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Is now a good time to get rid of the mortgage interest tax deduction?

Mark Calabria argues that the current moment of low home prices, low interest rates and broad recognition that it should not be official government policy to push people into bigger and bigger homes is ripe to eliminate the mortgage interest tax deduction and use the proceeds to lower income taxes. I'd use the proceeds to lower payroll taxes, but whatever. Getting rid of the mortgage interest tax deduction is a good idea, and I say that as a new homeowner who's benefiting from it.

That said, Calabria doesn't run the numbers on how many home foreclosures would result from his policy. A homeowner who bought based on the mortgage interest deduction might be pushed into default if it disappears. So I'd imagine it's something you'd want to structure such that there's no deduction for homes bought after X date but there's a phaseout period for existing homeowners. All this stands approximately no chance of happening, by the way.

By Ezra Klein  |  April 16, 2010; 3:07 PM ET
 
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Comments

It's ALWAYS a good time to get rid of the mortgage interest tax deduction. Phase it out over the next ten years through a progressively lowering cap, if you want to be easy about it.

Posted by: etdean1 | April 16, 2010 3:26 PM | Report abuse

One thing that should be remembered is that mortgage interest is only deductible on the first million dollars of home loan.

I don't know if that matters all that much, but my point is that it is NOT an all or nothing proposition. We can limit the amount of mortgage interest that is deductible without doing away with the mortgage interest deduction. In fact, we already do.

In my opinion it comes down to the following question: Should the US government incentivize home ownership. If you think it should, then doing away with the mortgage interest deduction is a bad idea.

The other, not so obvious point, is that without the mortgage interest deduction most of us wouldn't itemize our deductions. Our itemized deductions wouldn't exceed the standard deduction, so we wouldn't even bother.

Posted by: nisleib | April 16, 2010 3:31 PM | Report abuse

It's only a good idea in a vacuum. Reality is that getting rid of that deduction would cause mass chaos and force thousands and thousands of foreclosures and start a whole new mortgage crisis. Enough people are already underwater with their homes and just trying to stay afloat. And now you want to screw them even more? You sound like one of those sports stats geeks who doesn't get that games still have to be won on the field.

Posted by: thefoulness | April 16, 2010 3:32 PM | Report abuse

Instead of repealing it, why not phase it out between say 3-500K and eliminate it on non primary residences. People who buy 1000K homes or own multiple properties don't need additional federal largess.

Posted by: srw3 | April 16, 2010 3:36 PM | Report abuse

thefoulness,

In that case, we would never correct ANY terrible entrenched policy. Change is hard, but that can be mitigated by easing into the change slowly. No one would eliminate the deduction completely for next year, but passing a law now that would draw down the level you can deduct from the first $1 million by 100k each year would let people adjust.

Posted by: etdean1 | April 16, 2010 3:38 PM | Report abuse

@nisleib: "In my opinion it comes down to the following question: Should the US government incentivize home ownership. If you think it should, then doing away with the mortgage interest deduction is a bad idea."

You could incentivize home ownership without incentivizing McMansion ownership. The cap could easily be at $300k. Folks who can afford $300k+ houses don't need any additional interest deduction off their taxes. No matter where you live.

While the mortgage interest deduction is a de facto subsidization of home owners and reducing income taxes a point would be a more equitable form of tax relief, I think the real incentive to overbuy and over-commit to crazy loans were these 0% to 5% down mortgages with future balloon payments and adjustable rates and all sorts of gimmicks that anyone looking at them would have to think were designed to get people into houses that, a few years later, the bank would be foreclosing on.

No more ARMs. No balloon payment. Minimum of 10% down on a house. And, sure, get rid of the mortgage interest deduction. But that isn't what incentivizes home ownership, and isn't really for home owners, anyway. It's for the banks to get people into larger or higher interest mortgages.

Posted by: Kevin_Willis | April 16, 2010 3:39 PM | Report abuse

etdean1,

My thoughts exactly. It's always a good time.

But kill it now and completely - raise the standard deduction by a proportional amount.

The foulness,

If any one forecloses because their mortgage interest tax deduction goes away, then they spent way too much on their house.

Let's say a family can deduct $18,000 of mortgage interest (that's a big ol' house). Right now the standard deduction for a family is what, $11,400? If the standard deduction can be increased to, say, $15,000 for a family, then with the loss of the interest deduction, that family will only have to pay taxes on that extra $3,000 - $750 for the 25% tax bracket. I really could care less about people were so reckless so that $750 gets them to foreclose on their home.

