Asymmetrical Information

Or you could leave it alone, but charge an income tax on the rent they are deemed to be paid as owners of the house by hypothetical tenants. We had such a tax in Britain until the late 50s or early 60s. It was scrapped, but the deduction for the mortgage was retained. Now the deduction has vanished too. Probably wise, but don't let Them do it unless They cut some other tax in return: our Blairites cut deductions AND increase taxes.

It constantly amazes me how poeple think that making $100K a year means that it should be easy to buy a home. It depends entirely on where you live, and the reality is that jobs that pay 100K a year are in short supply in those places where 100K would make it "easy" to buy a home.

Actually,

Isn't it the mortgage and real estate industries that are the biggest direct beneficiaries of the mortgage interest deduction? The homeowners benefit (to a lesser extent) through higher home prices (via increased competition) as well as shielding a sizeable amount of their income from taxes. Real estate is also somewhat protected against depreciation because mortgage holders generally are unable to sell their properties at a loss.

You don't get the mortgage tax deduction unless you itemize deductions - and that's often a money loser for people in the lower brackets.

This is anecdotal, but the deduction was a huge factor in my house purchase (I didn't really want the trouble of home ownership but the tax benefits meant I'd be stupid not to buy).
Also, because it's a deduction of mortgage interest, you're encouraged to keep upgrading to maintain debt levels even after you build equity, so this deduction is really a gift to the banks and the real estate industry.

Simple solution: Just cap the amount of the deduction.

I have no problem with repealing the deduction. In return, drop the top two income brackets.

Those people who don't benefit from the deduction probably don't pay much income tax anyway. Only about half the people pay any income tax at all, so it's time to just plain stop this attempt and relief for the lower brackets. I'd be really worried if we ended up with only 35% of the people paying income tax, yet all the non-payers still get to vote.

Those people who don't benefit from the deduction probably don't pay much income tax anyway.

Just because you don't own a home doesn't mean you're collecting the earned income credit. The year before we finally saved enough to buy our first house, we owed so much income tax our withholding didn't cover it--and we were withholding at a higher rate than we were supposed to. We ended up writing a check to Uncle Sam that we hardly had money to cover. The next year, after we bought the house, our total tax bill went down, even though our income had gone up. The mortgage interest deduction really is a sop to the well-off. I don't know that it helps people become homeowners, either. Maybe more people could afford to buy a house if the mortgage interest deduction didn't artificially inflate property prices.

The value of the mortgage tax deduction is to a large extent reflected in higher prices for housing. (There must be econometric studies that quantify this.) Elminating the mortgage tax deduction all at once would have the effect of sustantially increasing the current cash costs of current homeowners while simultaneously knocking down the value of their homes. This strikes me as a non-starter for both macro-economic and political reasons. But a phased elimination over some period of time (10 years?) might make sense, if coupled with a plan to lower marginal tax rates.

K - "Simple solution: Just cap the amount of the deduction."

Congress is way ahead of you. The deduction is already capped in three ways: First, "only" the interest on the first $1 million of home mortgage debt is deductible. Second, the deduction is part of itemized deductions and is phased out above certain income levels. Third, large itemized deductions increase the likelihood a taxpayer will be subject to the alternative minimum tax (AMT). (This is true even though the home mortgage interest deduction is available for AMT, too.)

These three factors reduce the benefit of the deduction for higher-income taxpayers. They also make the tax law far more complex than it need be. The complexity makes it difficult for taxpayers to understand the after-tax cost of buying a home -- which dilutes the incentive to buy a home. We'd all be better off if Congress would quit using the tax code to reward and punish behavior. "All" that is except for we tax accountants.

"Elminating the mortgage tax deduction all at once would have the effect of sustantially increasing the current cash costs of current homeowners while simultaneously knocking down the value of their homes. This strikes me as a non-starter for both macro-economic and political reasons."

Very perceptive. This is, in effect, what Congress did to commercial real estate with the tax reform act of 1986. That act significantly increased the depreciation periods for commercial real estate and prevented tax payers from using their real estate losses to offset other sources of taxable income. The net result was that commercial real estate values fell by more than 25% in many markets. This, in turn, contributed to the S&L crisis of the late '80s. (I think of this example whenever someone opines that tax policy has little influence on economic behavior.)

Would eliminating the home mortgage deduction have a similar result? I don't think house prices would fall by 25%, but I do think prices would drop and that personal bankruptcies would spike upward.

