Commission Proposes Scaling Back Mortgage Interest Tax Deduction; Housing Advocates Push Back

Last week the co-chairs of the National Commission on Fiscal Responsibility and Reform — a non-partisan task force faced with coming up with creative and fair ways to reduce federal spending, reduce national debt and balance the budget — proposed scaling back the mortgage interest tax deduction among its various ideas in a 50-page proposal.

The commission, put into existence by President Obama in February, presented an entire tax reform section, with the goal of broadening the tax base, simplifying the tax code and improving compliance. One of the options included reducing the mortgage interest benefits to 80% of their current level and another option suggested limiting the mortgage tax deduction to exclude second residences, home equity loans, and mortgages over $500,000. Another idea would be to tax dividends and capital gains at the ordinary rates. The commission claimed this plan could reduce the deficit by nearly $4 trillion through 2020.

Michael D. Berman, CMB, chairman of the Mortgage Bankers Association, last week issued a statement reacting to options contained within the draft proposal.

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“Given the fragile state of the nation’s housing market, now is not the time to be scaling back incentives for homeownership,” said Berman. “The mortgage interest deduction is one of the pillars of our national housing policy, and limiting its use will have negative repercussions for consumers and home values up and down the housing chain.”

“We are also concerned about proposals to tax dividends and capital gains at ordinary tax rates, which would seriously impact investment in commercial real estate. We share the widespread concern over the growing national debt and want to help identify reasonable solutions, but we cannot support proposals that would chip away at the foundations of the real estate market.”

The home mortgage interest tax deduction has been around since 1913 and allows homeowners to deduct all mortgage interest from their federal tax bill; it is considered to be an incentive for prospective homeowners. Yet various sources report this policy will cost the federal government approximately $130 billion in 2012. Tax reform advocates have proposed deleting the deduction in the past.

To view the commission’s complete report, see here.

Written by Clare Pierson

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  • Every sector of the economy, every interest group must be willing to make sacrifices to reduce the national debt.

    The issue is national survival and national competitiveness in the face of real threats from own excesses and in the global economic environment. We live in a post-Lehman world. The clarion phrase should be “proportional sacrifice from all for country and freedom.”

    Business as usual and “not in my backyard” thinking is not an option. The stakes for our freedom and our posterity are too high, the dangers too real to succumb to small-mindedness.

    It is not

    • Atare,

      Many have written persuasively that the interest deduction does not support the number of homes owned as much as it provides artificial support for high prices. If that is true, our interest deduction policy has resulted in nothing more than transferring wealth to selling homeowners through tax subsidies and needs further restructuring; however, the price bubble did not result from bad tax policy but from pitifully poor lending standards and practices encouraged by irresponsible government policies favoring expansion of homeownership.

      To understand what happened in 1986 to make the situation feasible for change, there are several significant components to consider. In 1980, the highest income tax rate was 70%. In 1981, President Reagan successfully reduced that rate to 50% to stimulate the economy. Those policies of the early 1980s helped turn around the real estate industry in particular. By 1986, there were cries that this was the time to restructure the Internal Revenue Code. Representative Rostenkowski got Democrats to agree to lower the highest tax rates if Republicans broadened the tax base by closing loopholes, removing some tax benefits inherent with tax shelters, and othe changes.

      Since maximum tax rates were falling from a high of 70% to 28% in just six years, it was decided to remove some of the deductions enjoyed by those who would benefit the most from tax rate reductions. One area which was targeted was interest on home mortgages where the balance due exceeded $1,000,000 with an exception for home equity debt of $100,000. However, to avoid harming those who were relying on the deduction, all existing debt was grandfathered under prior law. What seemed like harmless independent tax reform decisions combined with reductions in the defense industry to crush home values in California for over a decade.

      So is now the time to be tampering with policies which impact home values? With the housing industry in disarray and hanging together by tearing and unraveling threads, tampering with the deductibility of interest on home mortgages even on a prospective basis only (as was done in 1986) could destroy any chance of seeing any recovery in home values for years particularly in states where HECMs are most highly concentrated.

      During the Carter Administration there were cries for austerity and sacrifice by all. President Carter decided he had a mandate to restructure the tax code and economic policy. His decision to attack what he considered excesses and create a far more comprehensive minimum tax was so disruptive that an economic slowdown quickly built into a recession. Interest rates rose to double digit percentages which other than on credit cards have not been seen since the early Reagan years.

      The return of home appreciation is critical to all home related industries. This is so critical to the HECM industry that Commissioner Stevens recently expressed his concern that the HECM program could have been lost this year without the introduction of the Saver. If home appreciation rates had not fallen, I would still be ignorant regarding the meaning of what being in the MMI means to the HECM program. In this case, ignorance would be bliss.

