A Tax Policy to Help Homeowners
By John O. Fox
Last January, President Bush named nine tax and business experts to form his Advisory Panel on Federal Tax Reform. Their task was to propose a fairer and sounder tax system. Lo and behold, the panel concluded, as part of its extensive Nov. 1 report, that the current home mortgage interest deduction - the most coveted of all tax breaks - makes neither social nor economic sense.
Under existing law, homeowners may deduct interest paid on up to $1 million of mortgage loans to buy, build or substantially improve a principal home and a secondary one.
The entire $1 million may be used for either home, or it may be divided between both homes. The panel would lower the mortgage cap from $1 million to 125 percent of the median sale price of houses by county. At today's house prices, tax relief would be capped at mortgages up to $227,000 in the least expensive housing markets, and up to $412,000 in the most expensive. Furthermore, the relief would be limited to a principal home. No more mortgage interest tax break for that beach condo in Boca Raton or ski condo at Park City.
Yikes! Isn't anything sacred? The American dream is not just to own a home or two; it's to claim a large mortgage interest deduction as a flag-waving, community-supporting, inalienable right. In this spirit, Republicans on the House Ways and Means Committee responded immediately that the panel's proposal to reform the mortgage interest deduction, if presented to the committee, would be "dead on arrival."
The panel was aware, however, of major economic studies that have concluded, contrary to popular assumptions, that our economy would be stronger, not weaker, if Congress reduced the tax breaks for homeownership. Although home building stimulates economic growth, the disproportionate tax savings for homeownership may result, as the panel observes, "in too little business investment, meaning businesses purchase less new equipment and fewer new technologies than they otherwise might. Too little investment means lower worker productivity, and ultimately, lower real wages and living standards."
The panel also noticed what policy experts have long known but few politicians have ever acknowledged. The mortgage interest deduction is an inefficient way to maximize rates of homeownership. It gives large savings to high-income types who can afford a comfortable home without any tax relief, and it gives chump change to ordinary workers in two-bedroom bungalows.
This year, the deduction is expected to save taxpayers a whopping $73 billion. But the bottom half of all tax filers will receive a mere 2.5 percent of the tax savings. Over 22 percent of the $73 billion will go to the top 2 percent, according to Congress's own, nonpartisan Joint Committee on Taxation.
In other words, the top 2 percent will save nearly 10 times more than the bottom 50 percent. This follows not just because McMansion owners have such large mortgages. The mortgage interest deduction is limited to taxpayers who itemize their deductions rather than claim a standard deduction; and a far larger percentage of high-income taxpayers itemize than do other taxpayers. Furthermore, deductions are most valuable when they shelter income from tax at the highest tax rates. While high earners typically have a great deal of income subject to the top 35 percent tax rate, two-thirds of all taxpayers never get beyond the 15 percent tax rate.
To make the tax break for mortgage interest more egalitarian, Bush's panel proposes to convert the deduction into a tax credit - each $1 credit offsets $1 of taxes you owe - equal to 15 percent of the allowable mortgage interest payment. If your interest payment were $10,000, you would reduce your taxes by $1,500 (15 percent of $10,000), whether you have the income of a CEO or of a rank-and-file worker. Equally important, the credit would be available to all taxpayers, as long as they owe taxes. The panel expects that by no longer limiting the tax break to itemizers, about 88 percent of all taxpayers who pay interest on their mortgage would save taxes, compared to 54 percent under existing rules.
Reforms of this magnitude, of course, should be gradually phased in over a period of years so that they're neither punitive to individual homeowners nor excessively disruptive to communities that depend upon the second home industry or to the economy in general.
Are the panel's proposals, however, politically "dead," as the Republicans on the House Ways and Means Committee insist? Probably. But what if voters realize that such reforms would benefit far more people and communities than they would hurt? The panel expects, for example, that the new mortgage limits would adversely affect no more than 10 percent to 15 percent of all homeowners. In fact, one of the panel's most striking observations is that the mortgage interest deduction may not contribute much to our nation's high rate of homeownership. Canada, Australia and the United Kingdom, for example, have about the same rate of homeownership as ours, yet those countries don't give any tax relief for home mortgage interest payments.
Furthermore, let's remember that panel members were chosen by the president for their expertise and good judgment. Will he disavow them?
One final thought. The principal obstacle to becoming a homeowner for a great many working households is putting together the down payment. While not mentioned by the panel, Congress could use several billion dollars of the annual tax savings from curtailing the mortgage interest tax break to subsidize low-interest mortgages that would help low- and moderate-income renters make the down payment for a starter home. Thousands of renters who can afford the monthly payments and other costs of homeownership could thereby become homeowners every year.
By maximizing the number of qualified homeowners, Congress is likely to produce healthier families, healthier communities, and a more buoyant economy, which would be in the best interest of us all. Now that would be a set of tax policies to celebrate!
John O. Fox lives in Amherst and is a visiting associate professor at Mount Holyoke College, where he teaches a course on U.S. tax policy.