Ramifications of Eliminating the Mortgage Tax Deduction

What are the economic ramifications of the Mortgage deduction being eliminated? How likely is it that such a significant tax change is actually enacted?

Ever since the President’s tax reform policy suggested capping the mortgage deduction at significantly lower levels, I’ve been wondering what the economic ramifications of this would be. Especially now, coming at the tail end of a huge Real Estate cycle.

The entire issue may be moot — at least for now — given the present political situation. Perhaps if President Bush were at full political strength, if he wasn’t dealing with numerous crisis and scandals and staff indictments and the fading support for the war in Iraq, while still smarting from the rejection of social security reform, and if his own polling numbers were not at an all time low in popularity — if all that were not weighing against him, the chance of eliminating or greatly modifying the home mortgage deduction might be 15-25%. Given his current predicament*, my expectations are that eliminating this extremely popular — even beloved — deduction are all but impossible. (Its surprising the opposition has not made more hay over this).

The home mortgage deduction is so ingrained into the economic fiber of the country, that the potential consequences of altering this are ginormous. The risk to overall economy, if this were to be even slightly mishandled, would be devastating. As is, the impact would be very significant, given Real Estate’s contribution to the economy.

This is especially true, given the factors which have been driving the Real Estate boom.   

Recall that back in May of this year, we referenced Northern Trust’s Asha Banglore, whose research showed that from 2001 to April 2005, 43.0% of private sector jobs were housing related. In this week’s Sunday Times, Daniel Gross further explored the correlation between Hosuing and Job creation (As the McMansions Go, So Goes Job Growth):

These data points are potentially worrisome, and not only for the legions of real estate brokers and Sheetrock layers toiling in offices and job sites across the country. In recent years, economists from Alan Greenspan on down have been discussing the way rising home prices and the growth of home-equity borrowing have fueled consumer spending, the piston that drives the country’s economic engine. But in recent years, housing, real estate and the related industries have become a huge factor in another crucial economic area: employment growth.

After the brief and shallow recession of 2001, the resilient United States economy stubbornly failed to create payroll jobs at the rate of past recoveries. Economists and politicians blamed factors and trends like outsourcing, global trade, high benefit costs and productivity growth. But amid the gloom, the real estate sector shouldered the burden of job creation . . .

As a result of the boom, the economy is more concentrated on housing than ever before. "Residential investment as a share of gross domestic product is at the highest level in 50 years," said Jan Hatzius, senior economist at Goldman, Sachs."

When discussing these data points just 6 months ago, I found the pushback significant. There has been less reluctance to acknowledge this issue more recently. Its intriguing to see how these ideas have slowly come to be accepted by the mainstream.

An earlier NYT article looked at another aspect of the proposd Tax changes: How they fall on people, based upon various economic classes:


Possibly the greatest NYT graphic ever:
click for larger graphic


Was there a nefarious ulterior motive in the way this was executed?  In an earlier piece by Dan Gross,
(Tax ’em Till They Turn Red) the elimination of the Mortgage deduction — or more accurately, capping it at a much lower
level than the present ~$ million dollars — is a way to offset tax revenue
losses from eliminated the Alternative Minimum Tax (AMT).

How much revenue? An expected $1.2
trillion over 10 years. And, as David Rosenbaum
reported in an Oct. 19 New York Times article (which you now have to
pay to read online), the panel came up with two simplification plans. Both would
severely limit the size of the home mortgage deduction. Now the deduction applies to up to
the first $1 million of a mortgage. The panel’s plans would cut it down so that
it would only apply to loans that are the "maximum that the Federal Housing
Administration will insure." The sum varies by market, but the maximum is
$312,895 and the national average is $244,000. Both plans would eliminate
deductions for interest on home-equity loans or mortgages for vacation homes.
And both would eliminate the deduction for state and local taxes paid, including
property taxes.

