THE DEDUCTION for mortgage interest is one of the most expensive tax breaks in the entire Internal Revenue Code: It’s an estimated $73.9 billion item for fiscal 2015, according to the Treasury Department. The mortgage interest deduction is also a significant cause of after-tax income inequality: The top 20 percent of earners get 75 percent of the benefits; the top 1 percent get 15 percent, according to the Congressional Budget Office. The deduction encourages overinvestment in single-family housing, increasing the economy’s vulnerability to real estate bubbles.
There’s only one concession to these realities in the law: It does not apply to interest on loan principal above $1 million. A new report from the National Low Income Housing Coalition, however, starkly documents the limitations of that limitation — and shows that the $1 million cap could be lowered to a still-generous $500,000 without affecting the vast majority of home buyers. The coalition surveyed the 20 million mortgages originated from 2012 through 2014, finding that only 5 percent of them were larger than $500,000. What’s more, these high-end loans, which by definition go to high-income households, were concentrated in a handful of localities.
Specifically, 10 metropolitan “hot spot” counties (among them Los Angeles in California and Fairfax in Virginia) with the greatest number of mortgages larger than $500,000 accounted for 45.1 percent of all such mortgages nationally. Just eight California urban and suburban counties accounted for 40 percent of the national total. Outside of such tony coastal precincts, the only big-mortgage hot spots were resort destinations such as Martha’s Vineyard, Mass., and Vail, Colo. — where many homes are vacation places, not primary residences.
Lowering the cap to $500,000 would save $95 billion over 10 years, the report says. Eliminating the deduction altogether and replacing it with a 15 percent tax credit would save $213 billion — and better target homeownership support to buyers of modest means. The coalition suggests spending at least some of the savings on direct aid to low-income housing, but even without that, curbing the deduction would help lower-income people over time by reducing tax-code favoritism for expensive housing.
The obvious objection is that this would hurt current owners of property whose high values are in part contingent on the deduction. To this we say: Yes, and if anyone should bear the costs of rationalizing tax and budget policy, better-off Americans are best able to do so. Reform could be phased in to cushion the blow.
Interestingly, the coalition’s map showing the concentration of big but deduction-eligible home loans overlaps almost precisely with Blue America: San Francisco, Manhattan, our very own District of Columbia. This could be the stuff of a bipartisan movement behind a $500,000 cap. For Democrats, it’s an opportunity to practice what they preach on income equality; for Republicans, a chance to show flexibility on raising revenue without harming their constituents.
So far, Democrats have protected their own higher-income constituents; Republicans have bowed to the real estate lobby. Reform won’t happen until the former act on their professed political principles and the latter act on their true political self-interest.