Chuck the Home-Mortgage-Interest Deduction

At his blog for Conde Nast's newish publication, Portfolio, Matt Cooper raises a fair question:

Why do we subsidize mortgage interest?…it's a truism that a subsidy yields higher prices. Home sellers can charge more because buyers are effectively subsidized by their ability to deduct mortgage interest. The purpose of the deduction is to encourage home ownership even though the deduction extends to people who hardly need government largesse. Canada has no mortgage interest deduction and yet its rates of home ownership are comparable to those in the United States. In other words, if we phased out the deduction, it probably wouldn't reduce the rate of home ownership….The mortgage interest deduction now costs us close to $100 billion a year. We should have a debate about whether we really need it any more and how it might be phased out.

More here.

The Tax Foundation points out that the HMID is basically welfare for the wealthy here.

A related reform that worked out just fine: USA Today recounts that 1986 tax reform bill that got rid of the deduction for interest on credit-card debt--a move that was predicted to destroy the credit card industry (and had no next to no effect).

Comments

[thoreau]

As somebody who's renting but hoping to save up money for a down payment, I look at what a mortgage will cost and I shiver and then everybody reminds me that the interest is tax deductible. This is true, but the tax-deductible interest is a cost that I recover on April 15. In the mean time, I have to make the big monthly payments. And I have to save up for a bigger down payment because the houses are more expensive than they would be without the deduction.

So from my perspective, it seems to raise the up-front costs of buying and then eases the pain once you've crossed that hurdle. The lesser pain after the hurdle is great and all, but until I clear that hurdle I'm not impressed.

So, yeah, I'm not sure this deduction is making it any easier for me to buy.

[John]

How about this idea, get rid of the home interest deduction and then also get rid of the taxes on capital gains and savings interest. You want to know why home prices are so high? Because owning a home and the home interest deduction is the only real tax shelter available to the middle class. That drives up home prices and also lowers the savings rate because people spend money on their mortgages rather than saving and have most of their assets tied up in their home. Lose the mortgage deduction and stop taxing savings and capital gains interest and people might actually have an incentive to save and put some of their assets into savings rather than home equity. You think that would benifit the rich too much? Fine, give everyone a million dollar lifetime exemption to such taxes similiar to the life time estate tax deduction. Call it the everyone a millionaire program.

[Brian]

I vote they stop using taxes as a way to control behavior. Oh, I guess that wasn't one of the options.

[x,y]

I bought my first place just under a year ago, largely because of the mortgage interest deduction and the (property) tax abatement the city provided for new developments. As invidious as it is, tax policy sometimes works.

[Dan T.]

I'll agree that this is probably a tax deduction that we could do without, but at the same time there's simply no way to get rid of it after millions of people bought houses with the deduction in mind.

[John]

Dan T,

The economic adjustment to eliminating this tax would be huge. I don't know how you get out of it to be honest. The best I could figure would be to grandfather it out. Everyone who has a loan now gets the deduction but no deduction on new loans. The problem with that is though, is that people would refuse to sell their houses and that would cause dislocations as well. It is just a mess.

[thoreau]

Dan-

Yep, that's a good point. Removing it would wipe out a vast amount of equity. I don't see any easy way to address that problem, let alone to make the solution politically salable.

I guess you could give a deduction to renters too. But then that would drive up rents.

OTOH, an across-the-board tax cut would give everybody more disposable income, which would result in some prices rising. But in that case, the products that became more expensive, and the rise in each product's price, would be determined by market forces, i.e. decisions of numerous buyers and sellers. If it's restricted to rent and mortgage interest, OTOH, the effects are concentrated on the housing market.

[thoreau]

John-

If you wipe out the credit for new loans, then the new buyers will insist on paying less. Which means that prices will drop, wiping out a lot of equity.

Those who want to can argue that the equity in question was created by fiat, so too bad for the beneficiaries. OK, fine, but the fact remains that there will be repercussions, making the change impossible to enact.

[Mad Max]

Since taxes are too high already, I have trouble feeling outraged that some fortunate people can get exemptions. The scandal is that other people have to pay high taxes, not that homeowners pay lower taxes.

[Dan T.]

Is this a H&R first? John, thoreau, and myself in basic agreement?

