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Mortgage Interest Deduction: Not A Tax Break For The Middle Class

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Flickr: TexasExplorer98
Flickr: TexasExplorer98

As Washington searches for ways to drum up tax revenues in a bid to avert the fiscal cliff, the interest deduction some homeowners claim on their mortgages may be on the chopping block.

The possibility that this deduction might go away has prompted the sort of dire warnings that might be reserved for news that the American flag will lose its stars and stripes: The housing market, finally recovering from a long decline, will plunge anew as values fall. People won't buy as many homes. Middle-class families will suffer and despair.

But this view, voiced with the most conviction by lobbyists for home builders and real estate agents, simply isn't grounded in reality. The deduction helps some middle-class families to a modest degree, but it is mostly a giant giveaway to the wealthy. Moreover, there's no evidence to suggest home prices would crash or people would suddenly choose renting over buying if it went away.

"It's time to take a closer look," said John Taylor, the president of the National Community Reinvestment Coalition, which advocates for low-income borrowers. "This is far and away the government's largest housing subsidy, and it primarily benefits people who are financially comfortable and some people who are extremely financially comfortable."

The mortgage interest deduction dates to the establishment of the federal income tax in 1913. But there's little evidence to suggest that Congress was thinking of the deduction as an incentive to encourage homeownership. At the time, most kinds of interest were deductible, and the standard deduction was so high that only the wealthy paid any tax at all.

Over subsequent generations, and especially after World War II, the narrative changed: Homebuilders and their allies began to describe the deduction as a stepping-stone to the middle class. Supporters of the deduction continued to cling to this description in arguing against its elimination as part of a budget deal.

"The one tax break most middle-income families in this country can get, unlike everything that's available to the wealthy and the special interests and everybody else, is their mortgage interest deduction," said Rep. Peter DeFazio (D-Ore.) on Wednesday, in an interview on MSNBC, according to Talking Points Memo.

Yet the deduction simply doesn't help that many people. Many low-income homeowners don't claim the credit, because they can't claim enough deductions on their tax filings to make it worthwhile. Renters, of course, are out of luck, as are people who have paid off their mortgage. In fact, just 1 in 4 Americans claimed the benefit on their taxes in 2010, according to the nonprofit Tax Foundation.

While most of those who did are middle-class borrowers -- about two-thirds made less than $200,000 -- homeowners with higher incomes typically saved much more on their tax bills.

According to estimates by the congressional Joint Committee on Taxation, 78 percent of expenses for the mortgage interest and property tax deductions in 2010 went to households with incomes of more than $100,000, and 32 percent went to families with incomes above $200,000.

People with incomes between $40,000 and $75,000 who claim the deduction, save an average of $523 each year in taxes, economists at the University of Pennsylvania found. That's less than $50 a month. Those with incomes greater than $250,000 who claim the deduction save an average of $5,459 on their tax bills, the economists found. That's nearly $500 a month.

The more expensive house, and the bigger the loan, the greater the savings. As The Huffington Post previously reported, Barack and Michelle Obama claimed a $47,564 home mortgage interest deduction on their house in Chicago, which they bought in 2005 for $1.65 million. That equates to a savings of about $13,000 on their federal tax bill.

In recent months, home builders and Realtors have mostly keyed in on a different argument for keeping the deduction: its elimination, especially now with the housing recovery still fragile, would trigger an economic catastrophe.

"[Getting rid of it] would throw the housing sector into turmoil ... and chill the market just as it is trying to recover," said Jerry Howard, CEO of the National Association of Home Builders, in a recent interview with CNN Money.

This argument isn't completely without merit, as the deduction does factor in a small way into home prices. But there are ways to ease into an elimination that could actually provide a short-term boost. Larry Summers, Obama's former economic adviser, suggested this week on "Morning Joe" that phasing out the credit over time would give buyers an incentive to take advantage of a "sale," possibly spurring a buying boom.

The most troubling scenario proposed by supporters of the interest deduction is the proposition that its elimination would cause prospective buyers to rent, and lower the overall rates of homeownership. This would be a blow to what has been marketed for years as a necessary pillar of the American dream, they said.

Leaving aside the question of whether promoting homeownership is good government policy -- housing experts said they simply don't believe people make buying decisions based on whether they might claim a deduction on the interest they pay each year.

"For most working-class families the mortgage deduction never comes up," Taylor said. "I know people are freaking out about this, but people buy houses in order to have a stable home environment and to build equity."

There's also historical precedent that suggests people won't stop borrowing money to buy houses if they can no longer write off that interest. In 1986, Congress eliminated interest deductions on credit card and auto loan debt, without damaging the market for either. Indeed, credit card debt soared over the subsequent two decades.

Moreover, in countries with comparable economies that don't give homeowners a tax break, homeownership rates are roughly the same as they are in the United States.

Most likely, the mortgage deduction will stay, in some form. The deficit reduction commission led by former Sen. Alan Simpson and former White House Chief of Staff Erskine Bowles proposed reducing the limit on the deduction to $500,000 of a home's value, down from $1 million, and eliminating the tax break for a second home -- options that seem likely to attract broad support.

The Obama administration has also proposed a cap on deductions at 28 percent for high-income households. This could force homeowners to choose between claiming a mortgage debt or some other kind of deduction. In either scenario, middle-class homeowners would retain their tax credit.

Though still not the most equitable distribution of tax relief -- renters and low-income homeowners would still be out of luck -- this option would at least put a dent in the $83 billion or so each year the deduction costs the federal government without effectively raising taxes on many middle-class families. No flag desecration required.