The popular tax deduction for home mortgage interest has come under fire again as politicians tasked with bridging an enormous budget gap puzzle over how the country can make ends meet. Nearly 40 million Americans take advantage of the deduction, which allows homeowners to write off interest paid on mortgages, lowering their taxable income. Experts say eliminating the deduction could result in about $150 billion of additional revenue for the federal government, which is currently expected to run a deficit of more than $1 trillion. But what politician has the political capital to suggest such a measure? According to a recent New York Times/CBS News poll, few Americans favored getting rid of the tax cut, long prized as a middle-class benefit.
Financial experts have also trained a critical eye on the tax break for homeowners, saying the program contributes to financial instability by encouraging consumers to carry more debt. Because of the incentive, some critics charge that consumers have piled on excessive amounts of debt, a key factor that contributed to 2008's global financial meltdown. "Congress should modify the U.S. tax system to reduce the incentives for destabilizing activities by banks and households," Minneapolis Fed President Narayana Kocherlakota said in a speech in late June at the Tri-State Bankers Summit. "Higher amounts of household and financial institution leverage mean that the financial system is more susceptible to these kinds of shocks."
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These discussions come against a backdrop of increasingly tense negotiations between Democrats and Republicans about raising the debt ceiling, and the economic drag of consistently disappointing jobs and housing market data. But despite the revenue the federal government could recover by discontinuing the program, could axing the mortgage interest deduction further hobble the housing recovery?
U.S. News talked to mortgage expert Keith Gumbinger, president of mortgage-information site HSH.com, to find out how tapping out on the tax break for homeowners could impact the housing market and economy. Excerpts:
This popular deduction has been sacrosanct for a long time, but should it be abolished in light of the country's fiscal difficulties?
Anything that might temper demand and temper demand of vitally important first-time buyers in the marketplace is probably unwelcome, at least right now. The question is, why now? In the middle of one of the worst housing markets arguably ever, why do we have to do this right now? Is it necessary to make this change right now? Right now, there is at least some value in [the mortgage interest deduction]. It helps to foster at least some demand in the market. Thinking about it that way and knowing that rents are rising and home prices are falling, this mortgage interest deduction may become more of an important component of that decision making process.
There are proponents and there are detractors for this thing and there always have been. Most of the strident voices on that side are involved in the industry: your Realtors, your builders, mortgage sales, and what have you, because it helps to sell products more easily. On the other side, you've got folks look at the tax code and say, 'Why are we trying to benefit this one particular class relative to other classes?' And then you can get into questions of fairness, and is this fiscally responsible and are we promoting or distorting certain markets at the expense of others?
Some critics say the home-mortgage interest deduction causes homeowners to borrow excessively. Is that true?
How does somebody get a mortgage? Aside from the recent episode with subprime where you could breathe and get a loan, when you walk into an office you're going to have to qualify for the amount of mortgage you can borrow based upon your income. The fact of the matter is, most first-time buyers leverage themselves up as far as they can anyway, relative to their income so it's not as if they're going to be able to turn around and buy more house, they're not going to have enough money to buy anymore house.
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And thinking about it conceptually, if you're thinking about buying or renting, no one's just going to want to pack all their stuff and move unless there are other reasons to do so. If there is some cost offset, in this case a mortgage interest deduction, that reduces the cost and makes it more palatable, then maybe I want to go buy a house instead. Does it provide an equalizer in some decisions? Probably, but I don't think you could say it's such a huge sway. Once you get outside of the expensive portions of the country, there's not a lot of benefit from this.
But we still need some sort of incentive to revive the housing market?
This marketplace needs virtually every possible buyer you could get into it. The $8,000 homebuyer's tax credit proved that very well. It advanced a lot of demand, to be sure, but it also fostered some demand. I know several folks who jumped into the market who would not normally have gotten into the market. To the extent that it is a deterrent, it's really hard to say this is a great idea. The consideration is that when homes don't sell, lots of states [lose out on] a lot of tax revenue because of the realty transfer tax. So if another home which might have sold with a little incentive that [the deduction] might provide doesn't sell, does that create more tax damage to the state? There's a lot of these interconnected things—it's not as simple as saying, 'Look at all the money,' because we've built policy in this country around fostering housing for 70 years or longer and one of those components we've built is tax policy to go foster homeownership. There may be wide-ranging and unforeseen issues which come as a result of that change.
How likely is it that the mortgage interest deduction will be abolished?
It's come around a couple of times since I've been doing this. It hasn't survived the political process yet and while there is some good consideration of it once again in light of our fiscal troubles, who would stand up and go against the only tax break available to the American homeowner? It's a populist program and no one wants to be the one standing up there holding the sword of fiscal responsibility and get run over by the train of angry homeowners.
I think most likely what you will find is that limits will come into being. Those might be income-based limits, those might be total mortgage indebtedness, it might be the deduction will only be available for primary residences as opposed to primary and secondary residences, as it is now. I suspect that any sort of a "compromise" would trim back the maximum total mortgage indebtedness, or income limitations, or otherwise means tested in order to have only certain borrowers qualify.
What would the time frame look like?
I don't think anyone is going to do this on a cold-turkey basis, I think anything would be on a phased-in basis. Elimination would probably come on a phased-in basis, but a means-tested change, limits, caps would come in on a much faster phase-in, to try to limit disturbance and see what happens. There are all these static projections that Congress likes to make, but humans don't work in static form, they work in dynamic form. If they make the change and suddenly no one is buying luxury homes as a result, are we willing to admit that we need this policy to help move that market forward? There's no way to know.