It’s Time to Rethink Home Ownership Interest Deductions

Let me ask a simple question. Do you think people who live in places like Waterloo, Iowa should subsidize the cost of homeownership for people who live in Honolulu? How about people in Topeka, Kansas subsidizing homeowners in San Francisco? Or homeowners in Beaumont, Texas subsidizing condo owners in Boston?

I thought not.

Well, thats what the National Association of Realtors favors. They dont put it quite that way, of course, and neither does President Clinton. But thats what it comes down to if you favor protecting the home mortgage interest deduction at the expense of replacing our current tax code with a rational flat tax.

I learned this from a recent NAR press release. ” we feel strongly that the ability to deduct mortgage interest must be retained. This key deduction, which has been part of the tax code since 1913, must be included in any tax reform proposal,” the release said.

“Several flat tax plans have been proposed in the past as alternatives to the current code and such plans could resurface this year. We will remain vigilant in opposing any tax reform plan, including a flat tax plan, that does not retain the deductibility of mortgage interest. These ill-conceived proposals must be viewed for what they really are: a hidden tax increase for the nations home owners— specifically, the middle class. Of the more than 20 million families claiming this deduction, 76 percent have household incomes of less than $75,000 and 45 percent have incomes below $50,000.”

Perhaps so. But how much is the deduction worth in actual tax savings? And to whom? The benefit to a $50,000 a year couple buying as much house as they could qualify for with a 5 percent down payment would be net interest deductions of about $200. That translates into about $30 in tax savings. Thats less than most people spend getting their taxes done.

On the other hand, its a great benefit to the highest income families. It has been estimated that families with income over $200,000 a year ( the top 1.2 percent) get 22 percent of the tax savings. The same study estimates that families with income over $100,000 ( the top 5.6 percent) get nearly half the benefits.

Apparently the National Association of Realtors would prefer to retain our miserable tax system just to maintain the illusion that residential real estate is a tax benefited investment widely enjoyed by the general public.

It isnt.

My suggestion to the NAR: rethink the problem.

The table below shows their most recent posting of median home sale prices across the country. It shows the median home price, assumes a 20 percent down payment, assumes a mortgage interest rate of 6.75 percent, and shows the approximate interest deduction in the first year of a home mortgage. It also shows, in rank order, how much that deduction exceeds the 1997 standard deduction of $6,900 for a joint tax return.

To be sure, there are further considerations. Many houses are purchased by single people. Or by heads of households. Many are purchased with down payments of less than 20 percent. And I have made no effort to estimate the additional value of deducting real estate taxes. That said, this list remains a quick and dirty proxy for the distribution of tax benefits to different cities and regions of the country.

What does it tell us?

In much of the country, the median home buyer— meaning that half the houses sold cost less and half cost more— gets no tax benefit at all from home mortgage interest. Remember, it only reduces your tax bill to the extent that the deductions exceed the standard deduction.

Net Tax Deductions For Median Priced Homes

Source: National Association of Realtors, author calculations

In addition, while half of all homeowners might enjoy a greater benefit, it depends on when they purchased their house, their interest rate, etc. Deductible interest is really terrific for people who own two houses or a house and a yacht (or RV) that they qualify as a house. Its also great for a Congressman who maintains a home in Washington as well as in his home district.

But the real result is typical of the hodgepodge, hateful tax system that we have. Great tax benefits are available to some regardless of need. Great taxes are forced on others, regardless of circumstances. With the median homebuyer getting virtually no tax benefit, the mortgage interest deduction can hardly be called a middle class benefit. Its a nice trinket for the Borrowing Upper Middle Class.

The Borrowing Upper Middle Class, like all taxpayers would be better served by a lower, and flat, tax than a random shipment of tax benefits from Pittsburgh to West Palm Beach.