Tax Break for Auto Purchases

The proposed stimulus plan includes some incentives for new car purchases by giving a tax deduction for the sales and excise taxes on the vehicle as an above-the -line deduction (Stimulus: How It May Affect Your Wallet). There is a phase out for those making more than $75,000 per year ($150,000 for dual income couples). The original proposal also included write-offs for loan interest on new auto purchases. Who will the tax break benefit?

As to the plight of the auto manufacturers, there is serious doubt whether such a modest incentive will have any meaningful effect. For starters, the benefit to a family purchasing a new auto in the mid-$20,000 range who is under the phase-out income level will only save about $400 on their taxes. This level of tax benefit is not likely to send droves of consumers out to purchase new autos. And should they? Time magazine released its Twenty-Five People to Blame for the Financial Crisis and included consumers on the list. Consumers are rightly faulted for living beyond their means to a whopping 130% of income.

It might be good to worry if the Congress had gone for the tax write-off on the loan interest for car purchases. Tax-deductible or not, many consumers purchasing new autos would simply be incurring new debt that they might not be in a position to repay. Kathleen Keest wrote today on CreditSlips about The Other Underwater Loans: Negative Equity in Auto Finance. Kathleen cautions against the practice of rolling over the remaining loan on a trade-in auto into the new car purchase which results in a LTV of 120-140% on many auto loans, which Kathleen dubs "Drive One, Pay for Two" practice. The estimate that 25% of car loans may be underwater actually seems low to me. With all the talk of stimulus packages and TARP monies, the major thing still lacking is a new thinking about lending practices. While giving consumers tax breaks for auto purchases might increase the number of purchases made, I remain unconvinced that tax breaks focused on loan interest will ultimately benefit the American consumer. This is particularly true when the purchase may include for some consumers the negative equity from their prior auto.

Add to all of this the risk associated with car loans which is still hampering the issuance of such loans and the forecast remains gloomy for the auto industry.

— JSM