Mortgage interest deduction madness

So you think the mortgage interest deduction helps make homeownership possible for most Americans?

Think again, says Roger Lowenstein.

In Sunday's (March 5) New York Times Magazine article "Who Needs the
Mortgage-Interest Deduction?,"
Lowenstein writes:

"But when exactly did the interest deduction begin? I had often heard
my father rhapsodize about the G.I. Bill of Rights, which was enacted
in 1944, when he was serving in the Pacific, and which a few years
later was paying his tuition at law school; the mortgage-interest
deduction came to be joined in my mind as an adjunct piece of social
policy. One got you an education and the other got you a house:
together, they bought entree to the middle class.

"Since the great migration to the suburbs also occurred after World War
II, I assumed that the interest deduction was of a similar postwar
vintage. Over the years, it has become an American folk legend: the
government invented the mortgage-interest deduction to help people buy
their own homes, and the level of homeownership has risen ever since.

"What part of the legend is true? Basically, none of it."

Lowenstein looks at the evolution of our tax system and how and why the
interest deduction came about. The tax break's usefulness to
homeowners, he contends, was never the driving force for creation and
continuation of interest deductions.

And today, the tax break isn't even doing a lot of mortgage-interest paying homeowners much tax good.

Lowenstein cites U.S. Treasury stats that show among homeowners, only
about half claim the deduction. When you add folks who don't own homes
into the equation, more than 70 percent of tax filers don't get any
benefit from the deduction.

And what does it cost the country to provide a tax break for less than
30 percent of U.S. taxpayers, most of whom are higher-income? This
year, says Lowenstein, it will be $76 billion.

Lowenstein speaks to economists who say that the deduction doesn't
really help more Americans buy houses. Homeownership here, he reports,
is about the same as in Canada, Australia and England, where interest
isn't deductible.

He further argues that the mortgage deduction really helps potential
home sellers more than buyers or owners: "Research suggests that
without the deduction, people would still buy the houses they do now;
they would just cost a little less. In effect, the market would adjust
downward to reflect some of the decrease in buyers' purchasing power."

That certainly explains the opposition of real estate agents to the
proposal by the President's Advisory Panel on Federal Tax Reform to
eliminate the deduction. You can find out more about the Panel's
proposed alternatives and Realtor reaction in my
blog post from November.

And the fact that the real estate professionals are vocal, organized
and contribute to the election and re-election efforts of politicians
explains why most lawmakers in Washington, D.C., also have turned up
their noses at the Panel's proposal. Even the guy who asked for it, the
president, put the brakes on the effort (blogged here) shorly after the Panel's report was released and subsequently has
publicly stated that the mortgage interest deduction will not be
removed from the tax code.

OK, so it's clear why the realty industry hates the idea: Prices of
homes would decrease, meaning the commissions would go down with them.

And politicians are generally loathe to change things that could endanger their fundraising and re-election efforts.

But if most Americans aren't getting a tax benefit from the mortgage
interest deduction, why isn't this majority raising a ruckus for tax
system changes that are fairer to them? Three reasons.

First, 99 percent of U.S. homeowners will one day be home sellers, so
if the deduction, as Lowenstein argues, helps keep prices up for that
eventual day, then they say "good."

Secondly, thanks to decades of anti-tax propaganda, very few of
Americans are willing to give back any tax break even if it's not doing
most of us that much good. We accepted the limits on mortgage interest
(up to $1 million in home indebtedness) that were part of the 1986 Tax
Reform Act. But that cap was part of a larger bill that drastically cut
ordinary rates. Plus, 20 years ago home prices were not so out of
control (as discussed here),
so that $1 million amount seemed a safe limit for most home buyers.

And then there's the third reason, a purely emotional one that is hard
to counter with numbers and sound tax policy arguments. It is that the
American dream of owning a home has a bit of a dark side.

Sure, many people are happy to get into any home of their own … at
first. But once there, the drive toward property escalation tends to
take over. We want to be able to use a mortgage to buy another house, a
bigger house, eventually one that's more than we really need or can
afford.

Once there, we'll claim the interest deduction and, from a window high
in our new castle, we'll look down smugly on those who haven't reached
the heights of homeownership — or depths of debt — that we've finally
attained.

TODAY'S TAX TIP: It might not be good tax or social policy, but our
tax system is full of advantages for homeowners. As long as they're there,
take full advantage of the breaks. In addition to the mortgage interest
deduction, you can write off points you paid for your loan, home equity
debt, property taxes, even a large portion of any profit you make when
you do sell. Get details on these tax benefits of homeownership in this story.

Festival fun! The 13th edition of the Festival of Frugality, "a weekly compendium of the finest from the frugal blogger," is now up and includes my confession of coupon clipping. This week's host is Simply Thrifty, so head on over there for some money saving tips.