[uncle sam]

a similar effect occurs with rebates for energy saving, as in insulation and solar electic panels. Increase in demand raises the price that vendors can charge.

[Ayn_Randian]

look at what a mortgage will cost and I shiver

Uh, thoreau? That's 'cause where you're living, a double-wide and a lot for the sump pump runs you 400K. I'd shiver too.

[thoreau]

Dan T.-

No! You're wrong! This is NOT a first! There must have been other times that we three have been in agreement!

So you're wrong! I disagree with you!

🙂

[Cracker\'s Boy]

Uh... as the article points out, eliminating the tax deduction on credit card debt didn't cause mass panic/rioting in the streets/cats sleeping with dogs.

Just do it. We'll adjust.

CB

[thoreau]

Mad Max-

I agree, but the issue is that this particular deduction places the thumb on the scales of the market and thereby distorts prices. The question is how to remove that thumb from the scales AND keep taxes low for everyone without evaporating a lot of equity in the process.

Ayn Randian-

Yeah, I know. But everybody tells me "Oh, it won't be so bad after the mortgage interest deduction." And they're sort of right, but first I have to make giant payments, THEN I get the tax refund. It's a risky way to go through life, making big payments and periodically getting a refund.

[Eric S.]

Please don't. This is how I stick it to the government.

[Ammonium]

If my mortgage was about triple its current size I'd start getting my mortgage interest deduction. Until then, I can't get past the standard deduction.

Luckily, it looks like the mortgage interest deduction still applies to the Alternative Minimum Tax. So when I start bringing in the big bucks I might get back a little money off my house. God bless tax breaks for the rich!

[RonRon]

I've been in my first home for two years, I'm married, and our combined income is about $50K, and for the last two years, the benfit from the HMID has been less than the standard deduction for me too. This is the case if we file seperately or jointly, and a CPA friend confirmed I wasn't missing anything.

Soooo... Repealing it wouldn't affect me or my decision to own.

[robc]

thoreau,

Lower the amount you have withheld each month to offset the eventual refund. Getting a refund is bad tax planning.

[Bronwyn]

Ditto Eric S. @ 11:43am.

[Russ 2000]

as the article points out, eliminating the tax deduction on credit card debt didn't cause mass panic/rioting in the streets/cats sleeping with dogs.

It also didn't stop people from maxing out their credit cards are running up huge debts.

I don't care one way or the other about HMID; but at this point it really isn't changing anyone's behavior. People will still over-extend themselves on home loans if the HMID goes away.

[Average voter]

"Getting a refund is bad tax planning."

What do you mean? Isn't that a gift from my benevolent overlords? I LOVE the free money they give me every May!

[robc]

Avg V:

Yeah, I love the April interviews "I didnt pay taxes this year, I got a refund!"*

*in some cases, with the EITC, this could be true.

[Jose Ortega y Gasset]

The question is, "Would the increase in tax revenue result in a reduction of other taxes"? Well, probably not.

At the risk of making taxes even more complex, I think a phase out would probably begin with a cap. In the interest of fairness, the cap could be tied to regional housing markets... because, frankly, buying a place in New York City is a little more expensive than in East Backwater Falls, Indiana. All the phasing plan would need to do is lower the eligible deduction year after year... until it disappears. On a side note, I am in favor of almost anything that makes taxes simple. I have interests in small corporations and despite a number of explanations, still don't know what all the damn boxes mean.

[crimethink]

Silly wabbits. The purpose of the deduction is not to encourage home ownership, it's to encourage homeowners to re-elect their Congresspersons.

[Satan]

Is this a H&R first? John, thoreau, and myself in basic agreement?

WTF is this? Solid water?

[thoreau]

OK, point taken on withholding and refunds. Thus far in life my withholding has come pretty close to what I owe (plus or minus a bit) so I never paid much attention to the fact that I can give my employer input on how much to take out.

[Fluffy]

Well, one reason the deduction makes sense to me is that if I as an incorporated person buy a piece of commercial property, I effectively can "deduct" my commercial mortgage interest because it comes out of the bottom line on my P&L. I can also deduct the cost of taxes, insurance, and maintenance. So to me the real question isn't why actual corporeal homeowners are allowed to deduct mortgage interest - it's why they aren't allowed to also deduct insurance and maintenance [they do get to deduct local taxes].

