With all the talk and activity in Washington, D.C., these days around issues like tax reform, I thought it might be interesting to look into the subject of the mortgage interest deduction. What was its origin, how is it used, and what is its future?
Federal income tax in the United States was first implemented in 1894, and all forms of interest on loans were deductible. Interestingly, the U.S. Supreme Court quickly ruled income taxes unconstitutional and it wasn’t until 1913 that Congress enacted a new income tax, after the Constitution was amended, and as part of this new tax interest was again deductible. In the early years of the tax code, it was safe to presume that Congress wasn’t thinking about mortgage interest deductibility, as homes in those days were generally bought for cash. Presumably, lawmakers were more concerned with mortgages on farms and business loans.
It wasn’t until the 1920s and the rise of the automobile that home mortgages outnumbered other types of loans. The generally held theory that the mortgage interest deduction was created to encourage homeownership is, in my opinion, a myth. Having said that, I do believe that the federal government does encourage and even subsidizes homeownership; how else can you explain the creation of the Federal Housing Administration, special mortgages for veterans, and USDA mortgages for rural America? The federal government also chartered the Federal National Mortgage Association, or Fannie Mae, to provide liquidity in the home mortgage market and institutionalized the 30-year fixed-rate loan.
Now, with apologies to my Realtor friends, let’s return to the “myth” of the mortgage interest deduction and its alleged benefits for homeowners. To put it all in perspective, the United States is only one of three developed nations that allow homeowners to deduct their mortgage interest as a way to reduce their taxable income. But when it comes to homeownership rate rankings, the U.S. is 41st in the world. Today, the American homeownership rate is at a post-war low of just over 62 percent. For comparison, the nation with the highest rate of homeownership is Romania, with a rate of 96.4 percent, followed by India with 86.6 percent, Mexico at 80 percent, and Canada at 67.6 percent. To further put the cost of the mortgage interest deduction in context, the federal government is subsidizing homeownership to the tune of $71 billion in annual tax benefits to wealthy Americans who itemize their taxes. The Atlantic calls the mortgage interest deduction “a public-housing policy for the rich,” with 90 percent of that $71 billion going to households earning more than $100,000 annually.
So let’s look at how the mortgage interest deduction works. For IRS purposes, the borrowed funds must come in the form of a mortgage, a second mortgage, a line of credit, or a home equity loan that’s secured by either a primary or secondary home. Interestingly, the IRS defines a home as a house, condominium, cooperative, mobile home, boat or a recreational vehicle. The “home” must also have basic facilities for cooking and sleeping and a working bathroom. Now consider: In order to utilize the mortgage interest deduction, a taxpayer needs to itemize his or her deductions and not take the standard deduction. Today, only around 30 percent of all taxpayers itemize their taxes, and fewer than half of all homeowners use the mortgage interest deduction. So it would seem the greatest benefit of the deduction does indeed go to those with the largest mortgages — up to $1 million — in the highest tax bracket, making it a tax subsidy for the wealthiest among us.
The Trump administration has rolled out a framework for comprehensive tax reform. As expected, the framework calls for fewer — and reduced — tax brackets for individuals and nearly eliminates all deductions and the alternative minimum tax. I believe that this is something that we can all get behind but, unfortunately, the proposal makes two exceptions to the rule: the mortgage insurance deduction and charitable deductions. The Trump plan also calls for increasing the standard deduction to $24,000 for couples filing jointly. One could argue to support keeping the charitable deduction for those who itemize purely on the basis that those who support charities by donating cash or goods are, in fact, providing for people and families who otherwise would need to rely on government support. But when it comes to the mortgage interest deduction, let’s look for ways to use that $71 billion to provide decent housing for all Americans. Just a thought!