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The mortgage interest deduction not about mortgages at all?

I'd always taken it as obvious that the mortgage interest deduction was policy Congress put in place specifically to encourage home ownership. But Barry Ritholtz says that's not true at all. Instead, it's a holdover from decisions made to soften the blow of the very first income tax.

As an offset for the taxes, any interest paid (for any reason) was deducted. These were considered business expenses. Indeed, taxes on rents from real estate was a large revenue source. The financing costs of purchasing such rent producing property — a/k/a interest payments — was an ordinary cost of doing business, and hence, deductible.

Keep in mind that during the pre-WW1 period, there was very little interest expenses paid by individuals. Home owners typically owned their houses outright (except for farmers, who either financed or leased the land). There were no credit cards, HELOCs, revolving credit, or student loans.

The deduction on interest was never intended to be a salve to the middle class. It was not designed to encourage home ownership. Indeed, when the interest rate deduction was first considered, home financing was non-existent, and home ownership was not thought of as a public policy. It is not part of any grand scheme of social engineering, as some have called it. It simply has existed since the Federal Income tax came about a century ago.

Indeed, the entire home mortgage deduction is little more than a historical anachronism, a carry over from when all interest payments were deductible.

By Ezra Klein  |  August 31, 2010; 12:18 PM ET
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Thanks, I've always wondered why we don't have a cap on this deduction! As it stands, the deduction encourages and helps people not only to buy a home, but also to borrow huge amounts for million--dollar and multi-million-dollar McMansions. A reasonable or even generous cap would make more sense to me.

Posted by: pjro | August 31, 2010 12:39 PM | Report abuse

sounds good. start it AFTER my last mortgage payment.

Posted by: popopo | August 31, 2010 12:42 PM | Report abuse

I'm not so interested in original intent, but on the effect -- and it has the effect of inflating housing prices.

Posted by: uberblonde1 | August 31, 2010 12:45 PM | Report abuse

Even if that were true, wouldn't the fact that individuals can now only deduct mortgage interest and a few other special case interest items (like, occasionally, student loan interest) show that, at some point, for some reason other than as an offset for the income tax, someone made the decision to keep mortgage interest deductions and scrap the other interest deductions?

I will never again in my life use the word 'interest' so many times in a single sentence.

Posted by: jpeg | August 31, 2010 1:38 PM | Report abuse

I thought there was a cap on the mortgage interest deduction. I thought lots of deductions were phasaed out somewhere above my income level. Is this wrong? If not, there should be.

I understand the solicitude for homeowners in this recession, but a renter who loses a job and faces big medical bills doesn't get help, and probably needs it more.

Posted by: Mimikatz | August 31, 2010 1:41 PM | Report abuse

..."show that, at some point, for some reason other than as an offset for the income tax, someone made the decision to keep mortgage interest deductions and scrap the other interest deductions?" -- jpeg

No; what is demonstrates, is how powerful the real estate industry has become. Everyone who has taken a serious look at it knows the mortgage interest deduction should go.

Posted by: Athena_news | August 31, 2010 2:45 PM | Report abuse

Despite the "original intent" of the various interest payment deduction provisions, the record shows that Congress demonstrated a specific intent to encourage homeownership by repealing virtually all other similar deductions when it enacted the Tax Reform Act of 1986. Combine the interest rate deduction with the home-sale tax exclusion and you've got an even more powerful bias toward homeownership. Incidentally, this same tax-regulatory anomaly led many homeowners to use their homes as "ATMs." Why would you finance a car regularly when you use a HELOC and deduct the interest portion of the payment? These two tax provisions certainly added fuel to the home bubble fire.

Posted by: garseea | August 31, 2010 7:52 PM | Report abuse

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