Posted by: justin84 | April 16, 2010 3:42 PM | Report abuse

justin84,


a lot of people DID spend too much on their house irregardless of the deduction. then they got second mortgages they couldn't afford etc to keep up with the Jonses'. that's the problem.

I'm fine with getting rid of the deduction too. I'd phase it out as srw3 suggests but the problem is that what $300k gets you in Mississippi is different than what it gets you in New Jersey, New York or Connecticut. Why should we get to deduct less because our cost of living is higher?

Posted by: visionbrkr | April 16, 2010 3:46 PM | Report abuse

Kevin:

Bingo. That was my point. The current rules state that mortgage interest is only deductible on the first million dollars of mortgage.


I would not be opposed to lowering that threshold to 300K, as you suggest, but I'd add a note of caution: Don't forget the COLA! COLA (Cost of living adjustment) is very important when discussing real estate. The 300K house in NY is NOT the same as the 300K house in El Paso.

One other thing to keep in mind is that the deduction is limited by the size of the mortgage, not the cost of the house.

Regarding ARMs, I'd agree that doing away with them could make sense for people buying a primary residence. But businesses? Hmm, I'd say let businesses do what they like as far as real estate financing goes. But I'm not too firm on that and would have to think on that a tad longer.

Posted by: nisleib | April 16, 2010 3:49 PM | Report abuse

I'll bet my house on the fact that I will continue to enjoy the mortgage interest tax deduction for as long as I live in it.

Regardless of whether people bought too much house or not... the fact is that the interest deduction is a major factor when figuring out what you can afford. reversing it at this time is infeasible and would also have disastrous effects on current home sales by effectively raising cost by the amount of the deduction.

Posted by: rt72 | April 16, 2010 3:51 PM | Report abuse

"Calabria doesn't run the numbers on how many home foreclosures would result from his policy. A homeowner who bought based on the mortgage interest deduction might be pushed into default if it disappears."

'Ya think? Home prices would drop further, wealth effect would be further devastating, ect...

You can't pull the rug out of folks who bought in 2004-2007. They are already on shaky ground, many anyway. They are already staring at a house worth less than they owe. Now is a good time to take them down a notch?

Ugh, I'm for higher taxes (to pay for what we are spending) and for making sense of the tax system (less credits/deductions, lower rates). But, it seems like the worst time ever to pull the interest deduction away...

Something like this would need to be phased in, over like 20 years! Let the home value adjustments happen slowly.

In a sense, the mort. deduction basically picks up the property taxes (and gets phased out over time).

Posted by: rat-raceparent | April 16, 2010 3:53 PM | Report abuse

Interestingly, it sounds like there's a relative consensus.

visionbrkr - what about allowing people to deduct up to a percentage of their overall home cost (say 40% as an arbitrary example), with a cap at 750k (for another arbitrary number). That way you can incorporate variable housing costs. I might be missing something though.

Posted by: etdean1 | April 16, 2010 3:58 PM | Report abuse

Why not eliminate or cap the mortgage interest deduction on new jumbo mortgages offered after June 31? That has high cost areas factored in, there is already a market based distinction and it is easy for people to understand. Sure it will continue to subsidize current homeowners who bought to much house, but perhaps it will prevent people from doing so in the future.

If they are interested in subsidizing home ownership it would make sense to maintain only the first time home-buyer tax credit instead of the mortgage interest tax deduction.

Posted by: tmorgan2 | April 16, 2010 4:00 PM | Report abuse

A 300k cap on mortgage interest deduction would be a massive tax increase on people who live in blue states.

And I think it would likely be a good idea to get rid of that deduction. It's just that it retains the subsidy for McMansion owners in Oklahoma while raising taxes on people who live in a suburban NJ tract home.

Posted by: constans | April 16, 2010 4:16 PM | Report abuse

also keep in mind that the deduction has been amended in the past, but has always grandfathered in the deduction rates that the homeowner enjoyed at the time of purchase.

If this rule is amended, it will have to be "from now on.." oh, and it would also have to be at a time of relative economic strength... so maybe in 5 years we can bring this up again

Posted by: rt72 | April 16, 2010 4:18 PM | Report abuse

"The other, not so obvious point, is that without the mortgage interest deduction most of us wouldn't itemize our deductions. Our itemized deductions wouldn't exceed the standard deduction, so we wouldn't even bother."

