Sunday, March 7, 2010

Brute Force Recovery

I summarize an article from Scripps Howard News Service in today's local paper:

A homeowner in these hard times still owes over $390,000 on the house ("after 14 years"), sells the house for about $188,000, and the bank forgives over $202,000 of the homeowner's debt. The homeowner asks "How much of this amount is taxable?"

Debt adviser Steve Bucci replies that "normally" any forgiven debt over $600 must be treated "as income that's fully taxable even though you received no cash."

But these are not "normal" times. "Because so many people were faced with potentially huge tax liabilities through debt forgiveness," Bucci says, "Congress passed an act that exempted a forgiven mortgage loan from taxation."

(Bucci notes time and circumstance constraints on the exemption; I omit these in order to focus on his central issue: the taxation of forgiven debt.)

So. This act that Congress passed -- the Mortgage Debt Relief Act of 2007 -- makes allowance for particularly bad economic conditions by canceling the tax on forgiven debt, a tax that presumably makes sense in better economic times.

In other words, things are so bad Congress had to take steps to prevent a normal tax policy from making things worse. We're in such a hole that something had to be done about the debt forgiveness tax.

Okay. I'm glad they did it. But I have a problem here. Let me ask a simple question: What are they trying to accomplish? Are they trying to keep a bad situation from getting worse? Or are they trying to turn it around and make things better?

If we only want to keep a bad situation from getting worse, the Mortgage Debt Relief Act is just what we need: Let things get so bad that "so many people" are faced with "huge tax liabilities" from debt forgiveness, and then cancel some of those tax liabilities to prevent things from getting a lot worse.

But if we want to turn the situation around and make it better, the Act falls far short. People have been borrowing and accumulating debt for decades now, until the load finally became unsupportable and our economy gave out.

To prevent things from getting worse, you cancel a tax that would really hurt a lot of people that are really hurting already.

To make things better, you admit you made mistakes in your policy decisions, and you start cutting down on accumulated debt any way you can. You cut debt and cut it until you have sure signs that the economy is solidly improving. And you make sure nobody has to deal with huge tax liabilities arising from your solution. You establish recovery by brute force.

It's not difficult, after we get past admitting that mistakes were made.

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