Although President Obama's bipartisan debt-reduction commission did not reach agreement today, their report has made clear to all that major changes in public policy are needed to solve our country's fiscal problems. Many of the proposed changes are considered too extreme by people on both ends of the political spectrum. But there has been remarkable accord among tax and policy experts from the left, right, and middle about one provision: reforming the tax deduction for mortgage interest.
The mortgage interest deduction in its current form is extremely expensive and does little good, the definition of a wasteful government program. Despite the popularity of the deduction among taxpayers and its ferocious defense by the housing industry, this is one public policy whose day of reckoning is long overdue.
To review, the mortgage interest deduction currently provides a tax incentive to borrow up to $1.1 million in mortgage debt when buying a home (or two). The family or individual who takes out a home mortgage pays interest to the lenders, which the lenders keep. The federal government then gives some of the interest back to some of the homeowners. The amount is between 15 cents (for those in the lowest tax bracket) and 35 cents (for those in the highest) for every dollar of interest paid.
Because this program is a tax expenditure, most Americans do not understand its cost. The interest goes to the banks and the benefit is paid by the government, so the deduction is really government spending on a mortgage subsidy program. In 2011, the program will cost $104.6 billion, two and a half times the money Congress appropriates for the US Department of Housing and Urban Development (HUD). Unlike HUD programs, the mortgage interest deduction provides the biggest subsidies to the highest income borrowers who take out the most expensive loans
Moreover, many Americans with mortgages do not benefit from the deduction. Forty-six percent of homeowners do not get the deduction because they have paid off their mortgages, they do not itemize on their tax returns, or they are very low income. Since still more households own their homes free and clear or are renters, 76% of all taxpayers do not benefit from the mortgage interest deduction at all.
Not only is the mortgage interest deduction regressive and costly, it encourages Americans to mortgage their homes to the hilt. What's worse, its value to prospective homebuyers is largely capitalized into the price of housing, making home buying more expensive than it would be otherwise. This price effect is particularly strong where markets are tighter and middle class people must take out bigger mortgages in order to purchase homes. It also puts lower tax bracket households at a disadvantage since they have to pay the same market prices and the same or higher interest rates, but receive fewer cents on the dollar from their deduction.
Over four decades of economics research and policy analysis have shown the influence of this price effect and further concluded that the mortgage interest deduction does not increase the homeownership rate among low and middle income households. Indeed, low income homeowners are likely worse off than if there never had been a mortgage interest deduction.
The commission report recommends replacing the mortgage interest deduction with a non-refundable tax credit available to all mortgage holders, excluding mortgages of more than $500,000, and limiting the types of mortgages for which the credit is given. Such a common sense reform would save tens of billions of dollars a year, dollars that could be used to reduce the deficit and create truly affordable housing opportunities for all Americans.
The National Low Income Housing Coalition proposes to use a one third of the savings from reform to help house the poorest Americans and end homelessness; one third for deficit reduction; and one third for a homeowner tax credit that maximizes the benefit to low income people who must take on a mortgage and work hard to pay it every month.
Many thoughtful people recognize that our country can no longer afford this out-sized, ineffective, and unfair subsidy to the housing industry. It is time for Congress to do the same.