Eliminating The Mortgage Interest Deduction: Mission Impossible
Over the past several years, faced with significant government spending deficits and debt, debate has arisen over whether the mortgage interest deduction should be eliminated or phased out as a means to generate income for the federal government. While there is disagreement over whom the deduction benefits and whether it is useful in encouraging home ownership, there is no disagreement that its existence plays a significant role in the economy and price of home ownership. Elimination of the deduction will unquestionably have a disparate effect on both home values and the economy generally. That effect can only be offset by other tax incentives. Practically speaking, it is highly unlikely that any elected government entity will knowingly support a measure that will tank real estate prices by over 10% and eliminate jobs, and therefore the mortgage interest deduction is most certainly here to stay.
Origins of the Mortgage Interest Deduction
The mortgage interest deduction has its roots in 1913, when Congress first introduced Income Tax and approved the deduction of interest on all loans. At that time, according to the New York Times, the purpose of the deduction was to benefit business owners, not home owners. The interest deduction was eliminated in 1986, but an exception was created for mortgage interest. Now, the mortgage interest deduction is codified in Section 163(h) of the Internal Revenue Code. It now allows mortgage interest on a principal residence or second home to be deducted from taxable income. The deduction has a cap of $1 million of debt on which the deduction can accrue.
Debate Over The Mortgage Interest Deduction
There is little consensus over the benefits of the mortgage interest deduction and its effect on the housing market and economy.
Supporters of the mortgage interest deduction assert it encourages home ownership by making homes more affordable, provides a stepping-stone for the middle-class by making home ownership more attainable, and helps families build equity in their homes. The benefit to taxpayers is significant – homeowners in 2013 received a total of approximately $70 billion in federal tax breaks through the mortgage interest deduction. According to the National Association of Home Builders, the deduction is supported by a majority of voters, including a majority of renters who do not have access to the deduction, and has bipartisan support. The National Association of Realtors “opposes any changes that would limit or undermine current law” with respect to the mortgage interest deduction.
Opposition to the mortgage interest deduction often asserts that it actually does nothing to encourage home ownership. Recent articles in the Wall Street Journal and New York Times both pointed to Canada, Australia, and England, countries that do not provide for the mortgage interest deduction but have home ownership rates similar to the United States, as evidence that the mortgage interest deduction does not necessarily encourage home ownership. While this may be true, it ignores the fact that those countries have other tax structures that incentivize home ownership. Moreover, the mortgage interest deduction was never available in those countries to begin with, and so they do not provide any insight into what would happen to the economy, or the real estate market, by eliminating a deduction worth over $70 billion annually to American taxpayers.
Those opposed to the mortgage interest deduction also claim that it only supports the wealthy. Some assert that only the wealthiest 1/3 of taxpayers itemize their deductions, and therefore only the wealthiest 1/3 benefit from the mortgage interest deduction. Of course, this ignores the fact that approximately 1/2 of Americans (43% according to the Tax Policy Center) do not pay any federal income tax, and so it should be obvious that they have no need for the mortgage interest deduction. Assuming, for simplicity, that the approximate numbers of 1/3 and 1/2 are accurate, then the mortgage interest deduction is actually utilized by ⅔ of American taxpayers – not an insignificant number.
Why The Mortgage Interest Deduction Is Here To Stay
While the extent and precise effect of elimination of the mortgage interest deduction is unclear, it is undisputed that its elimination will significantly impact not only housing prices, but also the economy as a whole. According to the New York Times’ article supporting elimination of the mortgage interest deduction, prices at the “upper end” of the housing spectrum would drop between 10 to 15 percent, while prices of less expensive homes “would probably rise a bit”. According to the Tax Foundation, a nonpartisan research foundation, elimination of the deduction would shrink the economy by $254 billion, eliminate 659,000 jobs, and drop wages by 1.1%. Thus, elimination of the mortgage interest deduction is a significant change that must not be considered lightly.
However, the relevant questions are actually much different from those surrounding the economic impact of the deduction. The true relevant questions are: (a) will any elected body of government be competent enough to put together an overarching tax reform that will eliminate the mortgage interest deduction and offset the disparate impact of its elimination with corresponding tax incentives and (b) is any body of government willing to take the risks inherent with putting together such a policy? The answer to (a) is “probably not”, while the answer to (b) is most certainly “no”. Accordingly, so long as the decision remains in the hands of a government reliant on public approval for reelection, it is safe to assume that the mortgage interest deduction is here to stay.
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