By Robert Freedman, Senior Editor, REALTOR® Magazine
So, there’s no final report coming out of President Obama’s deficit reduction commission, but as many commentators have said, the commission has changed the deficit debate by providing a concrete path for cutting $4 trillion from the deficit over the next several years. What’s more, any number of recommendations in the report could still end up in legislation before Congress. We can expect the President to incorporate some of the suggestions into the budget request he sends to Congress in January.
Would changes to the mortgage interest deduction be among them? They could be. The President sought a small curb to MID for higher-wealth households in his budget request last year. The proposal didn’t get far, but it shows that his administration is willing to take on MID.
What did the bi-partisan commission propose for MID last week in its now-stalled report? Among other things, it proposed changing the deduction to a credit (a 12 percent credit, in its model) and capping the benefit at $500,000, down from $1 million. It also proposed eliminating the benefit for interest on second homes and home equity loans.
One of the problems with the proposal is that it hurts younger households the most, because newer home owners are the ones that pay by far the most mortgage interest (on a percentage basis) and that in turn rely on the deduction to soften that blow. As Linda Chavez, the chair of the Center for Equal Opportunity, says in a well-reasoned piece just released, “most of the payments in early years go to pay interest on the loan, with only a tiny fraction going to principal.” (NAR has its own analysis of this point.)
Chavez uses an example of a household that’s paying a monthly mortgage payment of $3,000. Of that amount, $2,300, or well over two thirds, goes to interest. To cut into that would not only create a huge burden for the household, but it would have implications for all households, including those who’ve been owners for a long time and now pay a much smaller percentage of their monthly payment to interest.
How so? By causing home values in all price brackets to fall, because home prices today reflect the present-value stream of MID’s tax benefits. Remove that benefit, and home prices will plunge to reflect the loss of that present-value stream. Chavez, citing an analysis by Carlos Bonilla of American Action Forum, uses as an example of a $625,000 house. Of that value, about $72,000 stems from the capitalized worth of MID. Remove that value, and the price drops to $553,000, a loss of about 12 percent. That’s close to an NAR analysis estimating home values to drop 15 percent across the board if MID is cut.
Chavez also cites a simple fairness issue: MID is one of the oldest benefits in the U.S. Tax Code. It has been in place for as many generations as have lived since the Tax Code was created. As a result, households today make buying decisions based on the assumption that MID will be there. To suddenly curb that is to undermine that assumption.
Today’s households, says Chavez, would “now be told that because the government can’t control its own spending, the rules have changed. What would we think if a bank decided it should retroactively change interest rates or increase the principal on a loan because it wasn’t making enough money on its investment?”
Proposals to pare back MID and other programs that reflect our country’s historical support of home ownership as a fundamental value, including the capital gains exclusion on the home sale proceeds, still have a long way to go. But, as Chavez’s piece makes clear, a lot more thinking needs to be done on MID because of its unique place in our country’s social contract.