The tax deductibility of mortgage interest is almost as inviolable a part of the American dream as is the U.S. Constitution. The co-chairs of the White House deficit commission have boldly, and rightly, put this almost century-old sacred cow on the chopping block. Now they just have to convince legislators to swing the axe. They could start by killing the myth that the subsidy is all about middle class homeownership.
For starters, the deduction disproportionately helps those who can easily afford a home anyway. According to the Urban-Brookings Tax Policy Center, the richest 20 percent of taxpayers reap 70 percent of the benefit of mortgage and property tax deductions. A married couple able to take out a $1 million loan – the current cap for the deduction – reduce their taxes by more than $15,000 a year at a 6 percent interest rate. A more typical middle-class couple with a $200,000 loan saves only a few hundred dollars more than they get anyway from an alternative standard deduction.
This example suggests that, at a minimum, the cap is currently set too high. Not only that, it encourages homebuyers to borrow as much as possible whether or not they really need to, inviting the excessive leverage that helped produce the recent financial crisis. The deduction even applies to second homes, an absurdity if the ostensible goal is to help ordinary American families own their homes – and an inducement to speculate.
The deficit commission’s leaders, Alan Simpson and Erskine Bowles, have offered a menu of ideas. One would eliminate this and other deductions completely while reducing tax rates. Another would keep the deduction in place, but cap eligible mortgages at $500,000 and exclude home equity loans and mortgages on second homes altogether.
The first option might seem politically impossible, but courageous lawmakers shouldn’t dismiss the second. It would reduce the benefit diverted to the rich. And crucially, with more than 90 percent of new U.S. houses sold this year priced under $500,000, it would minimize the further shock to an already weak housing market – one argument used by those who say that now is not the time to tinker with the deduction.
Longer term, lawmakers should go further. Other countries like the UK manage to achieve high rates of homeownership with little or no tax subsidy. The eventual goal should be to eliminate the deduction altogether.