At the end of this year, a series of tax increases and spending cuts to address that deficit are scheduled to go into effect automatically, unless Congress acts to prevent or alter them. Revamping the mortgage interest deduction is one of the solutions proposed to head off that “fiscal cliff” scenario. The MID is a “tax expenditure,” meaning its cost must either be made up through higher taxes elsewhere or by adding to the debt, and it costs the government about $90 billion a year. Some members of Congress have proposed eliminating or changing the mortgage interest deduction as one way to help address the nation’s $15 trillion debt and a $1.1 trillion federal budget deficit.
Two years ago, a bipartisan deficit reduction commission recommended scaling back the mortgage interest deduction, which is currently capped at mortgages worth up to $1 million for both principal and second homes and home equity debt up to $100,000. The deduction is available only to taxpayers who itemize. The commission, often referred to as Simpson-Bowles, proposed turning the deduction into a 12 percent nonrefundable tax credit available to all taxpayers, capping eligibility to mortgages worth up to $500,000, and eliminating the deduction on interest from second homes and home equity debt.
Despite how revamping the MID could help reduce the deficit, the National Association of Realtors claims that changes to the MID could depreciate home prices by up to 15 percent. Christopher Thornberg, founding partner at Beacon Economics believes the current low interest rates mean that changing the MID “will have a more moderate impact on home prices,” he said. “With that in mind, it’s exactly the time to get rid of it.” He estimated home prices would drop perhaps 6-7 percent overall if the MID were eliminated.
Panelists observed that eliminating or limiting the scope of the MID could have unintended consequences. Lower home values could mean fewer property taxes paid. More incentive to pay down a mortgage could mean fewer goods consumed and fewer stocks and bonds invested in in the short run. Each would mean less revenue generated than proponents of cutting the MID anticipate. The panelists noted that most economists are against the MID. Some economists predict it will make housing more expensive, distorts the market, and the revenue that we could get out of it is more important than what it could do to the market.
Controversially, a recent survey of economists, real estate experts and investment strategists conducted by research and consulting firm Pulsenomics LLC on behalf of Zillow found 60% favored getting rid of the mortgage interest tax deduction, with 10% saying it should be eliminated immediately and 50% saying it should be phased out gradually. 30% of respondents said the deduction should remain, but that there should be more restrictions on eligibility. Only 11% said the deduction should remain as is.
The burgeoning federal debt makes it unlikely that the mortgage interest tax deduction will survive in its present form, but any proposed changes to the tax break for homeowners will likely spark a fierce debate over the fundamentals of the U.S. housing market, the value of home ownership, and consumer behavior.
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