Letting homeowners deduct interest paid on their mortgages from taxable income makes no sense. It encourages taking on more debt, discriminates against renters, subsidizes one kind of spending over others and favors the upper incomes. It advances the questionable public goal of making more Americans into homeowners. And it costs the Treasury about $100 billion a year.
Although the mortgage-interest deduction is bad policy on numerous fronts, neither party seems keen to take it on. The real-estate industry portrays any cross-eyed look at the loophole as a frontal assault on the American Dream.
To their credit, Republicans baby-stepped in the right direction by trying to drop their usual support for the mortgage-interest deduction from their party platform. Candidate Mitt Romney has called for revenue-neutral tax reform that would lower federal income-tax rates while getting rid of loopholes – what is called “broadening the tax base.” (He refuses to be specific on which ones he’d close.) By leaving out mention of the mortgage deduction, the platform would push the message along.
No sooner was that thought on paper than the real-estate industry went to work on the Republican Party. In its place was put a pledge to protect the mortgage deduction if tax reform doesn’t happen. Still, progress.
Why offer a tax break for buying one product and few others? If you take out an auto loan, the interest you pay cannot be deducted from taxable income. If you buy a sofa on the installment plan, same no-deal. If you charge airline tickets on your credit card, again, the interest on your unpaid balance is not deductible.
The social-policy argument for the mortgage deduction is that it helps Americans buy homes, and that homeownership stabilizes communities. The first part is debatable. Canada does not allow for a mortgage-interest deduction, and its rate of home-owning matches ours.
What we see here is social engineering gone haywire. The federal government should not care whether you buy or rent your residence. Because lower-income people are more likely to rent, they are left out. Because higher-income people are more likely to have bigger houses with bigger mortgages, they benefit disproportionately. Meanwhile, the deduction is useless to those who don’t itemize, which is most taxpayers.
This incentive to buy real estate helped inflate the housing bubble. Sold as a tax haven, the deduction propelled ordinary folks to take out bigger mortgages than they should have. And their ability to borrow more let them bid up house prices to absurd levels. When the bubble splattered, and house prices plunged, many buyers found themselves owing more on their home than the place was worth. How stable is a neighborhood full of foreclosed properties?
Here is a plan for getting rid of the mortgage-interest deduction. It would harm neither the currently fragile housing market nor the political career of any candidate with a modicum of guts:
Phase out the deduction very gradually. If house shoppers know that a full deduction for mortgage interest is available for only a few years, that might boost house sales now. There’s already a $1.1 million ceiling on the size of mortgages whose interest can be deducted. Over time, further limit the deduction’s value.
The housing industry will undoubtedly go through the roof, hollering that war has been declared on a rare (and much exaggerated) middle-class tax benefit. But closing this loophole could win wider backing if most mortgage holders are convinced that the value of the deduction they are losing would be offset by lower income-tax rates. You never know. Some day our political leadership may summon the courage to do the rational thing and treat real estate like any other possession.
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