It seems more and more people are calling for the abolition of the once untouchable mortgage interest deduction. The idea’s been kicking around for a while. In 2005, President George W. Bush’s Advisory Panel on Tax Reform advocated the complete elimination of the deduction, offering an interest credit in its stead. And for the last two years, the Obama administration has offered to do away with the deduction in its budget, albeit only for those making more than $250,000. Neither Bush nor Obama could drum up any support for the measure in Congress, however. More recently, any number of economists, columnists, and think tankers have talked about the elimination of the deduction as a done deal. No less than Moody’s Analytics chief economist Mark Zandi, in a real estate forum hosted by the U.S. Chamber of Commerce in July, suggested that not only should the real estate community support the elimination of the deduction, it should “lead the way” in getting it rolled back. Needless to say, the audience was less than enthusiastic about the idea.
I admit, when I first heard mention of eliminating the deduction, I dismissed it as political rhetoric. It’s been around forever, and it’s a cornerstone of the American dream, right? An embodiment of our government’s commitment to fostering homeownership, which creates better citizens and better communities? Not entirely.
It has been around forever, or as long as there have been U.S. income taxes anyway. But home mortgage interest deductibility was not on the minds of the creators of the income tax. In 1913, when the U.S. Constitution was amended to allow a Federal income tax, all interest was deemed deductible. That was because the income tax was aimed mostly at businesses, and their expenses, of which interest was one, were excluded as taxable income. Very few individuals paid income tax, and those that did, did not need a mortgage to buy their homes.
Even regular folks paid cash for their homes back then. Home mortgages didn’t begin to proliferate until the 1930s when the government created the FHA, which insured the mortgages, and Fannie Mae, which bought them and allowed lenders to increase their lending capabilities. After World War II, the G.I. Bill completed the transformation of the home buying process into a borrowing and lending transaction rather than a cash one, and turned a majority of Americans into homeowners.
So the federal government didn’t create the home mortgage interest deduction as part of its social policy. But there’s nothing wrong with an incentive that promotes homeownership. All studies seem to agree that a homeowning society is more productive, better educated, and even healthier.
But among the calls for abolition of the deduction, which center, of course, on financial reasons, such as the projection that it will cost the Treasury $131 billion in 2012, there are also some recommendations for replacement of the tax deduction with a tax credit. Many of these recommendations are revenue neutral, in that they don’t add more money to the federal coffers. But they do purport to be more equitable and progressive in their distribution of benefits to all home buyers. That’s a nice idea, but even if the system does need a fairness overhaul, the problem with changing it now is one of perception and timing.
The 1986 Tax Reform Act eliminated almost all of the deductions for personal debt. It retained the mortgage deduction, however, and President Reagan said he wished to “preserve the part of the American dream which the home mortgage interest deduction symbolizes.” He understood that the interest deduction looms large in its role as assistance in making ends meet for buyers, whether they are first-timers or purchasing the home they will retire in.
And at a time when the housing industry is struggling to survive, do we really need one more reason to make prospective home buyers question whether or not now is a good time to buy a home?