With Congress reviewing various measures to deal with the so-called fiscal cliff by the end of the month, one that some members are backing – and the bipartisan Simpson-Bowles Committee recommends – is the loss or reduction of mortgage interest tax deductions.
The subject is always widely debated whenever Congress takes a serious look at whether to scale back or eliminate this deduction for homeowners. However, now, with the housing market showing measurable signs of recovery, many people fear that such a move would be a major setback.
Some have gone so far as to say that a slow down in the housing recovery would negatively impact the economy as a whole, pointing out that slower home sales would also ultimately slow job creation.
The subject of mortgage interest deductions was brought up last Monday when the President connected directly with Americans regarding the middle-class tax cuts during a live #MY2k question and answer session on Twitter.
@whitehouse As a home owner, I worry deductions for home owners are at risk. Is that the case? #My2k
@soitgoesem breaks for middle class impt for families & econ. if top rates don't go up, danger that middle class deductions get hit - bo
While the mortgage interest deduction was not originally created with homeownership in mind - Congress made all interest tax-deductible when it approved a federal income tax in 1913 - it has helped make home ownership an attainable American dream.
As a result, Congress has repeatedly dodged all efforts to tinker with the mortgage tax break since it makes home ownership more affordable for everyone.
It also encourages households to spend more on housing once they decide to buy, and in the absence of the mortgage interest deduction, households would buy smaller or less fancy houses, or house prices would fall to partially compensate for home buyers’ having a higher after-tax interest rate, according to Wharton real estate professor Todd Sinai who recently co-authored a paper, “Revenue Costs and Incentive Effects of the Mortgage Interest Deduction for Owner-occupied Housing” with MIT professor of economics James Poterba.
As the second largest tax expenditure – the US Office of Management and Budget estimates that over the five-year period spanning 2012-2016, the tax revenues foregone by allowing a deduction for mortgage interest will total $609 billion – Congress is giving this topic serious consideration in the budget debate.
Professor Sinai explains what would happen if the mortgage interest deduction were eliminated completely:
“The average household’s annual tax bill would increase by a little more than $1,000. That number masks the real impact, however. Households earning less than $40,000 per year would see their tax bills rise by less than $110 on average — few of those households itemize on their tax returns and thus gain little benefit from the mortgage interest deduction, and those that do itemize tend to have relatively inexpensive houses. Households earning between $125,000 and $250,000, by contrast, would stand to lose nearly $2,700 in annual tax savings. And those making more than $250,000 — the ones subject to deduction caps under some tax reform proposals — currently save $5,400 per year on average from the mortgage deduction.”
President Obama has proposed cutting the mortgage interest deduction for taxpayers in the top two tax brackets every year of his administration. In his proposal, households that currently pay income taxes at the 33% and 35% rates would only be able to claim deductions at the 28% rate so for every $1,000 in deductions, a household would realize a tax savings of $280 instead of $350. However, to date, Congress has remained steadfast in its support of the measure as it currently stands.
Now, with a new Wall Street Journal/NBC News poll showing 60% of Americans find it totally or mostly acceptable to eliminate the mortgage deduction on second homes, home-equity loans and any portion of a mortgage over $500,000, the newspaper reports that the White House hasn’t said whether it would support more aggressive measures that would limit the mortgage interest deduction, such as limiting the deduction on second homes, limiting the deduction to interest paid on $500,000 in principal (the current cap is $1 million), or capping deductions across the board, an idea proposed by Mitt Romney.
“While it appears that an across-the-board elimination of the mortgage interest tax deduction is not something Congress would support, the real-estate industry warns that any policy changes could be disastrous for the fragile housing market, dissuading would-be buyers and depressing prices further” the report adds. “Even modest price declines could leave millions more Americans underwater, owning homes worth less than they owe on mortgages. That could undermine the economic recovery by depressing consumer demand and lengthening the construction-industry downturn.”
“Until Congress introduces specific legislation, there’s nothing to say about any proposed changes to the mortgage interest deduction,” Gary Thomas, president of the National Association of Realtors (NAR), stated. “However, it has always been the NAR’s position that the mortgage interest deduction is vital to the stability of the American housing market and economy, and we will remain vigilant in opposing any future plan that modifies or excludes the deductibility of mortgage interest.”