Government Commission Recommends Ending the Mortgage Interest Deduction

While I have already written about the proposed end of the Mortgage Interest Deduction (MID), most of those posts were admittedly selective, as there was never a serious possibility that it would actually happen. With the release of the Deficit Reduction Commission’s report, the debate has been ratcheted up a notch.

In its current form, the MID allows homeowners to deduct all mortgage interest from their annual tax liability, limited to million for home acquisition debt (for first and second homes) and home equity debt of 0,000. For example, if you paid ,000 in mortgage interest this year and you are in the 35% tax bracket, you can claim a deduction of ,750. Advocates of this deduction argue that it promotes homeownership, while detractors criticize it for being inequitable, economically inefficient, and costly to the federal government.

It is that latter aspect that interested the National Commission on Fiscal Responsibility and Reform, an 18-member, bipartisan commission created by President Obama charged with identifying ways to balance the budget by 2015. It is estimated that the MID will cost the federal government 0 Billion over the next five years in lost tax revenue, a figure that could be halved by some simple modifications. Specifically, the Commission proposed a “12% tax credit toward interest on the first 0,000 of a mortgage — and just on the taxpayer’s primary residence, with no credit for second homes.”

The National Association of Home Builders (NAHB) and the National Association of Realtors (NAR) – lobbying juggernauts – have already unrolled massive advertising campaigns designed to make sure that the MID stays firmly in place. Personally, I think all of their arguments are problematic. For example, they point out that many middle-class borrowers benefit from the current system, but neglect to mention that “75 percent of the entire .5 billion that people saved in taxes from the mortgage interest deduction in 2008 went to individuals or couples making 0,000 or more.”

While arguing that the tax credit promotes home ownership, they fail to account for the fact that home ownership levels are higher in many other countries (like Canada) that don’t offer mortgage interest deductions. Finally, while advancing the (dubious) claim that an elimination of the tax credit would lead to a 15% decline in housing prices, they ignore the implication that housing prices must then be 15% higher than they would be without the credit. Not to mention that borrowers whose home equity is either minimal or negative can hardly be considered homeowners.

Personally, I think it’s obvious that the tax credit in its current form is extremely flawed. It encourages homebuyers to fund their purchases primarily with debt, and rewards them for obtaining larger loans than they otherwise would have. It also unfairly penalizes low-income borrowers and renters, which are forced to pay a larger share of the federal tax pie. Finally, if the NAR is to be believed, it has elevated home prices to a level that is perhaps 15% above equilibrium. Why is this a good thing?

While the WSJ poll above shows that a majority of people believe that the mortgage interest deduction should be either modified or eliminated, it still seems unlikely that it actually will be. The lobbying power of the wealthy – which benefit disproportionately from the tax credit – is too strong. In fact, the Commission’s report has yet to even be ratified by a majority of its members, and as a result, Congress is not even obliged to look at it.

At the very least, the report captured the public’s attention. For the first time since I can remember, people are actually wondering aloud whether the Mortgage Interest Deduction might actually be eliminated.