Imputed Rental Income
A comment from Mark Kleiman:
Why be taxed on the theoretical income you supposedly could gain from renting out something you own rather than using it? The theory seems to be that "income" includes all of the value that you receive from any source -- not just money, but also including services or benefits of any kind (including those that you provide for yourself).
Thus, the exact same theory that is used to support imputing rental income also supports imputing income whenever you:
(a) wash your own dishes rather than paying a maid to do it,
(b) take care of your own children rather than hiring a babysitter or daycare,
(c) clean your own house
(d) use your own furniture rather than renting it out (leaving your house empty, I suppose),
(e) dress yourself in the morning rather than hiring a butler.
In each of these cases, the theory is absolutely identical: You are "receiving" a "benefit" compared to people who have to pay for each of these services or goods in the marketplace, and thus (the theory goes) you have additional "income" to be taxed. This is no exaggeration. Some people argue that stay-at-home mothers should be be taxed on the value that the household "gains" from the fact that she provides many household services that two-earner families have to purchase. Indeed, the famous economist William Vickrey even wrote that "money income from gainful work is subject to an income tax while imputed income from leisure is not taxed . . . Accordingly, an income tax tends to make individuals choose leisure in preference to gainful work to an uneconomical extent."
All of this implies that people could be taxed on the value they "gain" when a parent is free to attend a child's soccer game rather than working late at the office.
There are two simple reasons that the very idea of such taxation seems misguided. First, "income" should mean some benefit that you receive from someone outside of your household. (I.e., when something literally comes in from elsewhere.) When you get a paycheck: income. If an employer pays for you to have a free athletic club membership: income. If you win a free car in a contest: income. If your neighbor mows your lawn for free: income (although not the kind that anyone bothers about reporting, I suspect). But when you switch your own money from one pocket to the other (as opposed to lending it to someone else at current interest rates), or buy your own athletic club membership (and do not in turn rent it to someone else), or buy your own car (same), or mow your own lawn, it seems ridiculous to call that "income." Same for buying your own house.
Second, it seems unfair that a particular tax should be structured in such a way that you can't even conceivably avoid paying it. If you don't want to pay property taxes, for example, you can avoid them by not owning property. You can avoid car taxes by not owning a car; capital gains taxes by not owning or selling capital; sales taxes by not buying things; and so forth. But the above theory of income tax would mean that no one could ever avoid having "income," no matter what. If you don't have any real income from a job -- whether because you are a volunteer or a student or a stay-at-home parent or a retiree -- the theory still says that you should be taxed on the "imputed" value of anything that you do for yourself, or even your own leisure time.
Stuart Buck
The egregious tax loophole is the non-taxability of the imputed rental income on owner-occupied housing. A renter has to pay income tax on the money he earns to pay the rent, but a homeowner pays no tax on the money he saves by owning.I know that some analysts favor taxing "imputed rental income," i.e., the money purportedly saved because a homeowner owns and occupies a home rather than renting it out. But I don't know why that idea makes sense, let alone so much sense that the absence of such taxation is an "egregious" "loophole."
Why be taxed on the theoretical income you supposedly could gain from renting out something you own rather than using it? The theory seems to be that "income" includes all of the value that you receive from any source -- not just money, but also including services or benefits of any kind (including those that you provide for yourself).
Thus, the exact same theory that is used to support imputing rental income also supports imputing income whenever you:
(a) wash your own dishes rather than paying a maid to do it,
(b) take care of your own children rather than hiring a babysitter or daycare,
(c) clean your own house
(d) use your own furniture rather than renting it out (leaving your house empty, I suppose),
(e) dress yourself in the morning rather than hiring a butler.
In each of these cases, the theory is absolutely identical: You are "receiving" a "benefit" compared to people who have to pay for each of these services or goods in the marketplace, and thus (the theory goes) you have additional "income" to be taxed. This is no exaggeration. Some people argue that stay-at-home mothers should be be taxed on the value that the household "gains" from the fact that she provides many household services that two-earner families have to purchase. Indeed, the famous economist William Vickrey even wrote that "money income from gainful work is subject to an income tax while imputed income from leisure is not taxed . . . Accordingly, an income tax tends to make individuals choose leisure in preference to gainful work to an uneconomical extent."
All of this implies that people could be taxed on the value they "gain" when a parent is free to attend a child's soccer game rather than working late at the office.
There are two simple reasons that the very idea of such taxation seems misguided. First, "income" should mean some benefit that you receive from someone outside of your household. (I.e., when something literally comes in from elsewhere.) When you get a paycheck: income. If an employer pays for you to have a free athletic club membership: income. If you win a free car in a contest: income. If your neighbor mows your lawn for free: income (although not the kind that anyone bothers about reporting, I suspect). But when you switch your own money from one pocket to the other (as opposed to lending it to someone else at current interest rates), or buy your own athletic club membership (and do not in turn rent it to someone else), or buy your own car (same), or mow your own lawn, it seems ridiculous to call that "income." Same for buying your own house.
Second, it seems unfair that a particular tax should be structured in such a way that you can't even conceivably avoid paying it. If you don't want to pay property taxes, for example, you can avoid them by not owning property. You can avoid car taxes by not owning a car; capital gains taxes by not owning or selling capital; sales taxes by not buying things; and so forth. But the above theory of income tax would mean that no one could ever avoid having "income," no matter what. If you don't have any real income from a job -- whether because you are a volunteer or a student or a stay-at-home parent or a retiree -- the theory still says that you should be taxed on the "imputed" value of anything that you do for yourself, or even your own leisure time.