Don't think that this would only hurt current homeowners, the banks, and home builders. We are in the midst of a $45,000 remodel of our home. We would NOT have done this work had the interest on the $45k not been deductible. So, a lot of little guys would be hurt by a sudden change in the rules.

hi all,
please consider another alternative: allowing the mortgage interest tax deduction on your PRIMARY residence, and only that. there will be some wiggle room for those folks who use their kids to buy a second house, but one would assume that they would be living there.

Does anyone believe this monstrosity can be undone without triggering a terrible economic shock? Is it a question of timing--if it had been done before the real estate bubble inflated, would the outcome look very different?

I say this as a homeowner in a booming region whose finances are tied to the mortgage-interest deduction like a heroin addict to methadone. I would be happy to get rid of it in the interests of fairness and non-distortion, but it's already priced into my house and my debt.

This is so deeply woven into the economics of home-buying that it it a true 'third-rail' issue - very difficult to discuss on the merits, and easy to gore any number of voting and contributing oxen...

If it was not for the MI deduction I would have owed 2.5 times what my tax bill was for 2004. I don"t own an expensive house either. Don't forget the propoerty tax deduction too.

"I have no problem with repealing the deduction. In return, drop the top two income brackets."

Why? Just to make sure that the rich don't end up paying more in taxes?

I'd be more concerned about those in the bottom 60% of the income scale - and what could be done for those who benefit from the deduction now but who would not if it were scrapped.

The mortgage deduction is a selling point that real estate can use to sell. But this may increase the price of a home, thus making homes more expensive w/o the mortgage deduction. It may be a wash for homeowners, but for the agent, it means a higher commission.

I doubt it is a wash; the cost of interest of a mortgage is a whole lot more than the cost of the house itself. Not to mention that the ability to build a house lowers the cost of buying a used home; since the cost of building a house is labor and materials, the interest benefit cost increase would be limited (IMH, uninformed,O).

Rewarding special interests in the tax code harms the economy. The mortgage interest deduction persuades consumers to spend more on housing than they would otherwise, misdirecting economic resources. The US needs to save more and spend less. This tax provision subsidizes debt and encourages spending.

How about eliminating the deduction only on new mortgages? How would that screw things up?

"How about eliminating the deduction only on new mortgages? How would that screw things up?"

It would make it far more difficult to sell your home (which would also affect the price you could sell it for). That would limit the number of people hurt by the change, but the people hurt would likely be the least able to bear the cost.

At one time and perhaps to this day, Canada did not allow tax deductions for mortgage interest paid.

Therefore there is no home ownership in Canada.

Removing the interest deduction would kill me. I live in the DC area and could not but a home without it. My housing price doubled (for less house)when I moved from Shreveport, LA to Fairfax county VA. I make over $100K and could barely afford a house even with a big down payment (rolled from successful previous house sales). And I don't live in a McMansion either. On the plus sides, my car insurance was cut by 50% (!) and I don't have to pay for private schools in Fairfax. If this was repealed hear you would see a ton of bankruptcies and collapse of the housing market here. Lots of transient political and military people would get massacred.

If this happens I want to know ahead so I can sell my house and wait this out in a rental until housing prices stabilize downward.

I'm opposed to using taxes to encourage certain activities (home ownership in this case) and discourage others, so I'd like to see all deductions and exemptions eliminated. Taxes, in my opinion, should serve no purpose beyond raising revenue for government services. The only mortgage interest I should be able to deduct is the portion allocable to my rental income (it's a two-family home), since that's a business expense.

The really disgusting thing about the mortgage interest deduction is that homeowners can borrow against their home equity for any purpose whatsoever, say to purchase a new car, and still deduct the interest (interest from 2nd mortgages are an AMT adjustment, but relatively few taxpayers are subject to AMT). Meanwhile, those who don't own a home can't deduct the interest on a personal loan. If it does nothing else, Congress should close this loophole, and only allow taxpayers who refinance to deduct that portion of interest which accrues on the amount used to pay off the previous mortage(s).

I like it in theory. The mortgage deduction creates excessive consumption in many ways:

* Bigger houses = need for more crap inside said houses.
* The house itself. Nobody really needs 5K square feet. If you want it, fine, but it is consumption. Use taxable income to pay for it.
* Bigger houses = more costly to heat, cool, and otherwise maintain.