      Despite conservative instincts, it seems much better to reinstitute the estate tax in the way it was structured in 2005 (not 2009) and reduce the estate tax charitable deduction to the levels of those for the income tax, i.e., 50% for IRS recognized charities and 30% for charitable private foundations. Yes, the Bush tax cuts on income tax should be permanently extended, except the tax rates for single individuals on taxable income above $200,000 and for married couples filing jointly above $400,000 but only as long as “qualified” dividends retain their current beneficial tax treatment and the vast majority of the capital gain exclusion rules created in the last two decades remain intact.

  • While it is technically accurate to say that the interest deduction, including home mortgage interest, has been available since 1913, there was no separate category for home mortgage interest until 1944 when terms like Adjusted Gross Income, Itemized Deductions, and Standard Deduction were introduced into the Internal Revenue Code of 1939. From that point forward, itemized deductions including the home mortgage interest deduction came under a microscope.

    There are several sources from which the attack on home mortgage interest originates. One is the legislators from states where the average taxpayer receives less income tax benefit from the home interest deduction; generally the average home prices in those states are lower. Another comes from those who want to justify lower tax rates by increasing taxable income from the elimination or reduction in various “unnecessary” deductions. Yet another is those who are looking to raise revenues without raising rates. Yet another group believes that it is intrinsically unfair to provide a tax subsidy to support unrealistic home prices and provide wealthier taxpayers with the means to acquire a larger home than they would otherwise buy.

    It was surprising when Representative Rostenkowski (D-IL) and Senator Packwood (R-OR) alone emerged from a cigar smoke filled conference room with a bill which included limiting the home mortgage deduction back in 1986. How they managed to exclude the other members of the Joint Committee on Taxation and create such changes to the Internal Revenue Code that it was renamed the Internal Revenue Code of 1986, still amazes observers. That event took a very popular President, a strong Congressional environment for compromise in restructuring the Internal Revenue Code, and a conviction that the tax base could be spread across a broader base of taxable income while lowering income tax rates and collapsing the number of tax rate brackets.

    How two legislators took two conflicting bills, ignored them, and created a bill suitable to a supply sided President, a very Democratic House, a very conservative Republican Senate was awe inspiring. Every tax expert believed that the compromise would be little more than tweaking aspects of the 1954 Internal Revenue Code with no meaningful changes. Even marginal and mediocre changes in this direction failed miserably in 1985.

    Will the new Congress and President Obama have the political support and fortitude to see through a bill to reduce deficits? Does the 49 year President have the political will to pull off what only a 75 year old President has done so far? President Obama will have and President Reagan had a Congress not only divided by political party but also polarized by political philosophy. Do the legislative participants have the will to pare down the home mortgage interest deduction still further? It is an ambitious goal in the face of overwhelming odds against it.

  • Let’s play devil’s advocate and suppose this ludicrous idea actually went into effect. Are we honestly supposed to believe that the increased tax revenue would be funneled into reducing the deficit and not used to create more government programs or increase funding for those currently in existence? How naive do they think we are? Oh…I forgot…many voters are naive and continue electing the same clowns and clownettes that have been championing failed policies over and over again.

    It’s amazing that the folks on these panels don’t understand the basic principles that drive this country’s great economy. I thought that it was common knowledge that real estate ownership (earned not granted) and private property rights are part of the backbone of the American Dream. Why would any sane person want to mess this that?

    • James,

      Flattening out the tax rates and lowering maximum tax rates has long been the goal of many fiscal conservatives. Getting that done means modifying the subsidy structure within the tax realm. One of the sacrificial lambs must be large portions of itemized deductions particularly those related to home ownership.

      We spent the last few years trying to unravel the nightmare which those purporting to be the fulfillers of the American dream created. While there is nothing wrong with dreaming, not all dreams will come true. Clamping down on the interest deduction may be a necessary remedy to dealing with deficits. Many argue it will not change the percentage of homes owned by Americans but will reduce home values. Now does not seem like the right time to institute such change.

  • Over 40% of the populus pay no income tax. They are the working poor, however, they use more services than most. Some own homes. Let them keep their mortgage deduction. But they need to have some skin in the game. Not a huge amount, but some.

    • withbrowneyes,

      You are factually wrong. That 40% is not just the working poor it is the vast majority of seniors in this country along with the destitute including the imprisoned and mentally committed. It also includes illegal immigrants (some of whom are the working poor) along with their legally born offspring.

      But your statement about using the value of more services than they pay is precisely correct.

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