Note: I read an editorial by Merrill Matthews and emailed him toote suite: how is the 3.8% Medicare tax going to affect real estate here in Dallas, I asked? The resident scholar with the Institute for Policy Innovation, public policy analyst specializing in health care issues,  author of numerous studies in health policy and past president of the Health Economics Roundtable for the National Association for Business Economics, the largest trade association of business economists, was gracious enough to indulge me: 

We are moving closer to that “fiscal cliff,” and it will hit investors harder than most. If President Barack Obama gets his way, one very important tax rate will triple—literally, overnight.

The so-called Bush tax cuts are set to expire at the end of the year.  That means that unless Congress acts, all of the current income tax rates will rise to pre-2001 levels immediately.

Most of the attention has been on the income tax rate.  Those in the highest tax bracket will see their rate rise from 35% to 39.6%.

But the Bush tax cuts dropped the rate on dividends, which were taxed at the personal income level, to 15% regardless of income.  If the Bush tax cuts expire, the dividend tax for high-income workers will return to 39.6%.

But there’s more.  The health care law imposes for the first time ever a 3.8% Medicare tax on passive income, including dividends and interest.  So the effective dividend tax rate for those at the upper end of the income scale will nearly triple, to 43.4%.

That potential increase is affecting investment decisions now.  Several companies have announced that they will be paying dividends early, before the end of the year, in order to avoid the tax increase—if it comes.

Some investors are divesting of other assets.  A friend just sold a $1.2 million second home he owned in Colorado.  He’s convinced that if we go off the cliff, the economy will tank, bringing on a double-dip recession, and he would either lose money or be unable to sell the place.  He wanted to get out while the getting’s good.

The President’s plan couldn’t be timed any worse.  Dividend-paying stocks have been one of the bright spots for investors.  That’s in part because interest rates have been kept so (artificially) low by the Federal Reserve Bank.  Investors are understandably looking for better returns.

Higher dividend taxes will make stocks that pay dividends less attractive to investors.  So those who currently hold dividend-paying stocks—everyone from middle-class folks with 401(k)s to union pension funds to non-profit foundations—would see the value of their investments decline substantially.

Further, higher dividend taxes will likely cause companies to cut dividends in favor of deploying their cash in other ways, like re-purchasing their own stock.  So individuals counting on their share of a company’s profits for their income—which they’d normally receive via a cash dividend—could find themselves out of luck.

That will be particularly bad news for retirees, many of whom depend on dividends as a staple of their fixed incomes.  According to the IRS, more than half of dividend payments go to Americans over age 65—and almost 75% go to those over age 55.

Another bright spot for investors over the past few years has been Real Estate Investment Trust (REIT) mutual funds.  Money has poured into that sector, especially after the official end of the recession in June 2009.  People were putting money there in the hope of reaping strong capital gains.  But there’s a problem there, too.

The capital gains tax will also increase, from 15% to 20%.  Plus, we have to add the 3.8% Medicare tax for the first time ever, for an increase to 23.8%.  To be sure, not nearly as high as the dividends tax, but a significant increase nonetheless.

President Obama needs to understand that not all tax increases and tax cuts are created equally; some will have very little economic impact, others will have a significant impact.  While the income tax rate increases are important, and detrimental, they pale in comparison to the economic damage from dividends and capital gains tax increases.

A dividends tax hike could greatly dampen investment, which would bring a hammer down on a weak economy.  Investors would close their wallets, and the real estate market would be one of the first to feel it.  With housing prices finally moving up in most places, especially in Dallas Fort Worth, the negative impact of a tripling of the dividends tax would surely reverse those gains.

Merrill Matthews is a resident scholar with the Institute for Policy Innovation in Dallas, Texas.



We see it even in Texas: price declines, low mortgage rates and rising rents have made owning more affordable now than renting. But despite agents’ most positive view of the Dallas real estate market, housing is still kind of stuck in the mud, even here. Many markets report continued price declines, while Dallas is struck by another problem: lack of inventory. Our funky, fun Austin is now the most expensive place to live in Texas because of rising rents. Hardest of all is qualifying for a mortgage, which brings in cash buyers a.k.a. bottom feeders, and gives them even more power to drive down prices in hard ball negotiations. With this scenario, the market for the average American home is shrinking as fewer Americans than ever own homes. And it doesn’t take a rocket scientist to figure out that rising rents will beat the average American even more.

