End the Mortgage Interest Deduction? Expect a Fight
Senior Editor, CNBC
Over the decades the mortgage interest deduction has become American folklore — buy a house and get a tax deduction for the interest you pay on your loan.
But now, amid tightening budget belts and questions about economic class fairness, that American-as-apple-pie notion is being debated.
Taxpayers who itemize their deductions — and are homeowners — can deduct the interest paid on their mortgage up to $1 million, plus up to $100,000 of home equity loans, a type of loan in which the borrower uses the equity in their home as collateral.
And homeowners can do the same on a second home.
But as part of ongoing talks over U.S. tax reform and the closing of loopholes to help reduce the national debt, the mortgage interest deduction has a big target on its back for major changes if not total elimination. (Read More: Which Tax Deductions Are Likely to Go?)
The deduction costs the Treasury some $100 billion a year in revenues and many politicians from both sides of the aisle are calling for either the deduction to end completely, have it changed to a tax credit, or limit the deductions for higher incomes, a move President Obama said he supports.
Making any kind of changes to the deduction won't be easy ... those in favor of it are gearing up for a bitter battle to the end.
"We would fight it tooth and nail," David Crowe of the National Association of Home Builders told CNBC on Wednesday.
"Our members believe that it (eliminating the deduction) is not a way to reduce the deficit or save taxpayers money and it won't help cure the housing market," Crowe said. "There are others ways to address the budget deficit without affecting home ownership."
The powerful real estate lobby has played a crucial role in keeping the mortgage interest deduction intact, spending more than $80 million in lobbying Congress last year alone to advance their causes.
A key member of the lobby, The National Association of Realtors, strongly opposes eliminating the mortgage interest deduction, claiming in a statement that, "Housing is the engine that drives the economy, and to even mention reducing the tax benefits of home ownership could endanger property values. Home prices, particularly in high cost areas, could decline 15 percent if recommendations to convert the mortgage interest deduction to a tax credit are implemented."
However, not everyone sees the deduction as constructive. A recent study from George Mason University's Mercatus Center stated, "Most taxpayers don't benefit from this deduction at all or receive a very small benefit," and that "Its primary effect is to encourage Americans who would have already been able to afford a house to take on even more debt."
With the mortgage interest deduction, households realized tax savings of $83 billion in 2010, according to figures from the Reason Foundation. But only about 30 percent of taxpayers actually use the mortgage interest deduction each year. And the majority of those savings were taken by higher earners.
As currently structured in the tax code, those at the top income brackets (more than $400,000 in income) get nearly 39.6 percent of their mortgage interest payments lowered from their tax bill, while those with lower incomes who itemize get 25 percent or less lowered from their mortgage interest.
"We should not be subsidizing upper income levels and people who can afford second homes with this deduction," said Ian Shane, a lawyer and tax expert at Golenbock Eiseman Assor Bell & Peskoe. (Read More: Can You Trust Your Tax Man?)
"If we really want to help the housing market, we should be helping renters who can't afford to buy a home," Shane said. "Other countries don't have the deduction and they seem to be doing okay in housing."
How Others Did It
Proponents of killing the mortgage interest deduction often point to Canada and Great Britain as examples of how it could work.
Canadian federal income tax does not allow a deduction from taxable income for interest on loans secured by the taxpayer's personal residence. Homeownership in Canada rose to a high of more than 69 percent in 2012.
Great Britain phased out the deduction starting in the 1980's and ended it completely in 2000. But home ownership in England will slump to just 63.8 percent over the next decade, down from 72.1 percent in 2001, according to studies. Reasons for the fall include the need for huge deposits, combined with high house prices and strict lending criteria.
Crowe of the Home Builders said the British decline is a warning sign for the U.S. (Read More: Distressed Homes Still Drive Sales)
"Their first time home ownership (in Great Britain) is now much older than it used to be," Crowe said. "It's harder for the young people to get into homes. That's why we need the deduction."
As for the politics, two House Democrats recently proposed legislation that would turn the home mortgage interest deduction into a tax credit, a change they say would help more lower-income people receive a homeownership tax benefit.
Besides ending the deduction, the bill would eliminate current tax benefits for people with mortgages over $500,000. (Related: Taxes explained).
Some Republicans have picked up former GOP presidential nominee Mitt Romney's idea of capping all deductions —- including the mortgage interest — at a total of $17,000 while lowering overall tax rates. House Speaker John Boehner (R-Ohio) has said he is willing to limit all tax deductions to help raise revenues, but he hasn't said anything specific yet on the mortgage interest deduction.
President Obama has proposed ending the deduction for people above the 28 percent income tax bracket.
There's even some movement at the local level as Governor Sam Brownback (R-KS) earlier this year called for eliminating the mortgage interest deduction for state taxpayers. But a recent survey found 63 percent of Kansans opposed to the idea as part of a bigger plan to cut spending.
That type of reaction just shows how difficult it is to get anything done, said Shane.
"I think they could phase out the mortgage interest deduction so that it doesn't hurt," Shane said. "I don't think it would slow down housing. But I don't think it will be easy. It's so ingrained in the U.S. that people expect it."