Sometimes it is useful to take a step back and look at the claims made against a policy like the mortgage interest deduction (MID). A good example is this column authored by an analyst from the usually informative Tax Policy Center (TPC), which claims that repealing the MID would result in minor tax increases on homeowners. In fact, the impacts, tax and economic, would be significant, particularly at this moment in time, as the economy and the housing markets struggle to recover from the Great Recession.
The author claims that the average tax bill for taxpayers would increase by $700 if the MID were eliminated. This estimate is at odds with the official distributional analysis from the tax expenditure budget (JCS-3-10) of the Congressional Joint Committee on Taxation (JCT). Estimating from the numbers in that document, the average tax benefit for the tens of millions of MID beneficiaries is almost $2,200 per year. For home owners with incomes between $50,000 and $200,000 – the income class of most home buyers and MID benefiting taxpayers – the average benefit is approximately $2,350 per year.
What is responsible for this difference in estimates? It appears the TPC analysts are assuming in their analysis that home owners will sell off financial assets to pay down mortgages that, under MID repeal, now have a higher after-tax interest rate. In so doing, these home owners now have lower income (and taxes paid) because they have shuffled their financial portfolio. This lower income, and tax on that income, offsets the direct tax increase due to the loss of the deduction for mortgage interest. This effect is not mentioned in the text of the column, although TPC acknowledges it as a footnote on its analysis tables. It is nevertheless a real economic loss for home owners, and one that is only available for high wealth taxpayers who are cash rich. Cash-constrained home owners are at a loss.
The column also confuses the tax treatment of principal and interest payments for a mortgage, stating, “…someone in the 35 percent tax bracket pays an after-tax cost of only $65 for every $100 they borrow…” This is incorrect. The deduction is for interest payments, not for principal payments. This is a fundamental issue because it gets to who benefits from the MID. In the early years of an amortizing mortgage (such as the 30 year fixed rate mortgage), home buyers pay mostly interest. Eventually, interest payments decrease and principal payments grow. Analysis of IRS Statistics of Income data confirms this, showing that as a share of household income, younger home buyers have the largest benefits from the MID.
According to the Bureau of Economic Analysis data on mortgage interest payments and IRS data on MID claims, more than 85 percent of all mortgage interest paid over the last decade has been claimed as an itemized deduction, proving wrong the assertion that a surprising number of home owners do not benefit at all. Over the life of their mortgage payments, almost all home owners will benefit from the MID. Keep in mind that 40 percent of home owners own free and clear, and have no mortgage interest payments to claim on a tax form. Such home owners, and those in the final years of a mortgage, are typically older and likely benefited from the MID in the past.
The column also fails to reflect that the MID is, according to the data, a middle class tax break. According to the JCT, 70 percent of the benefits are collected by home owners with incomes of $200,000 or less. And as share of household income (economists typically measure progressivity of tax features according to income), the largest benefits go to households with incomes of less than $200,000 (1.76 percent of adjusted gross income (AGI) for such home owners vs. 1.5 percent of AGI for home owners with more than $200,000). Likewise, larger families also benefit more, as families with children require larger homes.
But in terms of the overall economy, the largest impacts from repealing or restricting the MID would be felt by all 75 million home owners – house price declines. TPC’s own analysis notes that just limiting the MID to a top deduction rate of 28 percent would reduce home prices in metropolitan areas by 7 to 15 percent, let alone the larger impacts that would result from a full repeal. Such dramatic home price declines, for example of 15 percent of all homes, would represent an immediate windfall tax on all home owners, with the largest effects in high cost areas. Such price effects would be terrible short-term macroeconomic policy given the ongoing impacts of the Great Recession.
Finally, the column discusses the impacts of a number of policy options, but ones that do not reflect the proposals of MID opponents. For example, no one is discussing a 20 percent tax credit to replace the MID. The recent national deficit commission that proposed a 12 percent credit, among other more aggressive options. A 2005 tax reform panel proposed a 15 percent credit with lower debt caps. These proposals would represent significant tax increases for home buyers and home owners.
While lowering the MID cap from $1 million to $500,000 may sound reasonable in some parts of the nation, a $700,000 home is a modest single-family home in many high cost areas of the U.S. Such areas would be subject to disproportionate price declines for existing home owners and much higher debt costs for prospective home buyers (those in the middle class who cannot afford to put down a larger downpayment – this proposal puts the squeeze on younger workers in high cost areas who are not cash rich) under any rule that would lower the cap.
There’s a reason why so many home owners, and renters who hope to be home owners, become nervous when they hear discussions about how long-standing tax rules for mortgage interest might be repealed. These rules have large tax and economic impacts, for soon-to-retire baby boomers with wealth in housing, as well as their children who are currently accumulating equity in homes or aspiring to become home owners.
For these reasons, eliminating or restricting the MID would be fundamentally unfair and would have tragic macroeconomic effects. For more information on some NAHB’s recent estimates concering the MID, consult the following linked paper.