Saving the US Economy - the Canadian Way

[Admiral Yi]

The issue is whether the business getting a deduction or the person getting a deduction for borrowing on the exact same asset is really similar or not.

The business assumes debt to generate a revenue stream.  The individual assumes debt to eliminate a cost stream.  There may be others factors but that part seems symetrical.

[Admiral Yi]

Its all part of the same thing.  Canada's regulation policy is all based on restricting the amount of debt a home owner can take on.  US policy encourages more debt.

Holding all other factors constant, the interest deduction should result in similar debt to *after tax* income ratios.

[alfred russel]

Here's the standard argument as to why profit-earning businesses should get the deduction while consumption such as housing should not:

http://www.taxfoundation.org/blog/show/1081.html

I disagree with their point of view.

This isn't especially complicated. Imagine that you want to buy a $1,000,000 home with nothing down. 5% interest rate. There is no home interest deduction and we aren't interested in capital gains. I have other passive income I can use to deduct rental related business losses.

If you buy the home, you pay $50,000 in interest a year.

If I buy the home and rent it to you, I pay $50,000 in interest, but get a deduction (say I pay 40% in taxes, my net interest after tax is only $30,000).

There is an aribtrage opportunity here: I can rent the home to you for an amount between $30k and $50k, and we are both better off.

In the real world there is a lot more that goes into a decision such as this--interest rates for a homeowner are typically less, and capital gains are a major factor driving real estate purchase decisions. But the analysis is sound in one sense--there is a distortion that is pushing you into renting.

[Admiral Yi]

The odd thing is that while home ownership rates are about the same in the two countries, rates of debt to equity are much higher in the US.

Put this together with the alleged fact mentioned upthread that homes in the US tend to be larger and more expensive, it appears that what US policies encourage is not rate of home ownership per se, but rather ownership of more expensive homes.

I assume your using recent data?  We just went though a bubble that saw massive increases in home ownership with little or no money down and a tanking of property values.  I would be shocked if we didn't as a nation have higher debt equity ratios.

[Malthus]

The issue is whether the business getting a deduction or the person getting a deduction for borrowing on the exact same asset is really similar or not.

The business assumes debt to generate a revenue stream.  The individual assumes debt to eliminate a cost stream.  There may be others factors but that part seems symetrical.

Where you see symmetry I see a fundamental difference.

[Malthus]

Here's the standard argument as to why profit-earning businesses should get the deduction while consumption such as housing should not:

http://www.taxfoundation.org/blog/show/1081.html

I disagree with their point of view.

This isn't especially complicated. Imagine that you want to buy a $1,000,000 home with nothing down. 5% interest rate. There is no home interest deduction and we aren't interested in capital gains. I have other passive income I can use to deduct rental related business losses.

If you buy the home, you pay $50,000 in interest a year.

If I buy the home and rent it to you, I pay $50,000 in interest, but get a deduction (say I pay 40% in taxes, my net interest after tax is only $30,000).

There is an aribtrage opportunity here: I can rent the home to you for an amount between $30k and $50k, and we are both better off.

In the real world there is a lot more that goes into a decision such as this--interest rates for a homeowner are typically less, and capital gains are a major factor driving real estate purchase decisions. But the analysis is sound in one sense--there is a distortion that is pushing you into renting.

Seems to me that encouraging business has a different effect than encouraging consumption, even if the business is selling (or renting) stuff being consumed.

[viper37]

First of all, in Canada, can banks cancel mortgages at will?  The article implies that they can (since it claims that a problem is that, in the US, only the borrower can do this).

Not really, unless you default on the capital of your loans (you can pay the interests only).  The contracts are short terme, not for the whole mortgage period.  Maximum is 5 years.  What happens is if they don't want you, they ask you to repay the loan when your term period is over (wich they have the right to do).

other possibility is that in Canada, loans are permanent (or, at least, one must pay a penalty for paying back a loan early).

There is a penalty for repaying your loan early.  You can usually negotiate this if you re-borrow from the same bank.

Secondly, in Canada, are fixed-rate mortgages illegal?  the article implies that they are, by making note of the fact that fixed-rate mortgages are legal in the US.

No they aren't.

I am rather astonished that someone would share such a shoddy article with us.  It says "lets do these things like Canada does them" and then doesn't bother to tell us how Canada does things! 

The article is bad, inmho.

The decline of the $US in 2007 had none of the miraculous effects that Frum said it would.

Actually, if you take the point of view of the author to be true, you'd need to wait 10-15 years to see the effect of this policy.

Now, if you don't take it for granted...
See, devaluating your currency can be good for exports: your stuff is cheaper, people want to buy cheap stuff.
It worked for Canada because we were selling to the US.
But Canadians and Europeans already buy from the US, no matter the price of your products.
What is happening right now, is that US, Canada and Europe are buying less from America and more from China.
Even if your dollar was worth 0,50$ CAN, I seriously doubt Wal-Mart would be filled with products "MADE IN AMERICA" instead of "MADE IN CHINA", or that my tv would have the mention "ASSEMBLED IN OHIO" instead of "ASSEMBLED IN MEXICO".