Building on @nisleib's post, eliminating the mortgage interest deduction would likely cause charitable contributions to fall considerably due to fewer people exceeding the standard deduction.

Posted by: BigTunaTim | April 16, 2010 4:25 PM | Report abuse

Phase it out over time. Can you really deduct interest on 2nd and 3rd homes? End that now.

Posted by: luko | April 16, 2010 4:27 PM | Report abuse

My primary worry would be the effect on housing values at the low to medium end. My house is currently worth about $225. Take away the mortgage interest deduction and the value probably drops to $200 or maybe even $175. At what point do I walk away form it and how do the banks write down the loss?

Nevertheless, we could still phase out the deduction over 10-15 years by allowing a deduction for 95% of interest in year 1, 90% in year 2, 85% in year 3 etc till the value of the deduction was so low it could be eliminated without hurting then existing home values.

Posted by: WoodbridgeVa1 | April 16, 2010 4:31 PM | Report abuse

Not to pile on, but eliminating the mortgage interest deduction will lead to an immediate drop in home values, which is not advisable at the moment. (It would have been a brilliant maneuver in 2003, though.) And lowering the cap will disproportionately impact homeowners in high-cost areas who are in higher tax brackets despite not having particularly high incomes for the area.

There are people out there who think the mere possibility of higher income taxes in the future prevents business owners from making decisions in the present. I'm skeptical of that. But the possibility that the mortgage deduction is eliminated will have that exact effect.

Posted by: mdg1111 | April 16, 2010 4:31 PM | Report abuse

@ constans : I could go with a regional adjustment of the capped amount or a % of the home's value as a ceiling on the amount that can be deducted. I just don't think that subsidizing massive homes and wealthy people is a good use of tax payer money...

@ luko : You betcha

Posted by: srw3 | April 16, 2010 4:37 PM | Report abuse

Luko asks, "Can you really deduct interest on 2nd and 3rd homes?"

You can deduct mortgage interest on two homes, but not on any more than that. Regardless, the total interest is limited to one million of mortgage principal. In other words, if you have a mortgage on your primary residence of 1 million and a mortgage of 500K on your second home, the mortgage interest expense on your second home would NOT be deductible.

BigTunaTim - That was my point exactly. There is a lot of social engeneering built into the US tax code. Doing away with the mortgage interest deductions would be a huge change, the full effect of which would not be known for quite a while.

Posted by: nisleib | April 16, 2010 4:39 PM | Report abuse

@ WoodbridgeVa1: Whatever, as long as it goes away or has a cap (adjusted for location) on how much interest can be deducted.

Posted by: srw3 | April 16, 2010 4:46 PM | Report abuse

"The cap could easily be at $300k"

300k doesn't by squat in some parts of the country. My 930 sqaure foot condo in Norhern VA is cost 100k more than that.

That said, I did not factor the tax break into my decision to puruchase a home. I new it would help come tax time, but it was not 1st, 2nd, or even 3rd on my list of financial considerations.

Posted by: NoVAHockey | April 16, 2010 5:03 PM | Report abuse

Visionbrkr,

I definitely agree lots of people spent too much on their home regardless of the deduction.

All I'm saying is that is the extra several hundred bucks in taxes puts you into foreclosure, I don't feel sorry for you - espeically if the proceeds of the mortgage interest tax deduction expand the standard deduction.

If we change the mortgage tax deduction into a larger standard deduction, most people won't be affected much either way.

Posted by: justin84 | April 16, 2010 5:10 PM | Report abuse

Government support of homeownership was supposed supposed to support stable neighborhoods and family security. We all know how that's turned.

It needs to be phased out. Reduce the eligible percentage over 10-15 years (eg. 100% of interest paid in 2011, decreasing by 6% a year until it is gone) and continue the new buyer credit.

Posted by: Athena_news | April 16, 2010 5:12 PM | Report abuse

"the current moment of low home prices."

What? Is he kidding? The Case-Schiller index shows home prices at about 180 percent of their 2000 levels, which is to say, worth much more in real terms than 10 years ago. The current moment is one of *high* home prices, and probably will remain so until there are a lot of new foreclosures (bad scenario) or until inflation in the rest of the economy drives real home prices down while they stay more or less steady (that's actually the rosy scenario).

And just to be clear - that 180 Case-Schiller figure obscures much greater inflation in some parts of the country. E.g. (and Ezra should know this!) homes in Northwest Washington, DC are generally listed for about 3 times what they were in 2000. Low home prices? Not a chance.