There is all sorts of secondary and tertiary consumption that gets created because of the mortgage interest deduction.

Now - I don't have a problem with people having nice stuff, or people having assets. I hope to do both myself. But frankly, I think government choosing one asset class (housing) over another (equities, or anything else), is somewhat arbitrary.

How would I solve it? Raise taxes on consumption, and eliminate taxes on assets. Money (principal AND interest) used to purchase housing should be all deductable at all income levels. Same thing should be true of money used to purchase stocks (and comparitivley, money used to pay margin interest on stocks). Or better yet, scrap the income tax entirely, and move to pure consumption based taxation.

Tax food, energy, and anything else that is not an appreciating asset. Tax the shit out of it. I guarantee you, there is no faster way to an ownership society - at all levels, than going to the above.

John is correct that Canada doesn't have mortgage interest deductions. But of course it isn't the lack of deductions that cause the problem so much as the upheaval caused by the removal of existing ones.

This is undoubtedly more complex than I'm making it sound and probably wouldn't fly politically, but wouldn't a one-time subsidy to homeowners equal to the present value of future tax savings (based on current mortage value) smooth out most of the transitional issues? In theory, the government payout should be offset by increased future tax revenues, and the subsidy should compensate homeowners for the increased mortgage costs/drop in equity.

The mortgage interest deduction will continue to be in existence throughout our lives. It ain't gonna be repealed. There is no political constituency that will support this.

Why waste time talking about it?

Rob, ostensibly Home Equity Line of Credit debt is only tax-deductible if it funds improvements or repairs to the home. That's unenforcable, though, and becomes irrelevant if the debt is rolled over into the mortgage.

Brittain33 - Interest on a home equity line of credit (up to $100,000) is deductible without regard to the use of the loan proceeds. The requirement that the loan proceeds be used to acquire the home (including refinancing loan acquisition indebtedness) or be used for improvements only applies to $1 million of qualifing home indebtedness. In total, a taxpayer may deduct interest on up to $1.1 million of home related debt. ("Home related" in the sense that the home equit debt, regardless of its use, is secured by the home.)

You cannot use your equity line to purchase municipal bonds however....the government wont allow "double dipping" in that case....Can only use your margin credit or other funds.

That's good to know, thanks.

because

(1) the main complaint with MI deduction is the influence it has on the choice between renting and buying housing, and as libertarians at heart, we'd rather not have gov't influencing such decisions....

(2)we all seem to agree that getting rid of the MI deduction would certainly deflate housing prices and really hurt those (like myself) who have a whole lot of housing debt that is priced based on this quirk of the tax law...

(3) we tend to agree that MI deduction really helps the more well-off than the struggling...

what about allowing for deduction of rent?

it'd probably raise rents and raise the values of rental properties, but it would eliminate the problems of (1) and (3) while avoiding the housing deflation of (2)

Can someone explain to me why I should have to pay income tax on interest income, but I can't deduct interest that I pay? I've no problem with getting rid of the deduction, but I think that what's sauce for the homeowner (and credit card user) goose ought to be for the government gander as well.

The inability to deduct credit card interest is just killing those who (like me) start businesses that way.

"Only 5% of the benefits go to people in the bottom 60% of the income scale -- those who may be struggling to afford a home." That does necessarily mean that more PEOPLE in the bottom 5% don't benefit, right? If the top 40% get many more $ per person, there needn't be as many of them. The 5% figure does seem to qualify this concern, but I thought it should be raised.

Personally, I have little sympathy for those who depend upon the deduction to get by. They must have fallen hook, line, and sinker to the sales pitch of their real estate agent, who tries to get suckers to buy the most expensive houses they can afford, just to increase the commissions. If you're prudent, you only take on a mortgage that gives you a lot of leeway, so as to be able to handle changes in your job situation and the economy, nevermind the tax code.

So in my mind, trying to protect bad decision-making is hardly a reason to oppose this reform (ditto for SS reform). And you can always phase it in gradually, as DBL suggested.

Rand - You need a new tax advisor. The interest on debt used to finance a business is deductible (on schedule C, E, or F, depending on the type of business). You will need to document that the interest relates to your business and not personal consumption. The easiest way of doing this is to have one card for business and another for personal use.