I have been troubled for some time by the way the tax code treats incorporated persons and nonincorporated persons differently, in this and many other regards. Why can't I also deduct 80% of my travel, meals, and entertainment expenses?

[thoreau]

Why can't I also deduct 80% of my travel, meals, and entertainment expenses?

Indeed. This brain of mine is what enables me to earn money doing physics, and I need to keep it well fed. Dinner is a business expense.

[Larry]

The key to eliminating home mortgage deduction -- which I am a beneficiary of -- is to phase it in.
Or out, rather.

Phase it out over a 30 year period and no one will notice.

[Satan]

Eric S. & Bronwyn,

How can you "stick it to the government" if the government lets you deduct it in the first place?

[Chucklehead]

Oops, that was me.

[Propertyless in Podunk]

Your tax deduction comes off your federal debt but your property tax goes to local authorities, correct? Why does the federal government have its nose in your home in the first place?

[MP]

All the phasing plan would need to do is lower the eligible deduction year after year... until it disappears.

Sorry, but I don't see how this (or any phase out) wouldn't cause massive economic chaos. For new homeowners, since the first 5-10 years of a mortgage is mainly interest, the government is in effect "paying" 20-30% of the mortgage. Thus, phasing out the deduction makes a gigantic impact on a family's budget, even if done gradually.

This beast is here to stay.

[thoreau]

The more simplistic Finance 101 model would suggest that the rent on a property should be equal to the interest one could get if the price of the property were invested in something with a similar level of risk. Of course, that neglects upkeep costs and whatnot, but it's a starting point.

How about letting renters deduct a percentage of their monthly rent?

Of course, then rents would go up.

[MP]

Of course, then rents would go up.

And so would the value of rental property.

[Mo]

First, there is a cap if the value of the loan is $1 mil or more or you're upside down on your loan.

A potential way to eliminate the exemption without seriously messing up the housing market is to phase it in over 10-15 years. By that time, the NPV of the tax advantage cash flow is a relatively negligible portion of the value of the home and it also eliminates the distortion caused by grandfathering. This is due to the fact that the interest portion of the payments is a much smaller percentage and the discount factor is so great. To truly make it fair, you could even have a rebate to homeowners to compensate for the lost home value.

Of course, this being a rational way to get out of our problem, it will never see the light of day, even if the exemption is eliminated.

P.S. t, a good rule of thumb re: how much mortgage you can afford is 50% greater than your rent (obviously, tax bracket has an effect. So if you can afford $1,600 in rent, you can afford a $2,400 mortgage. Just make sure that you update your exemptions at the place of work. They'll generally tell you to up them by one or two.

[ChrisO]

The mortgage interest deduction now costs us close to $100 billion a year.

That sort of argument makes my blood boil. It doesn't "cost" us a damned cent unless we assume that the gubbimint is required to spend all of the money that it currently does.

If people lost their mortgage interest and child deductions, and we got rid of withholding and required people to write a check to the feds each month, you'd see the government go back to its constitutional borders VERY quickly.

[mith]

That sort of argument makes my blood boil. It doesn't "cost" us a damned cent unless we assume that the gubbimint is required to spend all of the money that it currently does.

Could be he meant 'we' to mean 'non-homeowners'.

Probably not though.

[Gerg]

As someone who lived and paid taxes in Canada I can assure you that not allowing a deduction on home interest, is most certainly much more of a loophole for the rich than the American rule.

If you have the wealth to buy your home with cash, then you can still deduct the interest from your home. You just have to cash out enough savings to buy it with cash, then take out a mortgage and invest that money. All the mortgage interest is just carrying costs for your investments now.

But the poor shlubs who are buying their house as their first big investment and don't have the kind of savings that would allow them to buy it in cash are out of luck. They don't get to deduct it.

The American system is actually much more fair.

[thoreau]

And so would the value of rental property.

Making it harder for people to save the down payment to buy rental property.

