At least initially the stock market skyed higher over Congress’s down-to-the-wire fiscal cliff vote, but really does raising taxes and putting off dealing with deficit cuts for another two months diminish uncertainty and discomfort about the future course of the U.S. economy? Reality needs to hit home.
Taxes will go up on everyone—the debate focused on the higher income tax rates for the miniscule top fraction of income earners, but payroll taxes will increase across the board. Now taxes had to be raised to deal with the deficit, but that means the average American will have less to spend all the rhetoric aside about protecting the middle class. Given the ongoing rocky recovery, higher taxes will hardly provide a further stimulus to keep growth on track. Maybe we can sustain a 2% advance under the circumstances, but that would be historically anemic.
And next will come the likely difficult debate over significant necessary government spending cuts and possibly tax reform– a process only delayed—probably wrapped in another unseemly and likely treacherous confrontation over lifting the debt ceiling. Slashing government spending will mean less money pumped into all sorts of jobs creating programs led by defense. And any real tax reform, which closes loopholes, would mean higher taxes for many businesses and investors, who bewail the overall high U.S. corporate tax rate, but end up paying a good deal less.
In the real estate industry, the so-called “carried interest tax loophole” is one of the most precious and not surprisingly escaped any reformulation in the fiscal cliff brouhaha thanks to effective lobbying. The carried interest provision allows hedge fund managers and investment firm executives to have the profits from the sale of a company taxed at the capital gains rate (which now increases from 15% to 20%) instead of the traditional income tax rate (increasing to 39.6% for top earners). Real estate private equity investors argue this treatment is fair because of the risks they take. But most of the risk is with other people’s capital, not their own, and so why shouldn’t they pay ordinary compensation taxes?
Now you can bet that protecting carried interest will be front and center in the next round of deficit reduction and tax reform negotiations with powerful groups, including real estate lobbyists, angling to preserve it. The big mockers will bewail just having to pay more in capital gains. But the trend line is clear—real estate investors and their managers will be squeezed more at tax time—it’s just a matter of by how much. Everybody in our industry will have to dig deeper and pay more to the government. And then on the housing front, what happens to the mortgage interest deduction? There are good arguments to phase that out entirely or at least eliminate it on second homes—perish the thought among resort developers, most of whom are already flat on their backs.
The Era of Less means just that except when it comes to paying taxes.