Dump the mortgage deduction to revive U.S. housing
Some sacred cows need to be sacrificed in order for a country to prosper again. Let’s start with the deduction for mortgage interest on U.S. tax forms.
Killing the mortgage deduction wouldn’t be heresy for the American dream; it would allow more people to buy homes. The money saved by eliminating this break could actually boost homeownership, reduce payroll taxes or pare the budget deficit.
This sounds wildly counter-intuitive in light of the dismal home sales reported on Tuesday — the worst in 15 years. With the expiration of the $8,000 first-time homebuyer tax credit, buyers retreated to caves and thousands of more foreclosures came on the market.
I know the industry doesn’t want to hear this, but removing the interest break would lower prices — and ultimately sell more homes — if the deduction is transformed into a dollar-for-dollar credit that anyone can use.
The mortgage interest write-off may have over-stimulated the housing market during the bubble years. If you could write off interest on a higher-priced home, why wouldn’t you? This financial steroid also led to price inflation and led overstretched homeowners into more dodgy loans where they were exposed to bond-market risk.
As it stands now, the write-off subsidizes the affluent at the expense of everyone else, particularly renters. Residents of states with the highest mortgage values understandably took the most deductions. Maryland homeowners, for example, had the highest percentage of residents taking the write-off — about 38 percent — according to a National Association of Realtors, a Washington-based trade group.
Not surprisingly, the highest actual dollar amount of deductions were reaped where real estate prices are highest. California was the top state for loan interest write-offs with an average $18,876 deduction (of returns that claimed the break). Hawaii followed with roughly $17,000.
The unfair catch is that you have to itemize to get the deduction and only about one-third of US taxpayers do so. So two-thirds of taxpayers are not getting this break to reduce their taxable income. With the exception of Arizona, Colorado and Nevada, the top-10 states where interest was written off were on the coasts.
As the tax code’s single-largest individual subsidy, the mortgage break is estimated to have cost the Treasury about $80 billion last year.
There’s a better way to promote homeownership that will benefit more taxpayers. By scrapping the deduction in favor of a credit, the Treasury could save almost $400 billion between 2013 and 2019, according to the Congressional Budget Office.
A homeownership credit would be simpler and easy to access, although it would need to be capped. You wouldn’t have to itemize. If Congress decided to rescind interest write-offs for second homes and home-equity loans, the credit could be even larger or the savings could be channeled into payroll-tax breaks, which would help more working people.
The trade-off, of course, is that home prices may decline further in the priciest areas and after-tax income would drop slightly for the highest-bracket taxpayers. How is that a good thing?
With a more egalitarian mortgage credit, 80% of taxpayers would reap a benefit, the non-partisan Tax Policy Center found. Since there’s little academic evidence that the deduction raises homeownership, why not try the credit? It worked in stimulating home sales over the last year in one of the worst housing markets since the Depression.
It’s far more likely that the resulting drop in home prices from paring the write-off will be offset by more younger and minority buyers being able to afford homes.
One of the most reasonable deduction-for-credit swaps was proposed by President Bush’s tax reform commission, whose proposals were generally treated like root canals. The commission suggested a 15% credit on loans up to $412,000.
Ending the mortgage subsidy alone, of course, will not stem foreclosures or restore demand. For that, a national housing policy that allows homeowners who are “underwater” (owing more on their mortgages than their homes are worth) to write down their principal in bankruptcy is worth considering. Stimulating job growth will also be of paramount importance. There’s no sense in buying a home if you can’t be sure you’ll have the income to pay for it.