This is a lesson on the effects of tax breaks targeted to a behavior/action vs. across the board tax cuts. If taxes are cut across the board, then disposable incomes go up and people have more money to spend on whatever they want. Prices will go up, of course, in response to the income effect, but the magnitude of the increase on any particular item will depend on the propensity of people to spend marginal income on that item. With the price increases spread out over many items, it's unlikely that you'll see a significant barrier to any particular purchase or activity.

OTOH, if the tax break only attaches to mortgage interest, then only housing prices go up, and so the required down payment goes up, erecting a higher barrier to entry.

This is part of why I favor tax simplification: It removes the thumb from the scales, and doesn't incentivize or disincentivize any particular type of economic activity.

[Mo]

If you have the wealth to buy your home with cash, then you can still deduct the interest from your home. You just have to cash out enough savings to buy it with cash, then take out a mortgage and invest that money. All the mortgage interest is just carrying costs for your investments now.

WTF!?!? Anyone who goes through an ass-backward investment scheme like that must've inherited their money because they lack the financial acumen to earn that kind of dough. It makes no sense.

Why not just take out a mortgage like normal? The cash that would buy the house in your scenario could just be directly invested. No need to do the hand-waving that you did, since it's the exact same thing.

No matter what, people with more wealth are going to have an advantage because they can generally invest at a higher long term RoR than their mortgage payment. Doesn't matter if there is or isn't a mortgage deduction.

[Alice Bowie]

U C... Republicans believe in NO-NEW TAXES, No Tax Increase.

But, they need the money for War and their so called "Less Government Initiatives" like drugs,etc...

So ... what they do ... is eliminate TAX deductions...which is basically increasing taxes.

[Jose Ortega y Gasset]

Ah, again I agree with Thoreau. I would actually pay more taxes for a system I could actually comprehend (and one for which I did not have to pay handsomely for experts). The complexity of the current system is economic loss due to friction. The purpose of a tax should be to create a revenue for government, not to effect public policy. If you want to subsidize home buyers, write a check. Let everyone see what the check is and who gets it.

[Alice Bowie]

To take away the HMID is effectively raising TAXES on homeowners...and fleasing their biggest savings account (the Equity in their home).

I believe that the French Bastille Day, the Rodney King Riots in LA, an Al Sharpton Protest, the riots of the 60s and 70s would PALE ... compared to the RIOT that would break out if you take away the ONLY savings account many people have

[thoreau]

In keeping with what Jose Ortega y Gasset said, keep in mind that the income effect on prices from across-the-board tax reduction will only be related to the AVERAGE propensity of the population at large to spend marginal income on something. If you have an above-average propensity to spend marginal income on something, you're fine. In fact, if you are thinking about doing something profitable that's related to your interest (e.g. invest in real estate, open a business selling whatever you're passionate about, etc.) then your marginal income will exceed the price increase and you'll be better off.

But with the mortgage interest deduction, you only realize a marginal increase in disposable income AFTER you've made the purchase, and the purchase price has gone up. So the effect on the small investor seems pretty obvious.

[Alice Bowie]

The Very Very rich loose this deduction with AMT and other Tax gotchas for the rich...people that are not that rich don't know about these...

Only the middle class would be affected...and maybe in a bad way.

I pay $2,400 in HMI...I get back $800 for that...I would really hate to loose that $200 per week...just to spend it on more prisons, more war...and none of it goin to the public good.

I u told me that I would loose the $800 per month...but it would be used for health care...At least as good as it is now...I would give up the deduction

[Son of a!]

I don't see why people think this deduction is so awesome. The standard deduction for a single guy (like myself) is $5,350, and mortgage interest is a deduction, not a credit.

Putting me in, let's say, the 25% bracket, I'd need $21,400 in mortgage interest before itemizing makes sense. That can't be right, can it? Can anyone tell me what I'm missing?

[Alice Bowie]

Hi Son of A!

Schedule A on 1040 form is what's used to determine if u r above the STANDARD DEDUCTION.

It includes the following:

Home Mortgage Intereste
Property Tax
State Income Tax Paid
Casualties and Losses
Charitible contributions
Medical Expenses over $7500

[Alice Bowie]

And BTW... Son of a!...

It's not that hard (in NYC, New England, and California) to pay much more that $21,400 per year in Mortgage Interest.

[.]

I'd need $21,400 in mortgage interest before itemizing makes sense.