Stuart Buck
posted by Stuart Buck at
1:08 PM
8 Comments:
I get the impression that this whole business of "imputing" rental income to people who own their own homes boils down to, "I rent, so it's no skin off MY nose."
The taxman has always sought to extend his reach. While it's certainly a leap to go from taxing the real to taxing the imaginary, which still has to be paid in real dollars I assume, they seem to have found a way.
I believe the issue of imputing rental income generally comes up in the context of abolishing the home mortgage interest deduction. It is one of the two ways to get rid of the distortions of the people's housing choices by the tax code.
Let me explain:
Imagine that you have $1,000,000 and no place to stay (for ease of computation I'll assume that there is no inflation, real rates of return are 10%, and you pay a marginal tax rate of 40%. Of course the results, if not the figures, are the same for any other assumpted rates).
Under the current tax code you have three options:
(A) Buy. You take your cash and use it all to buy a house. Result: You get to live in a million dollar house.
(B) Rent. You invest your money and use the proceeds to pay rent. $1,000,000 will earn you $100,000 a year . After taxes, that is $60,000. You rent a home with an annual rent of that amount. What would the price of a home with a rent of $60,000 be? $600,000 (calculated by reversing our assumed 10% rate of return). Result: You get to live in a $600,000 house.
(C) Get a mortgage. You invest your money and use the proceeds to pay the interest on an interest-only mortgage. Your investment income will be $100,000. However, you can afford to pay $100,000 in home mortgage interest because the HMI will exactly offset your investment income. For a $100,000 annual payment, you can get a $1,000,000 mortgage. Result: You get to live in a $1,000,000 house.
So, under the current tax code, A (buy) and C (mortgage) are considerably advantaged over B (rent). Because of this advantage, some people for whom otherwise it would make sense to rent, buy or mortgage instead. Hence, the tax code results in another deadweight loss to the economy.
Abolishing the home mortgage deduction, does not eliminate this distortion. It merely puts C (mortgage) on par with B (rent), rather than A (own).
So how could the tax code put A, B, and C, on par and so eliminate distortions?
(1) Keep the HMI deduction and add a deduction for rent. Then everybody gets to live in a $1,000,000 home. Disadvantage: Now all forms of housing consumption are subsidized compared to other, cash-based forms of consumption.
(2) Abolish the HMI deduction and tax imputed rental income to home owners. Then everybody gets to live in a $600,000 home. Disadvantage: Difficulties in computing the imputed income when there is no actual cash flow to track. A political uproar by home owners.
Still, overall, if your goal is efficient, non-distorting taxation, option (2) is probably the best. (Of course, I'd only support option (2) if it was combined with a reduction in tax rates so as to render it revenue-neutral or, preferrably, revenue-negative).
Right, but as I point out, the same calculation could be applied to literally everything about your life. You decide to buy a bed rather than renting one from a furniture rental store. You are, in theory, privileged over someone who keeps having to rent a bed with after-tax income. But so what? The alternative is to tax you on the supposed rental value of everything that you own or use.
But said "distortion", while real, is no accident. It's the very PURPOSE of the mortgage interest deduction. Seems to me the "imputed income" advocates want to undo that very deliberate policy preference for home ownership, without having to directly confront the arguments in favor of it.
Let me try to take a stab at answering Stuart's question raised in his original post and iterated in his response in the comments: If taxing imputed rental income is such a great idea, why not tax the imputed income from all assets?
In principle, I would argue that taxing all imputed income from assets would improve the system. It certainly would reduce the distortion favoring the holding of assets yielding in-kind returns (such as houses or paintings on the wall or, for that matter, mattresses) over assets yielding cash returns (such as stocks or bonds).
In practice, this would of course be a nightmare. The costs both to the tax payer and to the IRS of estimating the value and yield of every piece of personal property owned by anybody and then collecting income taxes on that yield would be enormous, vastly outweighing the deadweight loss caused by the original distortion.
These administrative costs of valuation are probably only worth it for assets which (a) are high value, (b) widely held, and (c) in direct competition with assets paid for with cash.
Housing is probably the single case in which the balance of administrative costs vs. avoided economic distortion looks the best. Hence it can make sense to argue in favor of the taxation of imputed rental income, while not favoring imputed income taxation on all assets.
In response to the point made here that the distortion in favor of home ownership over renting was a deliberate policy choice by Congress, all I can say is yes. But then so are ethanol subsidies. If you believe that law makers are generally wiser at allocating private assets than the assets' owners are, then this is a dispositive argument.
I have my doubts (and, lest an enraged mob of home owners comes after me for arguing in favor of the taxation of imputed rental income, please let me note that, after living in rental housing for all my adult live, I bought an expensive house less than a month ago).
How much imputed income does a homeless person earn.
In dicta in 1934, the Supreme Court touched on the issue of the constitutionality of taxing imputed income:[3]
If the statute lays taxes on the part of the building occupied by the owner or upon the rental value of that space, it cannot be sustained, for that would be to lay a direct tax requiring apportionment. The rental value of the building used by the owner does not constitute income within the meaning of the Sixteenth Amendment.[Helvering v. Independent Life Ins. Co., 292 U.S. 371, 378-79 (1934)]
Whether the U.S. Supreme Court of the present day would conclude that there is a constitutional prohibition of imputed income is unknown.[4]
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