This tax is affecting many middle-class borrowers and pushing many into bankruptcy. But it is unfair and inconsistent with fundamental tax principles.

The decline in value should just be considered a "capital loss," rather than income. The reason that cancellation of debt counts as income is that the Code assumes that debt is used to finance consumption.

Where did you get this idea? You should first understand why the original loan proceeds are not income: it is because the borrower has promised to repay them. Consequently, when subsequent events allow portions of the debt to be forgiven, the borrower is no longer obligated to repay proceeds that he or she had previously received. So it's income. Whether loan proceeds are used for consumption, investment, or curing cancer is irrelevant; all that is relevant is that one borrowed money and didn't include the loan proceeds in income, and thereafter was forgiven for some or all of the debt. That's the fundamental tax principle. And part of the problem you raise is addressed by sec. 108 of the Internal Revenue Code, which provides that debt forgiven in a bankruptcy proceeding is not income.

In terms of your argument that the forgiven debt should be a "capital loss," "Purple State" is correct that the loan and the home are considered separately for tax purposes. The parties from the NY Times article may have both capital losses and cancellation of debt income. If one borrows $500K to purchase an investment home for $500K, and then sells the home for $350K with the bank forgiving $150K of the debt, the taxpayer has cancellation of indebtedness income of $150K and a capital loss of $150K. What I think you intend to propose with your "capital loss" argument is that the capital loss and the debt cancellation income should be netted out such that there is no income tax consequences to the final transaction.

What strikes me as unfair is that both Democratic candidates are committed to maintaining the capital gains preference in some form (even though the justifications for it are flimsy and it benefits mainly the wealthy), and prominent Democrats like Senator Chuck Schumer have equivocated on taxing the earnings of hedge fund managers as ordinary income. (Not to mention that Social Security taxes are still only paid on the first $90,000 of income and that Democrats do not uniformly support lifting that cap.)

The tax consequences of debt cancellation are the same for leveraged real estate investors and leveraged hedge funds. I'm not sure I understand your "unfairness" argument. [I'll leave the debate about hedge fund "carried interest" tax rates for another day.]

Lastly, you and "Jeannie See" are both mistaken: the cap on OASDI for 2008 is at $102,000 of wage income.

Posted at May 30, 2008 9:34 PM in response to A Huge (and Unfair) Tax Bill on Top of Foreclosure

To use Elizabeth Drew's term, it's more "molehill politics" from the Clinton campaign. That's when a candidate adopts mock outrage over nonsense to create a phony media issue. It's nauseating.

First, Sen. Clinton tried to make an issue of Sen. Obama's (correct) observation that Pres. Reagan was more transformative than Pres. Clinton, as though Obama was Alex P. Keaton in disguise. Didn't stick.

Then Pres. Clinton's comments in South Carolina. Oops, that stuck. On Sen. Clinton.

The Clinton campaign then tried to convince us that only big states that she wins really matter. Didn't stick.

Caucuses don't count? Didn't stick.

"Empty suit" who only uses words? Didn't stick.

Plagiarism? Amusing, but didn't stick.

Now this non-issue about "bitterness." If this sticks, then we deserve the government we elect.

Posted at April 15, 2008 12:20 AM in response to Hillary Airs New Ad In Pennsylvania Hitting Obama's "Small-Town" Comments

It's about time. The administration's position has been to ignore subpoenas and make blanket claims of privilege without providing logs or details as to why items are privileges. The missing RNC emails by White House employees are an outrage. If Congress permits this to stand, then it would never have any oversight over the activities of the Executive Branch. No checks, no balances, no accountability = door open to authoritarianism.

Posted at March 10, 2008 1:13 PM in response to House Panel Files Suit against White House

Dr. Baker:

Thanks for your insightful comments. I happen to agree with you here; the collapse of housing is having an substantial effect on consumer spending and the financial system. In contrast, the costs of a war can be deferred for a time through borrowing.

With regard to the current housing crisis, I recall reading your CEPR report from mid-2003, warning about the growing housing bubble and the departure of house prices from historical price/income ratios. You made the right call early on and stuck with it. If more folks had listened to you, we wouldn't be in the mess we're in.

Posted at March 9, 2008 10:22 PM in response to The Recession: It's the Housing Bubble, Not the War