The Republican tax-reform plan, if adopted, would put on the chopping block some cherished tax deductions—perhaps none more so than the $80 billion mortgage-interest deduction (MID) on residences, which mostly benefits affluent homeowners. As the various bills under consideration propose, the deduction should be pruned or eliminated—not just because it is inequitable but also because it distorts the housing market.
Currently, a taxpayer can deduct interest on a mortgage up to $1.1 million—substantially more than the median U.S. home value ($203,000). Not surprisingly, the Government Accountability Office has found that higher-income households are generally more likely to use the mortgage-interest and property-tax deductions. In 2008, the most recent tax year for which data are available, taxpayers with adjusted gross incomes of $100,000 or more “accounted for 13 percent of all returns but claimed nearly half (47 percent) of all mortgage interest and property tax deductions.” The mortgage deduction is larger than the break for state and local tax deductions or for charitable deductions, and it’s one of the largest tax breaks at a time when tax-code writers need to find “offsets” to reduce the burdensome corporate tax.
The core problem with the MID, though, lies in how it affects housing markets. Inevitably, any policy that provides a tax reduction for those who buy or own homes increases the price of housing, through the implicit promise that the tax code will lower the effective house payments. MID supporters say that it encourages homeownership, but the Urban Institute finds that it mostly “rewards affluent households who would have bought homes anyway,” giving these homeowners “incentives to buy more expensive homes, take out larger mortgages, and buy vacation homes (whose mortgage interest is also deductible).”
The effects on home prices vary by city, but there’s good evidence that cutting back the MID would lower prices in high-cost areas, where newcomers find it difficult to move nowadays. Benjamin Harris, who served as chief economist for former vice president Joseph Biden, wrote in a doctoral dissertation that abolishing the MID “would lead to a 28 percent decline in metropolitan-area housing prices in cities where the average taxpayer buying a new house is in the 35 percent tax bracket.”
Neither the House nor Senate proposes to eliminate the MID completely. The House bill would significantly cut back the ceiling on the value of mortgage interest eligible for deduction to just $500,000. And by increasing the standard deduction, both the House and Senate bills will make it less likely that taxpayers will itemize their deductions, including the MID—thus reducing its long-term political support.
Not surprisingly, the homebuilders lobby—among the hardiest of Washington swamp creatures—is fighting the proposal. “This plan will hurt millions of hard-working American families and marginalize homeownership,” says Granger McDonald, a Texas developer who chairs the National Association of Home Builders. But the typical homeowner in, say, Houston would be unaffected—the New York Times reports that all but 6.5 percent of homes there are worth $500,000 or less; it’s owners of high-end homes in overpriced areas along the coasts who would feel the pinch. In a moment of candor, however, another homebuilding industry executive, Glenn Kelman, who heads the national real estate brokerage firm Redfin, told the Times, “The current tax code favors people who are buying a home versus the rest of America,” he said. “As a captain of industry, I would prefer more tax breaks to help people buy houses, but as a citizen, I realize someone has to pay.” Exactly. Reducing tax deductions that put the U.S. at a competitive disadvantage should not be impeded by a special-interest group that has achieved its purported social goal—homeownership—in the U.S. at a rate (64 percent) that lags that of Canada (67 percent), where mortgage interest is not deductible.
Liberals concerned about tax-code progressivity, along with fiscal hawks worried about the deficit, agree that the MID should be cut; advocates for housing affordability are also on board. Social conservatives who make the case, rightly, that government-subsidized, low-income housing causes collateral social and economic damage shouldn’t throw stones while defending the glass house of the mortgage-interest deduction. Reform is the right choice now.
Photo by Scott Olson/Getty Images