What if the Mortgage Interest Deduction Went Away?
Recently, the United States Congress raised the debt ceiling after a lengthy and ugly debate about spending cuts and tax increases. One of the issues discussed is eliminating or capping the mortgage interest deduction. This deduction is quite popular amongst the American people and is often heralded as the best tax deduction for the middle class. What would happen if it no longer existed?
In the United States, the mortgage interest deduction allows taxpayers who itemize their deduction to deduct the interest of up to $1 million of debt used for buying, constructing, or improving a residence or a vacation home. The deduction also applies to the interest on up to $100,000 of home equity debt. This means that those with large mortgages and high tax rates benefit the most. (See also: The 7-Year Mortgage: Take It or Leave It?)
It is no surprise that a recent report by the Tax Policy Center shows that most of the tax benefits went to wealthy households. For many middle class families that buy an affordable home around the national median price of $184,000, the mortgage interest deduction may be moot because the standard deduction for a couple would be more than the mortgage interest. For these households, the elimination of the deduction would not change their tax liability. Those households that have large mortgages and already itemize will see their taxes go up without the deduction, but these households may just sell taxable investments to pay down the mortgage and break even on their total taxes.
The real estate industry is staunchly against eliminating the mortgage interest deduction because they argue that such a move will drag down home prices when the market is already weak. The deduction is also a great marketing tool for realtors. Practically every realtor I met has touted the deduction as a great reason for buying a home. I think prices may come down a little bit without the deduction in expensive markets where every mortgage holder takes the deduction, but in parts of the country where mortgage interest is smaller than the standard deduction it may not matter that much.
Even if prices drop, I don't think it will be catastrophic since housing prices are already severely depressed and many foreclosures are selling at or below replacement cost. According to the Tax Policy Center report, a little reduction in home prices may even raise homeownership rates because houses will just be plain more affordable, and that is not a bad thing.
If the deduction were eliminated, the Treasury would collect an additional $108 billion in tax year 2012. That is a decent chunk of change that could be used to chip away at the trillions of debt the country has. Although I do take advantage of the mortgage interest deduction right now, I would be happy if it went away because I don't think those who have small or no mortgage should subsidize other people's debt via the tax code. Ultimately, all mortgage interest goes to the banks, and I don't think it is good policy to encourage more debt and inflate housing prices for the benefit of large financial corporations.
What do you think? Do you love your mortgage interest deduction? Do you want it to be eliminated or reformed?