Nope. You need $5,351 in interest for itemizing to make sense.

[Son of a!]

Alice Bowie:

Thanks! State income tax is the really big one I should have noticed.

.:

I must be getting confused (about the tax code? pshaw!). I'm thinking in two different directions at once. In particular, I was thinking about how, as a deduction, you only get back part of what you pay. I'm sure you're aware of this, but my friends who encourage me to stop renting don't seem to realize they aren't making out like bandits at tax time.

I'll just shut up now.

[Bee]

Most things I've read on eliminating the MID flail when it comes to the expensive housing markets. I rack up $5351 in mortgage interest in a couple of months....in Los Angeles. I don't even know whether, at the end of my 30-year loan, the yearly interest would be less than $5K. I'll have to look at my schedule.

Don't think I've heard the 30-year phase-in idea before.

I would probably not have bought without the deduction. But I'm paying a little bit more each month now than I was paying in rent (rents are high here, too), and I feel somewhat less raped by the IRS. The tax code is unfixably warped.

[MP]

I would probably not have bought without the deduction.

Sure you would have. You just would have paid 20% less. The tax deduction is built in to the price of houses.

[.]

but my friends who encourage me to stop renting don't seem to realize they aren't making out like bandits at tax time.

Geez, NOBODY makes out at tax time. At best your get SOME of your money back, but you've still paid.

And if you have a mortgage, you've paid interest PLUS taxes; it's just that you've paid a little bit less in taxes than if you didn't have to pay interest. With the demand for mortgages over the last few years, renting is actually a better deal in some locations.

[NAL]

For a single person, it would be difficult to not beat the $5350 standard deduction when you consider mortgage interest, state income tax (or sales tax), and property tax. You'd have to live in a very low-cost-of-living area where your income, home prices, and taxes are all low.

Now for a couple, it might be a different story (The standard deduction being $10,700).

[Mo]

Most things I've read on eliminating the MID flail when it comes to the expensive housing markets. I rack up $5351 in mortgage interest in a couple of months....in Los Angeles. I don't even know whether, at the end of my 30-year loan, the yearly interest would be less than $5K. I'll have to look at my schedule.

Yeah but the PV of that last tax deduction is very low. For a $500,000 house, the total NPV on the tax deduction, assuming a 25% tax rate (since SS isn't included) and an 8% fixed rate is $92,000. Almost 1/5 the house's value! Of that, years 11-30 make up $27,000 of the NPV. So 2/3s the time only accounts for less than 30% of the tax benefits. The last decade, years 21-30, only account for $4,760 of value, about 5% of the value.

What this means is that the problem could be solved by having a 20 year phase out and cutting a $5,000 check (on average*) to every homeowning household and everyone is square. Actually, since the median home value is nowhere near $500,000 the number will be much smaller.

So while your deduction in 15 years may be worth something to you then, it's not worth that much today. As one of my finance professors said, "Two concepts that people don't understand well are the time value of money and risk. And that is why the skyline of every major city is dominated by banks and insurance companies."

* In reality, you would have to prorate it to the value of their loan. Especially since the cap is at $1,000,000.

[Bee]

Sure you would have. You just would have paid 20% less.

Well, right. =) I think I just betrayed my lack of faith in the government not to meddle in housing. A clear-cut swing in values equal to changes in the MID...as if it could be that simple.

I don't believe the value of my home is measurable in any real sense. Land and zoning restrictions, tax distortions, transaction costs...the list of obscuring factors is boggling. I gained an appreciation for the word "pettifogging" when buying that damn house.

I'm looking into starting a small business (run from the house, natch) and I may have found my next quagmire. Good God.

[joe]

thoreau,

Just reduce your withholding.

[robc]

joe,

Amazing advice. You would think someone would have given that advice as much as EXACTLY 5 hours earlier.

[David]

Ending the mortgage interest deduction is a great idea. Let's do it right after we end the deduction on corporate interest expense. If that one goes smoothly the mortgage one should be a piece of cake.

[MP]

What this means is that the problem could be solved by having a 20 year phase out and cutting a $5,000 check (on average*) to every homeowning household and everyone is square.

It's a much bigger hit than 5K. Your leaving out the NPV that's been factored into the price of the house.

