The Real Story…
News and commentary about the real estate market and related topics.
Dave Parrish, ABR®, CSP, GRI, ePRO®,REALTOR ®, RE/MAX MarketPlace
The opinions expressed here are my own and don’t necessarily represent those of RE/MAX International.
Is the Mortgage Interest Deduction in Jeopardy? (Part -1)
Over the course of the last several years there has been increasing attention focused on the nation’s ever increasing debt. The consensus is something has to be done… With that in mind the job of the Bi-Partisan Deficit Commission (National Commission on Fiscal Responsibility and Reform) has been given a serious and challenging task to move the nation from the status quo toward fiscal responsibility. The problem is that no one seems to be willing to have the corrections or reforms impact him or her personally in any fashion that would seem to lessen his or her personal benefits.
One of the sacred cows of the U.S. Tax Code has been the Mortgage Interest Deduction (MID). Approximately 40 million Americans claimed the mortgage interest tax deduction last year. It was estimated by Congress’ Joint Committee on Taxation that between 2009 and 2013, this deduction will allow about $600 billion in potential tax revenue to stay in homeowners’ bank accounts instead of going to the Treasury. In 2009, the tax break was worth over $80 billion to homeowners, or about 2 percent of all federal spending.
Since 1913 the tax code has provided deductibility of interest paid for the purchase of a home. The mortgage interest deduction has long been considered the cornerstone of American housing policy. The belief is that it makes owning a home more attractive, and proponents including the National Association of Realtors (NAR) argue that it helps stabilize neighborhoods by increasing homeownership. But the mortgage interest deduction is up for reconsideration as the country’s deficits continue to mount and its effectiveness is brought under consideration.
Why the Mortgage Interest Deduction (MID) was created
The deduction was added to the tax code with the assumption that it would increase homeownership and stabilize neighborhoods because homeowners are more involved in their communities than renters. That principle was likewise the driving force behind the creation of Fannie Mae, Freddie Mac and FHA.
However, according to a study by the Tax Policy Center, these assumptions aren’t true. It turns out that neither of these assumptions is necessarily true. For instance, for a half century (until the recent real estate boom and bust) home ownership rates in the U.S. have barely budged despite the value of the mortgage interest deduction. Similarly, there is no clear connection between home ownership rates and the availability of mortgage deductions in other countries.
While homeowners are more involved in their communities than renters, this may not be a cause and effect relationship. Does owning a home change people’s feelings about their area, or are the same kind of people who get involved in their communities more likely to buy homes?
There is also the question of who benefits most from the MID. It seems almost impossible to defend the MID on grounds of fairness and equity. The benefit is only realized by people whose income is high enough to warrant itemizing deductions, and its value rises with their tax bracket… that is the more you make the more you get to deduct.
A study for the Urban Institute and Tax Policy Center by Eric Toder, Margery Austin Turner, Katherine Lim and Liza Getsinger estimates that its elimination would cost the average household an average of $559 more per year in tax. But the impact is highly progressive: for bottom quintile the average increase would be just $2 or 0.01% of after tax income; for the middle quintile, $215 or 0.49% of income; and for those in the top quintiles minus the very richest 1%, it would average $1,723 to $4,234, or 1.59% to 1.63%. Only for the richest 1% does its relative importance decline.
The study notes that the MID has not been found to increase home ownership, which makes intuitive sense: the families that benefit most are precisely those most able and likely to buy a home regardless of the tax treatment. It only encourages them to buy larger homes, and to do so with more debt; anyone who pays off their mortgage gets no benefit.
Is a tax deduction the most efficient and equitable way to accomplish goals
The deduction, whether it accomplishes its goals or not, is hardly the most efficient mechanism for doing so. The mortgage interest deduction confers the highest benefits on those who would probably buy homes anyway: the wealthiest segments of society. Economists James Poterba and Todd Sinai figured that it saves about $523 per year for those earning between $40,000 and $75,000, and $5,459 per year for taxpayers earning over $250,000. Those with the lowest incomes don’t generally itemize, so they get no benefit at all from the tax deduction.
While it is true that homeowners with larger and relatively young mortgages who itemize deductions do enjoy the tax benefits of an interest deduction (mortgage subsidy), subsidies for home ownership are of questionable value in increasing homeownership. If we are to have subsidies, as a means of increasing homeownership, it makes more economic sense to target those with lower incomes in a way that those benefits could actually be realized. Perhaps a better way would be to replace the deduction with a tax credit so that the benefit can be accessed without the need to itemize deductions and does not increase disproportionately for higher income earners who are not in need of subsidies to afford homeownership.
Next week we will look at the actual proposals of the Bi-Partisan Deficit Reduction Commission and what is likely to happen.
Until then… May the Market be with you.