Canada was (still is) a small country (population wise) next to a huge neighbour with 10x our population.  We have a natural market for export, Americans have a natural interior market.

Besides, even if you try to devaluate your currency, what's to prevent China from devaluating its own currency even more to keep on par?

And about the budget balance... hey, if you want to do it the Canadian way, you'd need regional nationalism to crush, then reduce the transfer payments to States on any and all fields (say, Medicare/Medicaid, education, roads, etc), blame the deficit of the States on their nationalism, pay back your debt, tighten even more your States transfer, wait until New York and Virginia start to raise their voice, then come as savior with check harbouring the US Federal gov't logo to prove everyone how good&nice you are and how lucky your citizens are to have such an effective government and that any hostility toward the central authority is totally misguided and the result of fanatics.

Also, you'd need a previous government who made the tough calls, such as introducing a sales tax on nearly all goods&services (99,9%), selling state property (CN, airport), cancelling military contracts for new helicopters designed to replace the ones you have dating from the '60s, and then instutude a party funding scheme in wich government contractors will bill the government twice for their services while giving back the entire amount of one bill to the Democrat Party as a way to fund their propaganda machine telling every Americans that their country is the "most best in the world" (but well, that part won't be hard, most Americans already believe that ) and that a gun registry is essential to prevent kids from playing with nuclear weapons at home.

[alfred russel]

Seems to me that encouraging business has a different effect than encouraging consumption, even if the business is selling (or renting) stuff being consumed.

Hell, in the example above why not just structure the transaction as a lease rather than a purchase to take advantage of tax law? That doesn't encourage any business, just tax avoidance.

[viper37]

I wonder what Frum means when he says Canada "allowed" the currency to depreciate.  AFAIK the looney has been floating ever since the end of Bretton Woods.  Did Canada stop selling reserves to prop up the value?

Canada did not really "allowed" it's currency to depreciate, in fact, I can recall several interventions by the Bank of Canada to sustain our dollar's value because the gov felt it was sinking too low.

It so happened that our economy was crappy while the US economy was booming.

I also don't see the connection between the exchange rate and real estate markets.

I think it's 2 seperate points.
Anyway, the only thing to learn from Canada with the present crisis is too not get yourself in out of control debt and only reduce the taxes when you can afford the cut, i.e. not going into deficit to finance your tax reductions.
Of course, one could have also learned the same thing from the Reagan years when the US faced a similar situation at the end of the 80s, early 90s.[/quote]

[Malthus]

Seems to me that encouraging business has a different effect than encouraging consumption, even if the business is selling (or renting) stuff being consumed.

Hell, in the example above why not just structure the transaction as a lease rather than a purchase to take advantage of tax law? That doesn't encourage any business, just tax avoidance.

Are you claiming that it is effectively impossible to create a difference in tax treatment between business expenses and expenses for personal consumption, because the latter can always be disguised as the former?

[alfred russel]

Are you claiming that it is effectively impossible to create a difference in tax treatment between business expenses and expenses for personal consumption, because the latter can always be disguised as the former?

No, but when we are talking about a need such as housing, I think it is flawed to offer tax incentives for renting but not for buying.

[crazy canuck]

Holding all other factors constant, the interest deduction should result in similar debt to *after tax* income ratios.

I agree that is the goal of the policy but the problem is that the debt remains in the US while in Canada the debt is paid down so when things go bad the Canuckelhead is not in as much trouble as the Yank who is still burdened by a large debt load he can no longer afford.

In other words, a tax break only works when you have income to shelter....

[Malthus]

Are you claiming that it is effectively impossible to create a difference in tax treatment between business expenses and expenses for personal consumption, because the latter can always be disguised as the former?

No, but when we are talking about a need such as housing, I think it is flawed to offer tax incentives for renting but not for buying.

So far, I have failed to observe any particular bad effects from this. What's the downside of such a distortion, in your view?

[crazy canuck]

So far, I have failed to observe any particular bad effects from this. What's the downside of such a distortion, in your view?

Exactly,  I hope he answers this because I see nothing wrong with making rental accomodation more affordable while we have already addressed the problems with creating an incentive for people to acquire and maintain larger debt loads.

[alfred russel]

So far, I have failed to observe any particular bad effects from this. What's the downside of such a distortion, in your view?

There is a general principle that the tax code should have a minimal impact on decisions made in the marketplace.

FWIW, I can see a few good reasons not to encourage home ownership. The most important two being that it reduces the mobility of the workforce and creates a kind of real estate lottery for the middle class. In the case of the US, removing the deduction would be a disaster as it would reduce home values and increase the after tax homeowner costs which would fuel more foreclosures and reduce consumer spending.

If you want to avoid high debt levels, I think discouraging home ownership is a poor way to accomplish that. At least in this country, people can spend themselves into oblivion on their credit cards to their hearts content, and they often do.