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Mikulski's Incentive Plan To Increase Personal Debt

9:39 AM, Feb 9, 2009 • By JIM PREVOR
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Senator Barbara Mikulski succeeded in getting the Senate to incorporate her proposal for a tax break for new car buyers in its version of the stimulus bill:

Interest payments and sales taxes on new autos would become tax deductible under a measure approved. A bill passed by the House does not have a tax break for new car purchases, but the final package that Congress hopes to send President Barack Obama later this month might.

The $11 billion tax break would apply to new cars purchased from November 2008 to through 2009. Individuals with incomes under $125,000 and couples making less than $250,000 would be eligible, regardless of whether they itemize their deductions.

The plan, which applies to cars that cost $49,500 or less, suffers from one of the same flaws that contributed to the whole mortgage crisis. It rewards borrowing rather than simply achieving the policy goal--in this case getting people to buy cars.

Although the sales tax deduction would be the same whether one pays cash or finances, the interest deduction for a no-cash-down five-year self-liquidating loan at 10 percent is $13,603.73. Yet this deduction is only available if one borrows the whole cost of the car. If you pay cash, you get nothing. Even assuming that getting people to buy cars is a good idea, there is no public policy purpose to encouraging people to take on debt and leave their savings in a money market fund.

One of the subtexts of the mortgage crisis is how people came to have so little equity in their homes to begin with. In part the answer is that the national desire to promote home ownership was expressed through the mortgage interest deduction as opposed to a straight credit for home ownership. This led people who normally would have preferred to put down more cash to max out their mortgage borrowing.

Many people refinanced or tapped a home equity line of credit to pay off credit card bills or start a small business, etc., because then the interest would be tax deductible.

It is not clear if the Republicans learned this lesson or that, since home mortgage interest is already deductible, they had to come up with something different, but at least the Republican proposal, also incorporated in the Senate version of the stimulus bill, to offer a $15,000 incentive to buy a house is a flat credit, equally valuable whether one pays cash or borrows.

Whether bucking up failing industries is a good idea is debatable. If we are going to do it, however, we should stick to rewarding what we are looking to encourage and not encourage already overburdened consumers to take on more debt.