Today’s tax quotes:
“You want more of something, subsidize it; if you want less, tax it.” Old economic adage.
“Tax subsidies cause Americans to over-invest in oversized homes.” Robert J. Samuelson.
The deduction for mortgage interest has always been at the intersection of the disagreement between the points of view illustrated by the quotations above. The tax code contains a number of provisions that are intended to promote and subsidize homeownership. They include not only the mortgage interest deduction, but the exclusion for capital gains from sales of principal residences, the deduction for state and local property taxes, and a number of others. But it is the mortgage interest deduction that is the most costly, and has drawn the most criticism of the sort stated above by economist Robert J. Samuelson.
With both political parties calling for fundamental tax reform, reform is very likely to be actively considered in the current Congress. And at the forefront of individual tax provisions in the cross hairs is the mortgage interest deduction. On the list of tax expenditures published annually by the Joint Committee on Taxation, it is one of the largest individual tax expenditures, coming in at some $90 billion per year.
The deduction has a history of withstanding attack. It is actively and effectively defended by the National Association of Realtors, the National Association of Home Builders, the Mortgage Banker’s Association, and many others interested in housing. However, the deduction was pared back in 1986 (it is now limited to mortgage debt of no more than $1 million on no more than two homes, plus $100,000 of home equity indebtedness) and is no stranger to calls for repeal or further limitation.
For example, in 2005 President Bush’s advisory commission on tax reform proposed replacing the deduction with a 15% credit (which would have allowed both itemizers and nonitemizers to benefit), but capping the amount of mortgage debt for which the credit would be allowed at the average regional price of housing (which would have produced limits in 2005 ranging from about $227,000 to $412,000).
President Obama has several times suggested that all itemized deductions, including that for mortgage interest, be capped at no greater benefit than that received by taxpayers in the 28% bracket, and a similar limit was included in the recommendations of the President’s tax reform commission in the Spring of 2010.
Most recently, the President’s National Commission on Fiscal Responsibility and Reform issued a widely applauded report in late 2010 that included a number of fundamental tax reform options. Most prominent was a suggestion that all tax expenditures (which would include the mortgage interest deduction) be eliminated in order to reduce rates and simplify the code. The Commission also suggested that if certain deductions, including that for mortgage interest, were considered essential, that they be limited. The mortgage interest deduction would be changed to a 12% tax credit available to all taxpayers (similar to the 2005 Bush commission recommendation), and limited to $500,000 of debt on a principal residence only.
All of these suggestions are likely to be in play in the new Congress.
In addition, a new study illustrates some of the political considerations. Martin A. Sullivan, a tax economist with Tax Analysts, used statistics from the IRS Statistics of Income Division and the Joint Committee on Taxation to compute the average benefit per capita of the mortgage interest deduction in each state. Not surprisingly, Sullivan’s analysis is that states with high incomes and many high-priced homes benefit substantially more from the deduction than states with lower incomes and home prices. For example, the six jurisdictions that benefit the most from the deduction are Maryland, DC, California, Connecticut, Virginia, and New Jersey, while the six states that benefit the least are West Virginia, Mississippi, North and South Dakota, Arkansas and Oklahoma. According to his calculations, the deduction provides only a $102 per capita benefit in West Virginia, with Maryland netting $499 per capita.
These statistics, of course, don’t say anything at all about the relative impact on homeownership and the housing market of the deduction in any particular place. However, they do illustrate the states in which the pain from a limitation on the size of the debt for which interest could be deducted would be the largest, and the states whose political leaders are the most likely allies for defenders of the deduction.
We at Worldwide ERC will be following this issue closely. With the housing market still extremely weak, enacting limits on the benefits of homeownership would seem particularly counterproductive at this time.