What to do? I don’t want this to give anyone a heart attack, but the Wall Street Journal says economists, including some at the Federal Reserve, are urging President Barack Obama to do more than he has done in four years. Clearly, in four years Obama has been the most impotent president in history when it comes to housing. It is almost as if he wants us all to rent. He promises to be taking a newfangled “aggressive on housing” stance in tomorrow’s State of the Union address, or so his housing secretary told the WSJ. What he will likely outline: a refinancing initiative and programs to convert some foreclosed properties into rentals. That will likely make the mortgage holding neighbors of these properties upset, but it may be better than having a vacant home sprouting weeds.

I have said some of this before, but now it’s coming out the mouth of top experts. We need three things to happen to get this market out of the junk: stimulate lending, which everyone is afraid to do because they got burned and federal regulators have the banks shackled; enact more intelligent regulation if any, and something the banks don’t like: write down the debt on some of those underwater mortgages.

Here’s a link to the full article, but you must subscribe to the WSJ.

1. Be nice to the Mom and Pop investors trying to buy up foreclosures.  WSJ says banks owned around 440,000 homes at the end of October, but an additional 1.9 million loans were in some stage of foreclosure, according to Barclays Capital. It’s the REFINANCING, STUPID!  

“While there’s no shortage of investor demand in many markets, financing remains an obstacle. In 2008, Fannie Mae and Freddie Mac, the main funders of mortgages, faced soaring losses from speculators (and a stupid CEO) and reduced to four from 10 the number of loans they would guarantee to any one owner. Fannie now backs as many as 10 loans, but some banks have kept lower limits.”

Why those lower limits? When I ask, I’m told it’s the feds at work.

“If that number were raised…to 25, you would very quickly start whittling down this very big backlog,” said Lewis Ranieri, the mortgage-bond pioneer, in a speech last fall. He said loans should be made on conservative terms that include 30% or 35% down payments.”

Great point to sink through the Fed’s head: Today’s investors are not the speculators who  bought on the prospect of ever-rising values, which inflated the real-estate bubble. Look at the market fundamentals. Today’s cash-rich investors buy to lease properties. But because they cannot get financing, those with cash are king in the bargaining process and are keeping home prices down. I mean, who else is buying?

“The mortgage-finance companies and their regulator “are ignoring the market fundamentals of who the buyers are and where the money is,” said Tim Rood, a partner at the Collingwood Group, a housing-finance consultancy. “Right now, investors are treated like pariahs. You want to clear some inventory? Finance them.”

I’ve talked about CoreLogic: strip out foreclosures and other “distressed” sales, U.S. “normal” prices were down just 0.6%.

Here’s an idea that would likely make the current administration cringe: eliminate capital-gains taxes on properties bought as a longer-term investment and converted to rentals, or allow them to accelerate the depreciation of those properties. How about first-time investor tax credits?

2. It’s the topic of cocktail party chatter: the banks are stingy with credit. If you are self-employed, get ready to see the Proctologist. Here’s a good one the WSJ pointed out vis a vie the NY Federal Reserve:

“Fannie and Freddie are pushing banks to repurchase any defaulted loans that they can prove ran afoul of underwriting standards, even if the loan went bad for another reason, such as job loss. The “blanket repurchase regime” has led banks “to focus only on the lowest-risk customers,” said William Dudley, president of the New York Federal Reserve, in a speech this month.”

 3. Write down that debt. Sure, this is about as controversial as granting amnesty to illegal aliens living and working in the USA (which I think we should just do) but if we don’t get give some borrowers a breath of fresh air, they will never get ahead. Mortgage investors and banks should consider reducing debt for more troubled homeowners. After all, they made some of these bad loans and made millions off the process. Look at places like Las Vegas and Phoenix, where more than six in 10 borrowers owe more than their homes are worth. Think outside the box:

“Prof. Wheaton said investors in the loans should be given equity stakes in homes in order to deter all but the most desperate borrowers from seeking relief, and that relief should be limited to borrowers who are deeply underwater.”