Posted by: Sophomore | April 16, 2010 5:17 PM | Report abuse

Are you nuts? The only way I (and probably 90% of the US population who are home owners) would be ok with this passing is as part of a MAJOR tax reform bill that changes the tax rates and simplifies them.

There is 0% of this passing otherwise. None. Nada.

Posted by: JERiv | April 16, 2010 5:32 PM | Report abuse

Are you nuts? The only way I (and probably 99% of the US population who are home owners and still paying their mortgage) would be OK with this passing is as part of a MAJOR tax reform bill.

And the goal of that bill had better be one: Simplification.

Throw in a payroll tax cut for everyone, and you'll have yourself a deal.

There is 0% of this passing otherwise. None. Nada.

Posted by: JERiv | April 16, 2010 5:36 PM | Report abuse

sorry about double post. :-)

Posted by: JERiv | April 16, 2010 5:37 PM | Report abuse

I'd make some other changes:

1. Allow only one mortgage/family to have deductible interest (no more subsidizing mega motorhomes and yachts as "second" homes..yes, people do that)

2. Change the residency requirements for the capital gains exclusion for profit on the sale of a home to 10 years from 2 years. People were flipping homes out here in California like crazy because of this ridiculous two year rule. Who buys a house for just two years? Speculators.

3. Allow folks to take a capital loss on the sale of their home if they are underwater. This would help out those in foreclosure, and it would quickly clear the backlog of homes in the foreclosure process.

Posted by: Beagle1 | April 16, 2010 6:59 PM | Report abuse

I agree with phasing out the mortgage deduction. Consumers need a planning horizon. I also believe that the mortgage deduction has inflated interest rates over the years, removal of the deduction will encourage competition, Phase the deduction out over 15 years, 9% the first year and 6.5% thereafter, Immediately reduce the cap to $750,000.

Posted by: dwbarker1 | April 16, 2010 8:48 PM | Report abuse

"What? Is he kidding? The Case-Schiller index shows home prices at about 180 percent of their 2000 levels, which is to say, worth much more in real terms than 10 years ago. The current moment is one of *high* home prices, and probably will remain so until there are a lot of new foreclosures (bad scenario) or until inflation in the rest of the economy drives real home prices down while they stay more or less steady (that's actually the rosy scenario)."

That's a great reality check. Although many homeowners are underwater, the truth is that much of the bubble has not fully burst, and knowing that simple fact makes any choices to be made at this time connected in any way to real estate value (and demand) very tricky.

I always believed that we have done far too much over the years to subsidize the mortgage, real estate, and home construction industries, and we ought to gradually disentangle the government from constantly stimulating the market. But the consequences, and further potential consequences, of over-inflated home real estate pricing still have us in a very precarious position for the overall economy.

A gradual elimination of the home interest deduction would be great policy, but now is precisely the worst possible time to introduce the idea.

Posted by: Patrick_M | April 16, 2010 9:32 PM | Report abuse

>>Calabria argues... to eliminate the mortgage interest tax deduction and use the proceeds to lower income taxes. I'd use the proceeds to lower payroll taxes, but whatever.

How about eliminating the deduction in a reasonable way (lots of good ideas already posted) and *not* cutting other taxes? Instead, use the increased revenue to pay down debt, repair infrastructure, or "whatever"? As a country we're underwater on our mortgage and the roof leaks, so why would we want to continue to give away that revenue through some other means?

Posted by: CanadaTed | April 17, 2010 11:26 AM | Report abuse

CanadaTed -

It is argued by some that eliminating (or phasing out) the mortage interest deduction would only become politically palatable (and fair to those who have relied upon the deuction) if that action was neutralized by something like an increase in the standard deduction, so that mortgage payers were left no worse off on their net final taxees. Then at the same time tax preparation would become much more simple and much more fair (since income taxes paid would then be determined by income, and not by whether one chooses to buy or to rent).

As things stand now, the wealthy enjoy a disportionate benefit, since one can deduct interest on up to million dollars of mortgage debt, including vacation properties.

But savings would still be possible. If we don't completely offset the deductions for the wealthiest tax payers, by dropping the deduction to $500k worth of property and limiting it to a primary residence) we could still recover billions every year to lower the deficit and/or to invest in infrastructure and other worthy government programs.

Posted by: Patrick_M | April 18, 2010 7:13 PM | Report abuse

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