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Time to Rethink the Mortgage Interest Deduction

Adam Rust's picture

Posted March 15, 2010

I think that it is time to reconsider the home mortgage interest deduction. Though it may be presented as the greatest middle class tax advantage, the truth is not so clear. Only about 23 percent of tax filers claim the home mortgage interest deduction. Many don't itemize. Some upper income households rent.

The chart, sourced from IRS data and sorted by the Tax Foundation, makes a pretty compelling argument for dropping the mortgage interest deduction. While people will argue that this is

supposed to help the middle class, the truth is that it skews to the wealthy.  Remember that these are dollars after adjustments.  A person with an AGI of $100,000 probably earned more than $145,000.  If middle class begins at around $50,000 in income, then they would fall in the $30,000 to $39,999 range.

In fact, only 23 percent of all taxpayers claim the home mortgage interest deduction.

This means that the middle class actually don't get that much from the presence of the mortgage interest deduction. Why? Probably because many might pay mortgage interest, but they don't pay enough to make it worth giving up their standard deduction.  Three in ten households with a mortgage don't claim this deduction. I would hazard that this groups skews strongly to the lower part of the income scale.  Another reason is that many of them may rent, and another portion have already paid off their debt.

The mortgage interest deduction is not just a boon for the rich. It is also something that, on the margins, makes home ownership for the middle class all the more hollow.  Homeowners pay property taxes. Imagine that you pay enough mortgage interest to make it worth itemizing. Then you must surely pay a lot of property tax, too.  Property tax, plus the fact that the standard deduction for a married filing jointly household is $11,400, means that home ownership is not a sure "win" for a Main Street family.

The story is different on High Street.  The well-off love being able to deduct their mortgage interest.  People with AGIs of more than $100,000 claimed more than 35 percent of the deduction in 2003. In today's dollars, it is likely that six-figure households have an even larger share of the pie. Not surprisingly, there are other people who feel the same way.  The Realtors, who want to make sure that developers don't pay impact fees on new subdivisions (which would pay for schools for those families) are aghast at the possibility that this deduction might be clipped.

What is the cost of all of this? Treasury says that in 2008, the mortgage interest deduction cost $67 billion.

What could we do instead:

Make the home mortgage interest subsidy a refundable tax credit. In that case, the low-income families that don't have the income needed to benefit from deductions would be able to share the benefits.

Drop deductions on home equity lines of credit. If you want to buy a car, you'll get no breaks if you finance through a car loan. You'll have no luck using a credit card, either. However, your home is a veritable ATM machine that can offer low-cost credit.  It will also afford a new tax deduction. Why? This is all in the name of homeownership, but in reality, the deduction needs to be narrowed.

Drop deductions on second homes. What interest do tax payers have in easing the cost of a vacation home at the beach? 'Nuff said.

Drop the whole thing. Cut down on the deficit. Support middle class families with lower taxes. Spend the money on schools or health care. Save it for the next generation. Revitalize Section 8. Put money into affordable rental housing.