I'd offer to write you a memo citing all the relevant authorities, but I charge $285 an hour for that kind of thing (Tax complexity is my friend.) and the cost of the memo would likely exceed the benefit from the deduction. :)

Fling93 - I don't think it would just be the imprudent who would be hit by a sudden change in the law. In the late '80s, the commercial real estate market fell over 25% -- in some cases more than 50% -- because of a change in the tax law. What do you think would happen to the typical homeowner (who was transferred to a new job), if they had to sell their house a year after buying it in a market down 50%?

David Walser: I don't think it would just be the imprudent who would be hit by a sudden change in the law.

Then phase it in.

David Walser: What do you think would happen to the typical homeowner (who was transferred to a new job), if they had to sell their house a year after buying it in a market down 50%?

Anybody who sells such a large long-term investment after only one year already faces that risk regardless of what the government does -- especially if we're in a housing bubble. Indeed, much fewer people will be hurt if this reform ends up popping the housing bubble earlier rather than later.

You will need to document that the interest relates to your business and not personal consumption.

Ummm...that's the point. The main business expense I have is surviving (i.e., personal consumption, like groceries and utilities and mortgage payments)until the business is going, so I have to live on credit cards until things start happening. I could lend the money to my company, which could then pay me, but then I have to pay income taxes on it, plus payroll tax. I continue to be outraged that I get taxed on interest I earn, but can't deduct interest I pay.

Canada doesnt have such a ridiculous deduction.

This tax only benefits the rich. Scrapping it is the only way to go.

Oh wait, benefitting the rich is what the US is all about. Thanks Dubuyah !

Buffpilot wrote:

Removing the interest deduction would kill me. I live in the DC area and could not but a home without it.

Sure you could have!

Without the interest deduction, housing prices in DC would not have jumped to the levels they were at when you purchased your house.

Best,
Jeff

Sure, in an alternate universe without the tax deduction, I would owe the bank less money.

But I pay my bills in this one, and so I care about what my house price and tax will be here.
Remove the deduction, my house price goes down and my taxes go up. (And now we're talking about property tax too? So the feds get more, and my state gets less. Oy)

(And didn't the tax laws about non-home interest change in the 80's? I have a vague memory that they did.)

The federal income tax code treats mortgage interest for both rental and owner occupied residental property exactly the same - in both cases interest paid can be deducted from taxable income. If you don't believe renters receive the benefit of the deduction of mortgage interest thru lower rents then you must believe rental markets are very inefficient and landlords realize extraordinary profits. If you think that is the case then prove it.

Eliminating the deduction of mortgage interest for owner occupied residences would just increase the cost owing a home. There may be arguments for doing that but bringing equity to renting and owning ain't one of them.

BTW even if you do not itemize deductions you still get a deduction for mortgage interest to the extent your state and local income taxes and charitable gifts are less than your standard deduction.

Rand: "The main business expense I have is surviving (i.e., personal consumption, like groceries and utilities and mortgage payments) until the business is going, so I have to live on credit cards until things start happening. I could lend the money to my company, which could then pay me, but then I have to pay income taxes on it, plus payroll tax. I continue to be outraged that I get taxed on interest I earn, but can't deduct interest I pay."

It sounds like you want a "fair" tax system. Can't help you there! Even worse than the unfairness you point out is the fact you are taxed on the interest earned on your bank balance, but you cannot deduct any fees the bank charges to maintain the account! This is true even though the fees almost always exceed the interest earned. (If your account is large enough to earn much interest, you will almost always qualify for a no-fee account. Any fees ARE deductible as a misc. itemized deduction, subject to the 2% of AGI floor. This means that virtually no one benefits from the deduction.) This inequity just bugs me.

Another example: When in school I took out about $20k in student loans. At the time, the 9% interest on such loans was deductible. Just before I graduated, Congress eliminated the deduction. Now that my loans are paid off, Congress has reinstated the deduction. How fair is that? Encourage me to enter into a long-term financial commitment and then change the rules when I can no longer back out. Sheesh! It would be like repealing the home mortgage interest deduction, or something.

The mortgage interest deduction is gradually disappearing anyway due to the AMT. Haven't been hit by the AMT yet? Just wait--you will be.

Due to AMT, our mortgage deduction is already almost worthless and we don't have a large mortgage (less than $200K). In fact, we're pondering taking money out of savings to pay down the mortgage to get our deductions down to a point where we won't be paying AMT.