Fascinatingly, Gross observes that the
changes recommended by a commission appointed by the President will have much greater negative effects on taxpayers in Democratic regions. Its as if the tax changes are a form of economic gerrymandering whose impact will be to significantly reduce the net take-home pay of (surprise!) Democratic donors.

He proposes quite a fascinating thought experiment:

"Go to Realtor.com, punch in your ZIP
code and a price point, then punch in another ZIP code in a different part of
the country and the same price point, and check out the astonishing difference
in what you get."

Doing so reveals that the so-called Blue states are high level of Government services, higher income, higher state and local taxes. Property values are significantly higher. The mortgage deduction in these regions is worth quite alot more than it might be in the lower tax/lower property value Red states.

Fascinating analysis  . . .

As the McMansions Go, So Goes Job Growth
NYT, November 20, 2005

What’s Behind the Boom
THE WALL STREET JOURNAL, November 21, 2005; Page R4

Goodbye, My Sweet Deduction
NYT, November 3, 2005

Tax ’em Till They Turn Red
The Bush tax panel’s plan to screw Democrats.
Daniel Gross, moneybox
Slate, Posted Monday, Oct. 31, 2005, at 5:02 PM ET


*    I am going to venture outside of my area of expertise and make a broad political observation:  Typical Presidents get to make only 2 grand efforts during their terms:  Oftentimes, one is a rhetorical jawboning ("Mr. Gorbachev, tear down this wall!") while the other is actual legislation. President Bush ‘s two efforts are the War in Iraq and Tax Cuts, and they will likely be his legacy. (the Medicare Prescription Drug Plan was a secondary program). Its hard to imagine that tax reform, social security privitization, or another military effort will gain any traction.

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  1. me commented on Nov 21

    I do have a couple of thoughts. One, with interest rates so low, how significant is this deduction? I wonder if a lot of people did not lose their deduction when they refinanced at lower rates.

    Two, I would wonder if people quit using their credit cards when the credit card interest deduction was removed. It seems they charge more now than ever.

  2. Behind The Mortgage commented on Nov 21

    Eliminating The Mortgage Interest Deduction DOA?

    A few months ago, the Presidents Tax Reform panel recommended a reduction floated a deniable trial balloon aimed at reducing the mortgage interest deduction. It’s been our opinion that reducing this tax break in any sort of meaningful way would

  3. Behind The Mortgage commented on Nov 21

    Filed under Fat Chance: Eliminating The Mortgage Tax Deduction

    A few months ago, the Presidents Tax Reform panel recommended a reduction floated a deniable trial balloon aimed at reducing the mortgage interest deduction. It’s been our opinion that reducing this tax break in any sort of meaningful way

  4. cm commented on Nov 21

    me: Limiting the mortgage deductions has two immediate effects: (1) driving up the net monthly payment, and (2) a corresponding reduction in house price “comps”/equity available to HELOC/refi/upgrade. Some home owners I talked to are predominantly concerned about the latter. Their case was, whether you get you deductions limited by this or by AMT is more like a wash. They then went on that this screws primarily recent (since 2000) home buyers (and presumably serial refiers), in that they will be stuck in their houses and unable to “move up” due to the lost equity.

    Not sure how true all this actually is (esp. the AMT part), but it shows the importance of equity in people’s calculations.

    With credit cards I imagine as it increased net payments, it would have resulted in more bankruptcies at the margin.

  5. cm commented on Nov 21

    me: Many homeowners stretch financially to buy a house, and the mortgage deduction is a critical part of the equation for many. Changing the rules in mid-game will invalidate many a calculation, especially for those who pay a lot of interest as they are in an early part of their mortgage schedule.

  6. -cman- commented on Nov 21

    Just a nit on your footnote. In terms of long-term economic and social impact I’m not sure you can dismiss the Medicare D (Prescription Drug) benefit. You also miss No Child Left Behind, which has huge social and local financial implications. Bush’s awfulness as a president is made more awful by his “grand efforts.”