[Russ 2000]

A related reform that worked out just fine: USA Today recounts that 1986 tax reform bill that got rid of the deduction for interest on credit-card debt

Why is this called a "reform"? Its proper term is "ripoff". And why is an itemized deduction EVER considered a subsidy? Since the introduction of income tax, ALL interest was deductible. Little by little, the government has been taking small parts of the deduction away, whenever more people (read: the middle and lower classes) are able to take advantage of it. And thanks to the average American's stupidity and socialistic brainwashing, the interest deductions that remain are now considered subsidies.

In other words, if you think interest shouldn't be deductible, you are on the socialist side of the equation.

[free]

In other words, if you think interest shouldn't be deductible, you are on the socialist side of the equation.

You're the Socialist there should be NO deductions. Deductions are subsidies.

Lower rates and no deductions.

[Mo]

It's a much bigger hit than 5K. Your leaving out the NPV that's been factored into the price of the house.

MP,
Did you miss this part of my analysis:

What this means is that the problem could be solved by having a 20 year phase out

That's why it's only $5K. The rest was actually received. If you cute the 5 grand at the beginning of the phase out period, you already to take into account the last 10 years of NPV.

[Mo]

er cute should be cut

[joshua corning]

If by phasing out you mean giving everyone the tax credit whether they buy a home or not...sure i can support that.

[David]

What have you done with the real Nick Gillespie?

The wealthy pay most of the taxes, and therefore get the most benifit from ANY deduction without an income phase out. Where'd you get "welfare for the wealthy," John Edwards?

Credit card interest is only weakly related. Millions of people have used the mortgage interest deduction to make decisions involving multiple decades and hundreds of thousands of dollars. Nobody considers the deductibility of finance charges at the grocery store. The impact of changes is incomparable.

[The Wine Commonsewer-Reg US Pa]

I'm sure everyone's gone and moved on, these threads have a half life of a half day.

I would remind y'all that Reagan tried to eliminate the deduction for mortgage interest and was run over by the Real Estate lobby.

And, there are upward limits on how much mortgage interest can be legally deducted, which kind of means that the deduction isn't really welfare for the wealthy although many people we consider to be wealthy do actually benefit, in part, from the mortgage interest deduction, even if they can't deduct it all.

Although I agree with CB that we'll all get over it, abolishing the deduction will play heck with the RE market.

[The Wine Commonsewer-Reg US Pa]

And Russ is right--See medical expense deductions, where the reality is that you don't get to deduct medical expenses but Congress is too chickenshit to abolish it altogether. So they set all the rules to make it impossible to deduct medical expense.

[MP]

That's why it's only $5K. The rest was actually received. If you cute the 5 grand at the beginning of the phase out period, you already to take into account the last 10 years of NPV.

No, I didn't miss it at all. Whatever you purchase a house for today has the tax deductability factored into the house price. Your phase out plan only ensures that the present owner captures the full expected benefit of the deduction. However, when they go to sell the house to someone who can't obtain the deduction, that factor gets subtracted from the asset value. Thus, even though the present owner retained the deduction benefit, they suffer a capital loss upon the sale of the house.

[Mo]

MP,
Ahh, I see. What I intended was the phase-out to include current and new homeowners. So if I buy a house 5 years after the phaseout, I get 15 years of the tax benefit, and will pay appropriately. This would end up having the home retaining the majority of its value.

[Get A Mortgage]

My loans phasing out time was good and i really liked the comments.
*********
Jhon
Get A Mortgage

[FB]

If they got rid of the HMID the median house price wold instantly fall at least 20%, foreclosures would increase at least 20 to 30 times the current rate, and the billions our government and the fed have recently spent trying to prop up housing (by debasing the dollar, lowering interest rates to 40 year lows, etc) would all be lost. The bank failure rate would soar as the write downs would be astronomical and it could very well send us into a horrible depression. The yearly interest on your average home in California, NY, and other higher priced markets is around 50K. So I can understand how someone who lives in an area where homes cost less than 60K might think this is not a big deal, but in California for example the lost revenue to the state (from the MUCH lower property taxes due to MUCH lower home values) would be devastating to say the least. You might think I am being dramatic but I would wager my home that all of this would take place if the government were to take this deduction away.