I'm reading, sporadically, a book called Reforms at Risk, partly because one of its chapters deals with Freedom to Farm. Another chapter deals with the 1986 tax reform act, the best achievement of Reagan's second term. To describe the logic which connects the tax reform act to the Great Recession:
- in the old days, before the reform act, a taxpayer could include interest on personal loans when she itemized her expenses.
- the tax experts in the Treasury wanted to end itemizing all interest (and to include fringe benefits like employer-paid health insurance in income, but that's a story for another day)
- the experts got shot down before Reagan submitted his proposal to Congress, but the 86 act did end the itemizing of interest on personal loans.
- so one effect of the act was people reduced their personal loans, and increased their loans secured by real estate, because that interest was still deductible. This meant not only reducing the amount of down payments (fewer 20 percent down loans) but also taking out second mortgages, and taking equity out of the house by refinancing for higher amounts.
- so the effect of the 1986 tax reform act was turn up the heat under the housing market by increasing the relative advantage of housing loans. Where once the housing market was just simmering away, over 15 years it came to a rapid boil, and then popped.
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