Battle Over Mortgage Interest Deduction Continues in House Committee

The House Ways and MeansrnCommittee heard a wide variety of opinions today at a hearing on housing taxrnincentives.  Representatives of the housing,rnbuilding and real estate industries as well as policy experts spoke both inrnfavor and against the mortgage interest deduction (MID) tax deductions forrnproperty taxes, the real estate capital gains exemption and the low income taxrncredit. </p

Robert Dietz, assistant vice presidentrnof the National Association of Home Builders (NAHB), called on Congress tornmaintain its support for vital housing tax incentives. “Home building is an industry dominated by small businesses, so the idearnof simplifying the complicated tax rules related to business has great appeal.rnAt the same time, our industry remembers painful lessons from the 1986 TaxrnReform Act, when the commercial and multifamily sectors experienced a downturnrndue to unintended consequences,” Dietz said.  “Moreover, when housing fares well, it spursrnjob and economic growth. </p

Dietz spoke favorably about therncontinued need for the Low Income Housing Tax Credit as a way to attractrninvestment then addressed what he said were a number of false assumptionsrnregarding the MID. <br /<br /"First, we frequently hear that few home owners benefit from the mortgagerninterest deduction because itemization is required," he said. "Inrnfact, most home owners will claim it. In 2009, 35 million taxpayers, or 70rnpercent of home owners with a mortgage, claimed the mortgage deduction in thatrnyear. Among all home owners who have ever held a mortgage, the vast majorityrnhave claimed the home mortgage deduction for years at a time.”<br /It also does not necessarily encourage the purchase of larger homes.  Larger families need larger homes and willrntherefore have a higher interest deduction. "The need for a larger homerncreated the higher home loan deduction, not the other way around," saidrnDietz.<br /<br /He also noted that the cost of housing varies greatly across the nation, sornwhat appears to be a large deduction for a given home in one area may reflect arnmodest home in a high-cost area.<br /<br /Moreover, the mortgage interest and real estate tax deductions are two of thernfew elements in the tax code that that account for differences inrncost-of-living.<br /<br /"The real estate tax deduction is an important reminder that home ownersrnpay more than $300 billion in property taxes each year. This fact is oftenrnignored in the federal tax debates because these taxes are collected by staternand local governments," said Dietz.<br /<br /There is also a direct correlation between the age of a home owner and theirrnresulting benefit from the mortgage interest deduction. As a share of householdrnincome, the largest deductions are for those 35 and younger. The benefit of arndeduction that reduces the net cost of monthly house payments is particularlyrnimportant to these home buyers, who typically have less equity, tighterrnhousehold budgets, and must meet the needs of a growing family.<br /<br /"Given this demographic connection, NAHB believes that any policy changernthat makes it harder to buy a home, or forces young families to defer homernpurchases, will have a significant impact on wealth accumulation and the makeuprnof the middle class,” said Dietz.<br /<br /Dietz also defended the MID for second homes which he said is important forrnmany who don't think of themselves as owning two homes. Repealing the deductionrnfor second homes would penalize millions of home owners who move from anrnexisting home and buy a second home in a given tax year. There would be furtherrnnegative economic consequences in terms of lost home sales, home constructionrnand local tax revenues.<br /<br /Eric Toder, Co-Director of thernUrban-Brookings Tax Policy Center (TPC) said, if the Committee is to achievernits stated goals of reducing the top individual income tax rate to 25 percentrnand maintaining receipts at their baseline projected level of 19.4 percent ofrnGDP by the end of the decade, it will be necessary to eliminate or pare backrnsome major tax expenditures. But the mortgage interest deduction is one of thernmost popular benefits in the tax law, and politicians have in the past viewedrnit as untouchable. </p

The mortgagerninterest deduction is a subsidy that favors investment in home ownership overrninvestment in rental housing and most other business assets. The mainrnbeneficiaries are upper-middle-income households, and use of the deductionrnvaries greatly among states.  If the goalrnis to promote home ownership, the mortgage interest deduction should bernrestructured, with more of the subsidy directed to low- and middle-incomerntaxpayers who are more likely to be deciding whether to own or rent. </p

Eliminating the MID wouldrnraises taxes by $696 per household by 2022 or 0.66 percent of income.  Payers in the upper brackets except the top 1rnpercent would experience a larger average increase.  The impact on those in the lower bracketsrnwould be smaller in part because fewer of those tax payers itemize. </p

Another suggested change includes capping the deduction at the first $500,000 of home debt.  This would raise taxes by an average of $84rnper household or 0.08 percent of income with taxpayers in the 80th to 99th percentilernexperiencing larger than average increases, those in the bottom four quintilesrnseeing little or no tax increase, and the top 1 percent an increase onlyrnslightly less than the average for the entire population.  This would disproportionately impact a few highrnhousing cost areas and have the biggest effect on younger, very high incomernearners who have not yet paid down their mortgage debt.</p

More complex alternatives would involve replacing the MID with a 15 percentrnrefundable credit and capping interest deductions or replacing the MID with arn20 percent nonrefundable credit and capping eligible debt at $500,000. </p

