A Brief History of the Mortgage Interest Deduction

I keep finding very poor or misleading reporting on Housing in the US. Some of this is sloppy or lazy reportage; others reflect reporters being suckered by Think Tank spin and political narratives.

Lately, the area seems to be misreported the most is the coverage of the Mortgage Interest Deduction. The misleading impression created by some reports is that this deduction is the result of a specific policy designed to encourage home ownership. That is a false narrative, belied by history of the Federal Income tax.

Let’s take a quick look at facts so that people understand it better.

The first Federal Income tax in the US was passed in 1894, and subsequently struck down by the Supreme Court. This led to the passage of the Sixteenth Amendment (ratified in 1913), that empowered Congress “to lay and collect taxes on incomes, from whatever source derived.”

With this new power, Congress imposed the first taxes. Rates started at 1%, and rose to a whopping 7% for taxpayers with income in excess of $500,000. This applied to relatively few people, with less than 1% of the US population paying any 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 a 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.

Now you know . . .

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Previously:
Housing: Still Widely Misunderstood (August 24, 2010)

Source:
History of the U.S. Tax System
http://www.ustreas.gov/education/fact-sheets/taxes/ustax.shtml

See Also:
Who Needs the Mortgage-Interest Deduction?
ROGER LOWENSTEIN
NYT, March 5, 2006
http://www.nytimes.com/2006/03/05/magazine/305deduction.1.html

Defending the Mortgage Interest Deduction
Realator.com
http://www.realtor.org/government_affairs/mortgage_interest_deduction