Yes, and some have noted that AMT is a way to sneak a flat tax on everybody. While that'd be fine by me, I wouldn't count on it. There's a lot of political pressure to "reform" AMT after a lot of the rank-and-file got hit with it due to exercised stock options that became worthless after the bubble. Plus the fact that people like their deductions. Indeed, you can't create a budget forecast without somebody pointing out that your revenue projections are too high because you aren't taking AMT reform into account.

The best suggestion on this I've seen was in the WSJ a few days ago:
- Implement a flat tax with no deductions and a generous personal exemption.
- Keep the current tax code in place.
- Allow taxpayers to choose to go to the new flat tax if they wish - BUT, they can't go back to the old code once they file a flat tax return.

This ought to ease the shock.

That is a great suggestion. Dang, I wish the WSJ had open archives.

lower-case david,

I would be wary of drawing too theoretical an explanation of rents.

In my working-class suburb of Boston, multi-family homes are the majority of housing. The cost of two-family homes has increased by a factor of 10 since 1986. In the same time, I'd be surprised if rents have tripled. (A nice 2BR rents for $1200/month.) The explanation was simple: people didn't want to buy property in the city when it was crowded and had a bad reputation, but many were willing to rent here, if not the same crowds that rents here today. Changes in demand along with inflation drove rental prices up but property prices way, way up.

More recently, rents have been flat since 2000 while housing prices have gone up by 80%. I should know, I bought a 2-family house in 2000 that my partner had been renting one apartment in since 1994.

Mortgage interest is therefore a recent factor in the rental market, certainly much moreso now than it was 20 years ago, even if we take away the influence of much lower interest rates. I don't see the mortgage deduction playing much of a role in raising or lowering rents or else they would have moved somewhat more in tandem. The fact is that I have a mid-sized mortgage, my neighbor's mortgage is twice as big, our other neighbor owns their house free-and-clear, and we're all renting out similar apartments at the same price set by the market.

To get more to the point, the rent:mortgage payment ratio has been swinging pretty wildly over the last ten years. This would seem to point against a substantial pass-through of the deduction benefit to renters.

Brittain33

I have observed a very similar trend in Chicago regarding housing price vs. rent ratio increase over the last several years that you describe in Boston.

From my own experience deciding to go from renting to buying, the MI deduction was enough to change the calculation from renting to buying being the more cost-effective approach. I don't like tax rules influencing financial decisions. I think others in Katherine's situation struggling to save a down payment while renting would benefit from rent deduction.

a) I thoroughly concur with those above who argue against the desireability of tax code subsidies for home purchases (or for anything else under the sun, for that matter)

b) I thoroughly concur with those above who deem exceedingly remote the likelyhood of getting rid of this particular bit of our income tax law.

c) Therefore, I conclude as long as we have an income tax, we'll have a mortgage interest deduction. Which is another way of saying that jettisoning the taxing of personal income is the only way of truly simplifying the tax code.

d) The only other feasible way (in addition to the AMT) to get rid of the mortgage interest deduction is to let it inflate away. For much of America, however, a million dollars in principle will remain a substantial sum for many years.

re canada lacking MI tax deduction

yes MI is not tax deductible, while other interest for asset/income generating investments is. this is because we don't need mortgages, we just live in igloos!

really, it's because there is a vastly more important deduction, and the government doesn't want you double dipping! In Canada (this sounds like an "In Soviet Russia" joke..) gains on the sale of your primary residence is tax free. For most situations, this tends to be a much better deal than being able to deduct interest, though it of course depends on the relative tax rates of capital gains and current income as well as the general increase in value of the housing stock. Canada's system is skewed even more towards the wealthy as there's no cash flow assistance to buying a house, the tax code simply makes the asset class more attractive, increasing speculaiton. Further, you can change your "primary" residence rather easily, so that you can sell all of your properties over time as "primary" residences and not have to face tax. This isn't as much of a benefit as it would be in the US (rich people typically only have 2 or 3 houses in canada, and then have houses in global metropolises and/or warmer destinations like palm beach/hawaii).

anyways, getting rid of MI is great, but really hard to do well (SS / Medicare(aid) reform is infinitely easier and harder to screw up) just go to the steve forbes model of flat tax with a focus on consumption. That seems like it would tend to minimise the hit on housing prices, though it depends on how housing is allocated to investment or consumption. It could just exacerbate the problem.

Comments are Closed.