The 400 Percent Tax

I have explained how the FDIC-HASP mortgage modification plan massively distorts the supply of income-earning efforts, because its mortgage modification is large and means-tested: its formula implies that an action taken by a borrower to increase his income would increase his housing payment obligation by 31 percent of the income increment. If the affordable payment (i.e., the payment that would comprise 31 percent of income) were re-evaluated monthly, this would amount to a 31 percent marginal tax rate in each month that a modification could occur.

Standard practice determines an affordable payment based on the most recent year’s income, and puts that payment in place for five years. Thus, a marginal dollar earned in the base year raises mortgage payment obligations by 31 cents in each of the following five years, and may also raise payment obligations beyond the five-year modification period.

In what I have previously written on this subject, I ignored the later year terms as would be appropriate if modifications were achieved soley by reducing interest payments (that is, leaving the time path of principal payments unchanged), and interest payments were permitted to jump up to the originally contracted amount when year 5 was over (but note that the U.S. Treasury, 2009, has said “[the] lower interest rate must be kept in place for five years, after which it could gradually be stepped up to the conforming loan rate in place at the time of the modification.”)

At the other extreme, when followed by a modification of purely principal, a marginal dollar earned in the base year raises mortgage payment obligations by 31 cents in every year the loan is outstanding. For example, with 25 years remaining and an interest rate of 6 percent per year, this amounts to a 396 percent marginal tax rate!

It is my impression that interest reductions are the margin used most to modify mortgages, in which case the 396 percent marginal tax rate would not apply. But it does illustrate the point that the 131 percent rate I have been using could be significantly understated.

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About Casey B. Mulligan 76 Articles

Affiliation: University of Chicago

Casey B. Mulligan is a Professor in the Department of Economics. Mulligan first joined the University of Chicago in 1991 as a graduate student, and received his Ph.D. in Economics from the University of Chicago in 1993.

He has also served as a Visiting Professor teaching public economics at Harvard University, Clemson University, and Irving B. Harris Graduate School of Public Policy Studies at the University of Chicago.

Mulligan is author of the 1997 book Parental Priorities and Economic Inequality, which studies economic models of, and statistical evidence on, the intergenerational transmission of economic status. His recent research is concerned with capital and labor taxation, with particular emphasis on tax incidence and positive theories of public policy. His recent work includes Market Responses to the Panic of 2008 (a book-in-process with Chicago graduate student Luke Threinen) and published articles such as “Selection, Investment, and Women’s Relative Wages,” “Deadweight Costs and the Size of Government,” “Do Democracies have Different Public Policies than Nondemocracies?,” “The Extent of the Market and the Supply of Regulation,” “What do Aggregate Consumption Euler Equations Say about the Capital Income Tax Burden?,” and “Public Policies as Specification Errors.” Mulligan has reported on some of these results in the Chicago Tribune, the Chicago Sun-Times, the Wall Street Journal, and the New York Times.

He is affiliated with a number of professional organizations, including the National Bureau of Economic Research, the George J. Stigler Center for the Study of the Economy and the State, and the Population Research Center. He is also the recipient of numerous awards and fellowships, including those from the National Science Foundation, the Alfred P. Sloan Foundation, the Smith- Richardson Foundation, and the John M. Olin Foundation.

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