Wednesday, October 27, 2010

Could Your Mortgage Interest Deduction Become a Thing of the Past?

Over the past year, there have been frequent rumors about ending the mortgage interest deduction. But with new pressure on the White House to balance the budget by 2015, the prospect of eliminating the mortgage interest deduction is looking like more of a real possibility.

An October 25 story in the Wall Street Journal states that the National Commission on Fiscal Responsibility and Reform, which is a bipartisan council, is currently seeking ways to trim $240 billion annually in order to balance the budget by 2015.  And cutting off income tax deductions, including the mortgage interest credit, is an attractive way to do that.  According to Yahoo News, the mortgage income tax deduction will total about $131 billion in 2012.  Yahoo News is quick to point out that this is seven times the 2011 budget for NASA and greater than the budget for the VA, or the Department of Labor or the Department of Education.

According to the Tax Foundation, 28% of U.S. filers claim the mortgage interest deduction on their income taxes and the average amount deducted was $12,221.  In California about 30% of filers took the deduction and the average amount was about $18,876. 

A spokeswoman for the Obama administration had reportedly commented that removing the mortgage interest deduction would have little effect on most families because "most Americans don't itemize."  And there certainly appears to be an false idea floating around that getting rid of the mortgage interest deduction merely raises taxes on the rich.  But nothing could be further from the truth.  Many homeowners who are in higher income brackets do not get to deduct the mortgage interest on their homes because they have to pay the Alternative Minimum Tax--in other words they are responsible for paying a certain amount of income tax to the government regardless of any deductions they may have.  In fact, eliminating the mortgage interest deduction for primary residences is one tax increase that is really going to hit the middle class squarely in the jaw since middle class families who own their own homes and are not subject to alternative minimum tax are the main beneficiaries of the deduction. 

A key factor in how we look at this issue is going to revolve around two basic questions, "Whose money is it anyway?"  and "What behaviors do we want to encourage as a society?"

The "Whose money is it anyway?" question is really critical as we look at this, because that is central to whether we see the deduction as a cost to the government or a savings to the tax payer.  If we take the approach that the money is rightfully the government's, then we have to look at the deduction as a form of  legally "stealing" what should rightfully go to the Treasury.  But if we take the approach that we earned our money through our own efforts and it is rightfully ours, then the logical conclusion is that we have a right to take permissible deductions.  Using the first argument we are costing the Treasury $131 billion annually; using the second we the people are saving $131 billion which we can put back into the economy, or into savings or into charitable contributions.

Second, what behaviors do we want to encourage as a society?  The mortgage interest deduction was introduced in 1913 to encourage home ownership.  For nearly 100 years, it has been a mainstay of our society, just as home ownership has been a vital part of the American dream.  But if we want to transition to a society of renters, there is no need to promote incentives to home ownership--in fact, it is counter productive to the goal of having a renter society.

An interesting statistic by the Census Bureau states that in 2009, half of all homes which are free and clear are owned by the elderly.  Most Americans buy their first home around age 35, and by age 65, over 80% of Americans are homeowners.   The ability to purchase and pay off a home is an important part of planning for a secure retirement.  And the ability to deduct the mortgage interest provides a financial incentive to Americans to purchase their homes and pay the mortgage for thirty years so that they can have a home that is paid for in their golden years.  It will be interesting to see how those statistics will change in the future if the commission determines that the $131 billion is really the government's money after all.

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