When candidates make policy proposals on the campaign trail, they often sound beneficial but don’t always hold up to closer scrutiny.
Vice President Kamala Harris and former President Donald Trump have both suggested eliminating taxes on tips, which might sound appealing to service workers but could have unintended consequences and end up helping fewer individuals. As The Brooking Institution points out, 37% of tipped workers do not earn enough to pay federal income tax anyway, so this policy wouldn’t benefit them.
Another recent example is Trump’s suggestion during a speech at the Detroit Economic Club that his administration would make car loan interest fully tax deductible.
On the surface, this type of move sounds like it would help people’s finances on a widespread basis, even more than a niche issue like tips. In all, Americans have $1.63 trillion in auto loan debt across over 100 million loans, according to the New York Fed.
However, depending on how the deduction is structured, it could be irrelevant for most and even end up hurting some.
“The devil is in the details,” said Francine Lipman, a CPA and professor at UNLV’s William S. Boyd School of Law, specializing in tax law.
Standard deduction vs. itemized deductions
Although specialized tax deductions like this sound good, it’s hard to take advantage of them in practicality. That’s because many of these deductions can only be taken if you’re itemizing, meaning you’re adding up all of your tax-deductible spending like state and local taxes, mortgage interest and charitable contributions.
However, the standard deduction that anyone can take for tax year 2024 — regardless of spending or income — is $29,200 for married couples ($14,600 for single filers). Unless your itemized deductions are more than the standard deduction, it makes no financial sense to itemize. You can’t take both — it’s one or the other — so roughly 90% of Americans take the standard deduction.
Meanwhile, for the approximately 10% of Americans who do itemize, they tend to be very high-net-worth individuals who buy cars with cash, rather than having to borrow money, said Lipman.
Making car loan interest tax deductible might sound appealing, but likely would not change most people’s tax situations
Thus, while making car loan interest tax deductible might sound appealing, it likely would not change most people’s tax situations.
“This is yet another proposal that on its face appears to be beneficial, but for anyone who understands the tax system, it’s actually misleading, because it then makes someone think they’re getting a benefit that they’re not,” said Lipman.
Many taxpayers are “going to think they get a tax deduction, and so maybe they will be more inclined to finance a car…and so they’ll be making bad economic decisions because they don’t really understand the way this benefit or lack thereof works,” she added.
Even if you were close to reaching the threshold where itemizing makes more sense than taking the standard deduction, and now deducting car loan interest could put you over the edge, you won’t necessarily get the full benefit.
Suppose you normally had $28,000 in itemized deductions, so you would instead take the standard deduction for married couples at $29,200. If you also had $2,000 in car loan interest to add to your itemized amount, you’d be at $30,000 in deductions and thus would itemize.
Yet you’re only netting $800 more in deductions, not the full $2,000 in car loan interest, based on the difference between itemized vs. standard deductions. Of that $800, you’re only saving a fraction because it’s a tax deduction, not a credit — at a 20% tax rate, you’d save $160.
“It’s just such a marginal difference that pushing people to an automobile loan” is often not in their best interest, said Lipman.
An exception could be if a law ends up being written in a way that allows for the tax deduction to be taken as a so-called above-the-line adjustment, which essentially allows the deduction to be taken in addition to the standard deduction. However, the Trump campaign has provided no details in this regard, and historical precedence shows this is unlikely to happen.
For one, personal interest — including car loan interest — used to be tax deductible only for those who itemized, but the Tax Reform Act of 1986 under former President Ronald Reagan got rid of this deduction, in part because most people take the standard deduction anyway.
During Trump’s presidency, the Tax Cut and Jobs Act of 2017 raised the standard deduction and cut many deductions that used to be eligible for itemizing, so it would be a departure from his and other Republicans’ tax policies to create an above-the-line adjustment for car loan interest.
Even if the law allows for an above-the-line deduction, that might not be worth it for many Americans either, as that could create a risk of someone taking out a car loan to the detriment of their finances.
The risk of chasing a tax break
Trump, looking to court union members and working-class voters, has suggested that fully deductible interest on auto loans would stimulate the industry. However, that would likely rely on more people buying new cars or increasing the frequency of buying new cars, which isn’t necessarily something that most people can afford.
“Even if the interest is deductible, you’re still paying the interest, it’s just deductible at your tax rate,” so you’re effectively only getting some of that money back, said Jason Runung, CFP, senior financial advisor, VP at Summit Wealth Group.
For example, if you paid $10,000 in interest and your effective tax rate is 20%, that means you’re only getting $2,000 worth of tax savings, while you’re still paying an additional $8,000 more than if you didn’t have that extra interest, he said.
Although some may say that buying a new car would have happened anyway, so you might as well get the tax break, the reality is that people frequently convince themselves that financial “wants” are financial “needs.” Odds are, you could make do with a much less expensive car that you can buy outright, rather than going into debt for it.
In general, car payments “should represent a maximum of 10% of your monthly budget,” said Runung. You should also dig into the numbers regardless of the budget percentage to make sure you’re not overextending yourself with debt, he added.
Plus, with cars, taking out a loan typically means you’re losing money. For one, interest rates are usually higher than they are for assets like homes. Keeping low-rate mortgage debt might enable you to earn more on your cash than if you paid that debt down quickly, but it’s harder to do the same with car loan debt. Worse, cars typically lose value quickly, so after you’ve paid off the loan, you might not have much to show for it, compared to a home that you can often sell for more than what you paid.
A car “is a depreciating asset,” said Runung. “They tend to drop in price rather aggressively.”
So, even with a tax break, you could be costing yourself more in the long run than if you were more conservative with your car spending and instead focused on growing your savings and investments.
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