The Fine Print – Home Buyers to Pay for the Payroll Tax Cut

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Their Payroll Taxes Go Down While the Cost of the House Goes Up

For anyone who runs a business or a household, budgeting is a zero sum game.  So much comes in and that is how much can go out.  Since the government can print money and the rest of us can’t, it does get to play the game with different rules.  That said, assuming that the government is committed to deficit reduction and monetary policy that doesn’t include increasing the money supply (which comes with inflation risks), then every tax cut needs to have more revenue associated with it from someplace, to at least be deficit neutral.

Now that the silly political fight over the payroll tax cut extension is over, at least for the holidays, we can try to actually understand the policy implications.  Basically, it calls for increased fees by the home loan agencies, Fannie Mae and Freddie Mac, to pay for the tax cuts.  I do think that the extension is a good thing.  For those who are interested in the fine print, take a look at these points of view:

Andrew Rosenthal writes:  ”there is less here than meets the eye.”

Teresa Tritch, who covers the economy for the editorial board, had this to say:

In a rational world, stimulus — whether in the form of government spending or tax cuts — would be deficit financed, rather than “paid for” with offsetting spending cuts. That’s because the whole point of stimulus is to juice the economy and spending cuts, by definition, remove juice from the economy. By pairing stimulus and spending cuts, lawmakers give with one hand and take away with another.

The payroll tax cut is paid for by an increase in the guarantee fee on new loans backed by Fannie Mae and Freddie Mac, the government run mortgage companies.

In general, it’s a bad idea to conflate paying for tax cuts with changes to Fannie, Freddie and broader mortgage finance system. Is this a back door way to force changes in the mortgage finance system?

More specifically, the new fees will likely be passed on to homeowners, precisely when the Obama administration is trying to make refinancing easier for struggling homeowners. If you want to encourage an activity, the last thing you want to do is make it more expensive.

It’s true that paying for the payroll tax cut by raising refi fees is better than, say, kicking poor children out of Head Start. Then again, why should hard-pressed homeowners subsidize the payroll tax cut?

In fact, if lawmakers insist on paying for stimulus measures, the best way to do so is to increase taxes on the rich. That’s because the rich have more money than they can spend, so taxing them more does not translate into a dollar for dollar hit to consumer spending.

Keith Hennessey favors increasing the Fannie Mae and Freddie Mad fees, but, he thinks the proceeds should just go to deficit reduction.

When Fannie Mae and Freddie Mac guarantee and securitize a bundle of mortgages they charge aguarantee fee or G fee for the service. The bill mandates an increase of 10 basis points (one-tenth of one percentage point) in this guarantee fee.

Since this is a fee charged by Fannie and Freddie to their clients, by itself this provision would increase revenue for the firms. The bill also requires Fannie and Freddie to passthrough that increased revenue to the U.S. Treasury. This would increase federal government revenues and reduce the budget deficit. That’s why the provision is in this bill, because Democrats are insisting that the deficit effects of preventing a tax increase be offset with provisions that reduce the deficit.

These additional 10 basis points of guarantee fee, passed through to the U.S. Treasury, would result in about $3.5 B extra revenue and deficit reduction per year for the federal government over the next decade…

…What should be done with the increased fees?

Some investors are telling Congress that the higher fees should be left in control of Fannie and Freddie’s management rather than passed through to pay down the deficit. These increased guarantee fees should not, they argue, be “used to pay for a payroll tax cut,” and they argue that doing so undermines the prospect of future GSE reform.

The “pay for a payroll tax cut” argument is a red herring being used with Republicans who don’t like the payroll tax cut policy. Imagine if instead this were a standalone bill consisting only of the higher guarantee fee. Should those funds be used by the government for deficit reduction or left with Fannie and Freddie executives, to be used at their discretion for some other purpose?

…I think these funds should be used to reduce the deficit.

So, the zero sum budgeting that the President is so far being firm about is a step in the right direction.  After the new year, we’ll see if this commitment continues when the two sides hammer out the long term plan.

Related articles

• REPORT: Payroll Tax Cut Deal Near (businessinsider.com)
• How will Congress pay for the payroll tax cut extension? (politicalticker.blogs.cnn.com)
• Payroll tax cut bill boosts cost of new mortgages (seattletimes.nwsource.com)
• Payroll tax cut debate: why all the fuss? (guardian.co.uk)