Democrats and Republicans seeking ways to reduce the federal deficit are beginning to talk about the once politically unthinkable cutting back the home mortgage interest deduction. And the discussion is focusing on the well-to-do who benefit disproportionately from a tax break so untouchable it has been called the third rail of tax reform.
But lawmakers ought to go ahead and touch it, squeeze it and figure out how to change it no matter how much the real estate lobby argues that the deduction is essential to the American Dream. What its actually essential to is the American deficit which, as responsible lawmakers in both parties acknowledge, needs to be reduced via a well-planned, fair blend of revenue increases and spending cuts.
Dennis J. Ventry Jr, a professor at the University of California-Davis School of Law who has written extensively on the deduction, says it produces the opposite of its supposed benefit, i.e. encouraging home ownership.
Rather, Ventry finds that the deduction distorts housing prices upward by enabling people to buy more house than they could otherwise afford. Cutting the deduction may cause housing prices to decline toward what the natural market can bear, but it would also make homes more affordable to millions of potential buyers currently on the margin between owning and renting.
Meanwhile, a cap on the deduction which now applies to interest paid on mortgages of up to $1 million plus $100,000 in home equity loans and such changes as eliminating the deduction for mortgages on second homes would be a major step toward reducing the national deficit.
The deduction costs the U.S. treasury more than $100 billion a year, according to the Office of Management and Budget. Much of that subsidy goes to those who can afford a home without the deduction. For instance, Ventry notes in his 2012 article The fake third rail of tax reform, taxpayers with incomes exceeding $100,000 just 12.4 percent of all tax filers capture 78 percent of the deductions total tax benefit.
The mortgage interest deduction has become so ingrained in the minds of homebuyers and the finances of the residential real estate industry that it cant and shouldnt be eliminated immediately. That would undermine a recovering real estate market and shortchange those who bought homes with the deduction in mind. But its time that grabbing the third rail of tax reform became a realistic option for helping close the deficit.