Toder said his biggest concern is how paring back the MID is how it mightrnaffect housing prices.   Some past researchrnhas found eliminating housing tax incentives has substantial effects on prices butrnothers have found confounding factors mitigating the effect such as lowrninterest rates or active investor presence. rn”All that said, however it would be prudent to introduce changesrnslowly to avoid a major market disruptions.” </p

Mark A. Calabria, Director ofrnFinancial Regulation Studies, Cato Institute told the committee members that arntax code that would improve both economic growth and housing affordabilityrnwould ultimately be one with low, simple flat rates and few if anyrndeductions.  </p

He urged the committee torneliminate the MID and the local property tax deduction in a budget-neutralrnmanner, lowering overall tax rates for the following reasons.  </p<ul class="unIndentedList"<liThe MID does notrnhave a significant impact on homeownership rate.</li<liIts housing pricernimpact differs dramatically across U.S. cities</li<liBenefits are highlyrnconcentrated among the highest income and most leveraged households</li<liTax "savingsrnfrom the non-taxation of imputed rent is almost twice that of the MID. Tax savings from the property tax deductionrnis much smaller than either.</li<liSome value of thernMID is actually captured by lenders via higher mortgage rates.</li<liThe value of thernMID is positively relate to interest rates.</li<liTo the extent thatrnhigh loan-to-value rates contributed to the recent financial crisis, removal ofrnthe MID would improve financial stability.</li</ul

Because households have maderninvestments and decisions based on the current tax code, he said, changesrnshould be phased in over a reasonable number of years, but no more than seven. </p

Jane G. Gravelle, SeniorrnSpecialist in Economic Policy, Congressional Research Service (CRS) told thernCommittee that in considering tax reform there are three points tornconsider.  </p<ul class="unIndentedList"<liIt is difficult itrnidentify base broadening provisions that realistically will allow significantrnrate reductions. </li<liIt is even morerndifficult to identify provisions that would allow significant reductions of therntop rate while maintaining the current distribution of tax burdens </li<liIf the objective ofrnlowering tax rates is to lower marginal rates to encourage supply side responses,rnbase broadening will increase effective marginal tax rates and offset in partrnor in full the incentive effects of lowering statutory tax rates.</li</ul

The most significant housingrnprovisions are associated with owner-occupied housing – mortgage interestrndeductions (75 billion in revenue in FY 2015), real property tax deductionrn($30.4 billion) and the exclusion of capital gains ($26.0 billion.)  By comparison, the low income housing creditrnreduces revenues by $7.2 billion. </p

Two out of three of thesernowner-occupied provisions are already subject to caps.  Are these provisions desirable candidates forrnbase broadening?  Many economists haverncriticized the provisions as distorting the allocation of resources, divertingrncapital from other uses, encouraging overconsumption of housing, and treatingrnrenters differently than owner-occupants. rn</p

As CRS reported earlier, thesernprovisions would be technically easy to eliminate or reduced and can be view asrncausing distortions, but the broad use and popularity of the provisions are barriersrnto major revisions.  There are alsornarguments in favor of keeping them.</p<ul class="unIndentedList"<liEncouraging homernownership has positive neighborhood effects and is a source of wealth buildingrnand enforced savings for middle-income families.</li<liIn terms ofrnfairness, homeownership subsidies do favor homeowners over renters but the MID increasesrnfairness between homeowners who mortgage and those who finance out of assets.</li<liThere arernparticular justifications for the capital gains exclusion. Requiring capital gains taxes wouldrndiscourage labor mobility by increasing the cost of relocation, discouragernolder individuals from scaling down. and impose a penalty on elderlyrnindividuals who are forced to sell for health or financial reasons. This "lock-in" effect mayrnsignificantly reduce the potential revenue to be gained. </li<liThere are transitionrnissues, particularly for those in the middle incomes who have recently enteredrninto large mortgages and may find it difficult to budget if they do not receiverna full offset in in rate cuts. Grandfatheringrnprovisions would not offset effects on housing demand and phasing in wouldrnleave new homeowners with the awareness their deductions will not last.</li</ul

Owner occupied subsidies are not generally the most significant taxrnpreferences to those in the top brackets, partially because of caps but alsornbecause as incomes rise, spending on housing does not keep up.  Also high income taxpayers are less in needrnof mortgages and may avoid increases taxes by paying off mortgages or avoidingrnsale of their homes.</p

The increase in effective marginal tax rates through eliminating deductionsrnfor owner-occupied housing are also not likely to be important for top-bracketedrnpayers whose deductions are not very important relative to income but theyrnwould increase effective marginal tax rates and offset statutory raternreductions for taxpayers in the middle and upper income levels. </p

Gravelle concluded by suggesting that decisions on broadening the basernshould focus on the merits of the individual provisions rather than theirrncontribution to base broadening to permit lower statutory rates.</p

The committee also heardrntestimony from Mark Fleming, Chief Economist, CoreLogic; Phillip Swagel,rnProfessor of International Economic Policy, University of Maryland School ofrnPublic Policy; Gary Thomas, President, National Association of Realtors; ThomasrnMoran</p

Chairman, Moran & Company,rnand Robert Moss, Boston Capital, appearing on behalf of the Housing AdvisoryrnGroup spoke principally

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