  7. -cman- commented on Nov 21

    Oh, and as a recent (2003) home purchaser of a charming and pretty well restored 1916 home which still needs some ongoing work, loss of the deduction would probably cause us to consider moving to a newer existing home.

  8. M1EK commented on Nov 21

    While I normally agree, and hate Bush, I think ending this deduction isn’t such a bad thing – it acts as a subsidy to expensive home purchasers who need that subsidy the least while failing to help those for whom it was originally intended. From my own experience:

    First home – condo in 1997, $96,000, 25% down, 15-year-mortgage. Had it not been for Texas’ reliance on the property tax for all things, I wouldn’t have been able to deduct ANYTHING past the first year (would not have exceeded standard deduction). Even as a 30-year 5% down mortgage, my deduction would have been minimal.

    Second home – house in 2003, $292,000, 20% down, 30-year-mortgage. We make out like bandits on the interest deduction until the cows come home.

    Now, which home is more likely to be the one bought by people who we’re trying to steer towards first-time homeownership?

    (Austin is one of the most expensive markets in Texas but obviously no New York, but still the same rule applies – the cheapest housing in your area doesn’t take those poor homeowners much above the standard deduction compared to the exurban McMansions, so their benefit is minimal).

  9. alice commented on Nov 21

    On balance Democratic states pay more to the federal government and get back less than Republican. The differences are significant.

    i have often thought that this shows fundamental weaknesses in the democratic “paradigm,” they simply don’t think along economic issues.

    Similarly in foreign policy they are not stressing the fact that we are now cutting a deal with North Korea we could have gotten 3 or 4 years ago before they claimed to build a couple of bombs and definitely set aside material for a couple more. Given their skill in smuggling our ports are now vulnerable. But the Democrats seem to think about real national security as much as the Republicans, but the Republicans do a good job of defending.

    Related to that is that almost no Democratic supporters of withdrawal point out that we’ve goven southern Iraq (through which our supplies go) to Iranian allies and also much of the government, so that if we want to put pressure on Iran we face *serious* conflict in Iraq as long as our troops are there.

    We simply don’t see the opposition thinking “big picture.” Economically they don’t point out that a flat tax (which is supposed to end the real estate deduction but which won’t since Republicans want a regressive system not a flat one) is not the *only* form of simplified tax. A simplified tax can be progressive.

    But repulblicans take over the concept.

    And Democrats don’t point out that some of the SS surplus could be invested in stocks with a good chance of being profitable in the 30 year time frame before they are needed. This would provide diversification and is done by most insurance companies, but the Republicans have managed to link stock investments with private accounts.

    Of course on the subject at hand, while the reduction or removal of deductions will hurt Democratic states more, previous tax cuts benefitted them more because they had higher incomes. They tend to be more prosperous just as they tend to have less crime on average.

    It does baffle me why the supposedly hard hitting Democrats don’t use the themes of federal dependancy and lack of real values (which crime represents) to hit Republicans were they lie, but I suppose it’s the same sort of mind block that makes this administration think there are only 2 positions on Iraq, decent people who support what it does unquestionaly and terrorist loving traitor liberals.

    I think we need a new political party, one which can see more fully.

  10. dirge commented on Nov 21

    Just looking at the NYT examples one could forecast an immediate drop in homes prices of 10%(15%?). Of course calculating any sort of future costs right is a little futile given the inflation reporting fiascos.

    Also, I came across an interesting 1983 study from the Urban Institute(Struyk, Mayer, Tucillo) suggesting that the mortgage deduction saps productivity by redirecting funding from capital expeditures towards housing expeditures. Of course in the day of the telecommuter maybe better homes do result in better productivity.

  11. wcw commented on Nov 21

    AMT? Qualified housing interest is deductible for the AMT, including as many refis as you want. Please see http://www.irs.gov/newsroom/article/0,,id=136889,00.html cm, have your friends file amended returns to claim their deduction. I may not like that law, but they are under no obligation to pay extra.

