Housing, home builders, and other businesses in the residential construction sector saw some policy wins in the recently enacted tax reform legislation. The once-in-a-generation legislation reduces tax rates for large and small businesses, protects the business interest deduction for real estate firms, and retains the like-kind exchange rules.
It also makes a number of improvements with respect to tax accounting rules, like greatly reducing the reach of the inefficient Alternative Minimum Tax (AMT). NAHB estimates that the number of taxpayers affected by the AMT, which in prior years included many small businesses, will fall from 5 million taxpayers to just 200,000 each year.
With respect to housing policy, the tax law protects the second home rule for the mortgage interest deduction (while reducing the overall cap to $750,000 of mortgage debt), retains the interest deduction for substantial improvements for remodeling (despite repealing the $100,000 HELOC rule), leaves untouched the important capital gain exclusion for the sale of a principal residence, and retains the Low-Income Housing Tax Credit and the private activity bond program. The bill does cap the amount of state and local tax (SALT) that can be deducted.
The tax legislation will measurably improve macroeconomic conditions in coming years. For the first time for a major item of tax policy, congressional scorekeepers estimated the dynamic or supply-side effects of reducing tax burdens. For example, according to the official “score,” the tax cut reduces the static cost of the legislation from $1.5 trillion over 10 years to $1 trillion due to growth effects from the policy changes.
Congress’ Joint Committee on Taxation (JCT) estimates the tax cut will increase gross domestic product (GDP) by 0.7% over the next 10 years. This projection matches the NAHB forecast, and in a similar calculation we marked up our GDP forecast for 2018 to a 2.6% growth rate. The JCT also estimates business investment will increase due to higher after-tax rates of return, leaving the nation’s capital stock 0.9% higher after 10 years. More business capital means more business investment, more efficient markets, and higher wage growth.
According to the JCT, the labor force will also grow faster, due to higher after-tax wages, adding an additional 0.6% of workers—or 900,000—over 10 years. This economic impact has benefits for both the supply-side and demand-side of the housing market, with this bump in the labor force offering tens of thousands of potential new construction workers. This overall job growth will also add to demand for apartments and single-family homes.
There will be some transition effects in high-cost, high-tax markets. For example, we have reduced our home price forecast next year to a lower 2.9% growth due to localized price softness in markets with high taxes and newly limited SALT deductions for income and property tax (now capped at $10,000 a year). However, the reduction of the AMT, which previously eliminated 100% of SALT deductions, should provide an offsetting benefit in such markets.
Overall, the tax benefits for workers and small/large businesses on the supply-side of the economy should boost economic growth, which is a net positive for housing and home building. These benefits come at a good time given the existing supply-side constraints in the market, as well as the need for additional after-tax income for younger, renting households to be able to save for a down payment to purchase a home.