Losing and Winning with Tax Reform

My informal and unscientific polling leads me to conclude that Scarsdale residents believe that our village, county and school property taxes should be deductible from our state and federal income taxes. We as a group feel that the same income should not be taxed multiple times, and that it is at the local level where our tax payments benefit us most directly (and where we have the most control over taxing and spending). And we generally feel that the belt-tightening imposed on us by Albany and Washington is not accompanied by commensurate belt-tightening from those geographies.

Unfortunately, save for $10,000 of the total of our state and local income and property tax levies, that deductibility from our federal tax obligation is gone. And for the majority of our homeowners whose deductions have not been entirely eliminated by the alternative minimum tax, this is very bad news. With Westchester being home to the country’s largest property-tax burden, Scarsdale’s median property tax bill is among the top five villages in in the county at $30,621. Losing deductibility will cost our median homeowner about $9,800 per year assuming they pay at the 32% marginal tax rate (i.e., assuming median Scarsdale income as well as home value). Suddenly, it costs a lot more to live in Scarsdale.

In fact, if a new “median” homeowner expects to live in a home for 22 years until junior is out of college (or until the entire brood has graduated from SHS), that’s about $216,000 of cost increase due to tax reform. All else equal, this must necessarily lower our housing prices, as demand falls at every given level of purchase price and supply increases at every level of selling price. In Econ 1A terms, the supply curve shifts rightward and the demand curve shifts leftward. It is interesting (but not conclusive) to note that the Julia Fee Sotheby’s April 2018 Market Report indicates that the monthly supply of single-family houses for sale increased 109.7% from a year earlier (323 vs. 154) and total homes sold year-to-date has fallen 31.9% from year ago levels. Given this, it's not surprising that average price per square foot has also fallen 5.1% from year ago levels.

It's doubly cruel that tax reform both increased our costs of staying put and decreased the sales price we can expect if we flee these increased costs.

Lisa and I are going to stay in Scarsdale – the only good reason to sell now (except for those who absolutely must for personal reasons) is that it’s likely that some potential homebuyers are also buying into a scheme resolved recently by the Scarsdale Board of Trustees. This resolution authorizes creation of a charitable gift reserve fund that will give donors a credit of up to 95% of their donation against New York State income taxes and/or Scarsdale property taxes. And such donation in theory will be deductible against federal income taxes thus maintaining property values at pre-tax reform levels. Personally, I see no way this is going to fly with the US Treasury. However, let’s not disabuse potential buyers of the soundness of this theory. It’s likely that the local housing market has not yet fully absorbed the implications of tax reform and may not until April 2019, and as homeowners we needn’t accelerate the learning process to the detriment of our friends hoping to sell at favorable prices.

So how is my family going to cope with this increase in the cost of living in Scarsdale? Of course, the Voters Choice Party (VCP) will continue to lobby for more responsible fiscal policies on the part of Scarsdale taxation authorities and for more accountability on their parts for affordable housing for all residents. We will also work to identify taxpayer-funded expenditures that should instead be legitimately covered by 501(c)3 organizations employing pre-tax monies and to find economies by sharing services with neighboring communities. But – on a personal level I am also increasing our allocation to equities in our investment portfolio, and I fully expect gains in those investments to offset losses in the value of our home equity over the long haul during which we expect to remain in our home. While

The Oracle of Omaha has explained the impact of tax reform on the stock market like this: “You had this major change in the silent stockholder, the US government, in American business who has been content with 35%, and now instead of getting a 35% interest in the earnings, they get 21%, and that makes the remaining stock more valuable.” Whereas equity holders were previously paying 35% of their firm’s earnings to the government (and keeping 65%), now they are paying 21% (and keeping 79%). With lower tax rates, corporations will have more after-tax earnings to distribute as dividends and as investors continue to see evidence of the positive effects of tax reform stock prices should rise commensurately. In an early May publication, one prominent US bank suggested that investors overweight their asset allocations toward the stocks of US firms most likely to benefit from lower corporate tax rates. Clearly that would indicate that the market has not fully baked in the benefits of tax reform (Warren Buffet said as much back in January).

I don't generally give investment advice to others (and this is not investment advice – you should certainly discuss changes in your expenses and revenues with your financial advisor), but I’m happy to have shared my family’s approach to being among tax reform’s “Biggest Losers”, and also to being among tax reform’s “Biggest Winners” concurrently. Of course, our property tax losses are written in stone and our equity market winnings are certainly risky at least in the short run. But I do believe the odds are that we’ll come out ahead.

Robert Selvaggio is a long-time Scarsdale resident. He is a graduate of the University of Pennsylvania and holds a Ph.D. in Economics from Brown University where he was a University Fellow. Dr. Selvaggio is a member of the American Economic Association and National Association of Business Economists. He is a BAI Certified Risk Professional in Credit and Treasury/ALM.