As the Senate examines existing tax policies as part of its “blank slate” approach to tax reform, and as the House Ways and Means Committee continues its review of the tax code, it is appropriate to keep in mind the importance of the mortgage interest deduction (MID) as a middle-class tax provision that makes it possible for many families to achieve homeownership. It is also useful to review some of the claims against the MID to determine if those claims are valid. Over the past few years, using data from the IRS and the Census Bureau as well as estimates from other sources, we have assessed the validity of these claims. This information also formed the basis of NAHB testimony on housing tax policy before the Senate Finance Committee in October 2011 and the House Ways and Means Committee in April 2013.
Claim #1: The wealthy get most of the benefit from the mortgage interest deduction.
Fact: The majority of the tax benefits from the MID go to middle-class households. Data from the Congressional Joint Committee on Taxation shows that 86 percent of households who benefit from the mortgage interest deduction have incomes of less than $200,000. It is also useful to keep in mind that the majority of home owning households are married couples, so the household income measure will often include two incomes.
Claim #2: Repealing the mortgage interest deduction would not damage the economy or individual households.
Fact: Almost all studies examining the elimination of the mortgage interest deduction find that it would reduce demand for housing by raising taxes on prospective home buyers. This reduction in housing demand would also lower home values for existing home owners who would experience a significant loss in wealth.
A 1 percent decline in home prices would result in a loss of $185 billion to American households. Just a 6 percent decline would eliminate $1 trillion in household net worth. If repealing the deduction lowered prices by 10 percent or more, Americans would lose trillions of dollars in household net worth. If home values fall, then more families will find themselves under water, in default and in foreclosure. Eliminating the mortgage interest deduction would reduce the financial resources families can draw on for education, entrepreneurship and retirement. And if home values fall, then state and local tax revenues fall, making it harder to fund schools, infrastructure, public safety and other important government functions. Repealing the MID would have serious economic consequences.
Claim #3: Only a small percentage of home owners claim the mortgage interest deduction.
Fact: The mortgage interest deduction is broadly claimed. Seventy percent of home owners with a mortgage claim the MID in a given year, and almost all home owners benefit from the deduction at some point during their homeownership lifecycle.
The argument that only an estimated “quarter of taxpayers” claim the deduction is misleading because it ignores the lifecycle element of homeownership. Of the two-thirds of households who are home owners, one-third own free-and-clear with no mortgage. And of those with a mortgage who claim the standard deduction in lieu of the MID, many are in the final years of a mortgage and are paying small amounts of interest and greater amounts of principal. In the early years of their mortgage when much greater amounts went to interest, those home owners very likely claimed the mortgage interest deduction.
Claim #4: Repealing the mortgage interest deduction would make the tax code more progressive.
Fact: A progressive tax system is one in which taxpayers with lower incomes pay a smaller share of their earnings in taxes than higher income households. Repealing the mortgage interest deduction would result in larger tax hikes – as a share of household income – for the middle class. For example, for households with less than $200,000 in adjusted gross income (AGI), the typical mortgage interest deduction is worth 1.76 percent of that family’s AGI. For taxpayers reporting more than $200,000 in income, the benefit falls to 1.5 percent of AGI. Thus, in the event of repeal, middle-class home owners face a larger tax hike as a share of their income, making the tax system less progressive.
Claim #5: The mortgage interest deduction incentivizes buyers to purchase a larger home.
Fact: While the mortgage interest deduction is sometimes connected with larger homes, evidence shows that it is more often the case that the tax benefit reflects family size and underlying housing demand. Larger families require larger homes, which in turn means a greater amount of mortgage interest paid and a larger tax benefit. And NAHB analysis of IRS data confirms this. Taxpayers with two personal exemptions (a measure of family size) who claimed the MID had an average tax benefit of $1,500. Taxpayers with four personal exemptions had an average benefit of approximately $1,950. In fact, the benefit increased correspondingly from one personal exemption to five-plus personal exemptions, which is consistent with the notion that larger families require larger homes.
Claim #6: Renters do not support the mortgage interest deduction.
Fact: Public opinion polling has generally found the MID to be popular with renters, most of whom hope to become home owners. Given that recent home buyers receive the greatest tax benefits from the deduction, such renters would have much to lose in case of repeal. A 2012 poll found that a majority of renters were opposed to eliminating the mortgage interest deduction.
Claim #7: Because mortgages on second homes also qualify for the mortgage interest deduction, taxpayers are subsidizing vacation homes for the wealthy.
Fact: The rules relating to second homes are complicated, and often apply to situations that do not involve a vacation home. The rule allows owners who sell their home and buy another – those who own more than one primary residence in a tax year – to claim the MID for both homes on their annual tax return. The rules also allow home owners who are building a new home to claim construction loan interest as a deduction.
And the rules support investment in seasonal residences that provide an economic foundation for many parts of the country. In fact, 49 states in the U.S. have at least one county where more than 10 percent of the housing stock fits the tax definition of a second home. But we are not talking about million-dollar homes on the beach, which are usually paid for in cash or claimed as rental property. According to an analysis of the Consumer Expenditure Survey, the average income of a household with a mortgage on a second home is $71,344.
Claim #8: While the mortgage interest deduction supports homeownership, federal policy neglects renters.
Fact: Housing policy support, in dollar terms, is roughly proportional to the total population living in renter- and owner-occupied homes. For example, the report of the Housing Commission of the Bipartisan Policy Center, which looked at all of the tax and spending programs for rentership and homeownership, found that about one-third of housing policy spending is attributable to rental housing, which is equal to the share of the population living in that form of housing. Such analysis is important because it shines a spotlight on important housing programs for affordable rental housing, including the Low-Income Housing Tax Credit (LIHTC).
Claim #9: Since not all home owners itemize, a credit would be better for the market.
Fact: Identifying winners and losers from moving from an itemized deduction to a credit depends on a number of factors, most importantly the tax credit rate. For example, the Simpson-Bowles report recommended a 12 percent tax credit, meaning a tax benefit of 12 cents for every dollar of qualified mortgage interest paid. A revenue-neutral tax credit would be approximately 20 percent. Thus, such a low rate as 12 percent would represent a significant tax hike for home owners. Moreover, it is important to remember that under most MID tax credit proposals, the property tax deduction (worth on average about one-third of the value of the MID) would cease to exist, further increasing the tax burden on home owners.
Claim #10: There is too much policy support for housing.
Fact: At the federal level, much of the focus on housing tax policy is centered on important and long-standing policies like the MID and the LIHTC, but this focus ignores the fact that home owners pay property taxes that are not collected on other forms of investment. For example, owners of owner-occupied and rental housing pay approximately $300 billion a year in property taxes to local and state governments. Such tax burdens should not be ignored in federal tax debates when considering the overall effective tax rate on housing.