California Forum

Republican tax legislation contains a gem: Phase out mortgage deduction

One of the most costly and widespread subsidies in America is finally being questioned in Congress – the deduction of home mortgage interest.

Fewer than half of American homeowners qualify to deduct mortgage interest even though the deduction can be used for two homes. Yet the real estate industry perpetuates the myth that the deduction is a boon to homebuyers.

The subsidy is challenged in the proposed overhaul of the federal tax code put forth at the end of February by Rep. Dave Camp, the Michigan Republican who chairs the powerful Ways and Means Committee.

Camp’s 979-page bill proposes that interest on mortgages issued in the future would be deductible on only the first $500,000, half the $1 million now allowed. He says that would affect only about 5 percent of mortgages. Speaker John Boehner and Senator Minority Leader Mitch McConnell declared the package dead on arrival.

“Blah, blah, blah, blah,” Boehner said, before quickly adding it was good to start a conversation on tax reform.

Democrats are in such disarray on taxes they have no comprehensive proposal, though they make a lot of hay out of pointing out loopholes and inequities.

While Camp’s plan will not be enacted, he deserves credit for challenging the myth that the mortgage interest deduction is a benefit to homebuyers. In reality, it inflates housing prices by as much as a third, the National Association of Realtors has acknowledged. Paying a dollar of interest to get back a dime or even 40 cents in tax savings is not smart. Promoting paying off mortgage debt would be smart, however.

Most homeowners don’t deduct mortgage interest for two reasons. First, 70 percent of people do not itemize deductions so they cannot claim the deduction. Second, some people, most of them older, own their homes outright.

The home mortgage interest deduction is what economists call an upside-down subsidy – the more you make and the bigger your mortgage, the bigger your subsidy.

On average, for each dollar saved by taxpayers making $50,000 to $75,000, people making $200,000 or more save $5, my analysis of a Congressional Joint Committee on Taxation staff report shows. High-income taxpayers are subject to new rules that lower the value of their deduction, so the committee economists also took those into account. That lowered the ratio to $3.36 to $1, still an upside-down subsidy favoring the top 2 percent of households like mine.

Canada does not allow a deduction for mortgage interest. Its home-ownership rate is slightly higher than America’s. If a third of house prices reflect efforts to capture the tax subsidy, what would happen if we got rid of the tax break?

Imagine you make $50,000 to $75,000. Statistically you would save $75 a month in federal income taxes if you bought a house, the congressional study shows. Now which option would you prefer?

•  Pay $300,000 for your house, the median for Sacramento in late 2013, and save $900 annually on your federal income tax by deducting the mortgage interest?

•  Pay $200,000 for your house, but without being able to deduct your mortgage interest?

Assuming you borrowed the entire purchase price at 4 percent interest the initial mortgage interest savings would be $4,000 per year. Not only would you have more than $250 more cash in your pocket each month, you would have a much smaller debt to pay off. Of course, if you own that home, this is not such a good deal, which is why Camp proposes to phase in his modest change over several years, a change that would only affect new mortgages of more than $500,000.

Our tax code abounds with subsidies, which I have been exposing for years. The pipelines collect a tax that they get to pocket. State and local government giveaways to companies cost the average family of four $900 annually, which is more than a week’s take home pay for that family.

Over time, subsidies that start out benefiting homebuyers, working parents or anyone else tend to be captured by others. The child tax credit for working parents benefits employers if they hold down wages, as we have seen since 1998. Inflated housing prices benefit brokers who work on commission and bankers who lend more money.

Let’s tell our lawmakers we want to end this upside-down subsidy, phasing it out over a decade. It will cause some pain to existing homeowners including me, but over time it will help generations of Americans save more – and have more money to invest in their own children and thus America’s future.