small family-owned businesses. The current tax treatment that we live under limits the ability for current owners to pass these companies onto their family members. Family businesses should be passed to heirs without tax. Death taxes force family owners to liquidate, sell off at a fraction of market value, or pay dearly in estate planning costs instead of growing their business. Additionally, these taxes make parents reluctant to help their children establish themselves in independent business. This forced sale of the family business is disruptive the home building industry and increases the cost of producing housing. Further, building homes and developing subdivisions is a long term process which many times is interrupted and frozen as an estates of a builder. Creation of affordable housing should not be stalled or curtailed as a result of a complicated estate issue or the eventual sale of the business.
For these reasons, NAHB supports estate tax relief. Although complete repeal of the estate tax makes the most economic sense, NAHB also supports a reduction in the current estate tax rate and increasing the current estate tax exemption. Additionally, NAHB supports legislation to preserve family-owned business by either repealing the estate tax in general or eliminating it for small family-owned businesses.
Although the President's budget contains some estate tax relief for closely held businesses, it is minimal and needs to be significantly expanded. His budget proposes to ease the burden of estate taxes on farms and other small businesses, allowing their owners to defer taxes on $2.5 million of value, up from $1 million under current law. The deferred taxes could be paid over 14 years at a favorable interest rate. The proposal expands the type of businesses eligible for such treatment by making the form of business organization irrelevant.
The President's proposal does very little to eliminate the estate tax burden on small business and is merely a loan program. Many other proposals on estate tax relief have also been introduced on the Hill -- ranging from complete repeal to an approach similar to the President's. The best solution would be to raise the exemption level from $600,000 to $1 million and reduce the overall estate tax rate. NAHB looks forward to working with the Ways and Means Committee as well as the Administration to craft a workable, passable proposal.
CONCLUSION
For the reasons stated above, the National Association of Home Builders believes that the tax cut proposals currently being considered by the Congress and the Administration are important to our nation's economy and the creation of affordable housing. Home building creates jobs both directly and indirectly, as well as fuel our economy.
Once again Mr. Chairman, NAHB thanks you for this opportunity to present our recommendations. We look forward to working more closely with you and your staff in the coming months as the budget process and tax cut proposal move forward.
1. The State of the Nation's Housing 1993, Joint Center for Housing Studies of Harvard University and Who Can Afford to Buy in House in 1991, Current Housing Reports H121/93-3, Bureaus of the Census.
2. Employee Benefit Research Institute, EBRI Notes, November 1993 and Issue Brief, December 1993.
3. The median existing home sales price for the first half of 1993 was $106,000 and closing costs for an FHA loan are about 2.5 percent of the mortgage amount. Hence, cash required is $10,600 for the 10 percent down payment and $2,456 for closing costs on a 90 percent mortgage plus the 3 percent up-front insurance premium.
4. "Down Payments for Retirement Accounts", Housing Economics, March 1991.
5. Annual appreciation of 4% for 30 years on the 1996 median priced existing home.