    The economic results of the thought experiment (completely axing the mortgage interest deduction) are obvious: residential home prices immediately come down up to 20%, though not uniformly. You’ll only see that 20% in high income tax jurisdictions for properties valued just over $1M. Lower tax rates mean a less valuable tax shield, cheaper properties mean less interest to deduct, and expensive properties hit the $1M mortgage-balance cap on interest deductions. Parenthetically, it is interesting how many U shapes like that you find in the federal tax code. Whether intentionally or not, the law does like to favor the extremely rich as well as the poor. Odd, that.

    So, what’s the result of a U-shaped decline in property values that varies by tax jurisdiction? It would appear likely that you’ll cut consumer spending in a manner that approximates the same pattern.

    It’s never going to happen, of course, given the political verities. However, I could see the deduction turning into a credit. Maybe.

  12. Lord commented on Nov 21

    It is not that mortgages are not deductable under the AMT, but that the incidence of this and the AMT would fall similarly by design. This would merely exchange limitations on AMT deductions limitations on mortgage deductions. Who this would fall on would differ naturally. Recent buyers, refinancers, move-up buyers would be hurt most. As it would change property values, it would really be more a wealth tax than an income tax.

    As someone put it
    Q: How can taxes on the middle classes be raised without increasing them on the wealthy?
    A: Eliminate the mortgage deduction.

  13. Blackwood commented on Nov 21

    Eliminating all state and local tax deductions is a second part of the new tax proposal.

    Which will totally suck for those in high state income tax states California and New York. New York City residents worst of all losing the ability to write off their city income tax.

    Residents of Texas and another 7 states will not be effected at all, since these states have no state income tax. http://www.taxadmin.org/fta/rate/ind_inc.html

  14. cm commented on Nov 21

    wcw: Lord already said it, but the point was limiting of e.g. property tax deductions by AMT vs. non-AMT limiting of mortgage deductions under the proposed change.

    Case in point, I know somebody who had their property tax reassessed (i.e. raised) last year, and could not deduct the hike due to AMT (that is, the deduction became ineffective as AMT kicked in). Apparently they had been right at an AMT crossover point.

    Conceivably a limited mortgage deduction would have put them at a larger distance from the crossover point, allowing the full(er) property tax deduction.

  15. wcw commented on Nov 22

    We’re talking at cross purposes.

    Lord’s point is that AMT reform is part of the proposed package. That doesn’t speak to current law, under which the mortgage interest deduction does not go away with the AMT — unless I really misread my IRS bulletins. Might well be. If I did, I’d love a link.

    Your point is that the property tax deduction goes away under the AMT, which congrues with my understanding as well. I figured I’d address the initial thought experiment on the economic effects of removing the mortgage interest deduction.

  16. cm commented on Nov 22

    wcw: Not to beat this to death, but the point of both Lord and me was that whether you lose let’s say $1000 of interest deduction due to limiting the mortgage deduction, or (effectively) $1000 of property tax deduction due to AMT comes out to roughly the same thing. Don’t hold me to the exact amount, I made it up.

    The people that I quoted are apparently (judging from their remarks) in the situation that today their property tax deduction is (effectively) limited by AMT. That is, their deductions vs. income situation is such that AMT triggers. Were their mortgage deduction limited, they would pay more taxes that way, and not be pushed into AMT by their property tax, as AMT would (presumably) not trigger due to the higher regular tax.

    I’m talking about people who are just at the “fringe” of AMT territory, good-earning two-earner professionals with kids and a house so they have just enough deductions to be hit by AMT.

  17. Austin Real Estate Group commented on Oct 25

    Removing the mortgage tax deduction will mostly affect the middle class. Frequently, when
    someone has an annual income of 2 million a year they will buy a house for less than 2 million.
    So their house price/income will be less than one. In contrast when people are making 30 to 50k
    their house price/income ratio will be 3 or 4. So basically elinating hte mortgage deduction
    will have a small net effect on the wealthy. In the same hand it will not hurt people with lower
    incomes because they frequently dont own homes. So basically it will effect the middle class.

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