Washington is currently looking for new ways to hike up tax revenue in order to avoid the fiscal cliff, and one of the first groups that may be affected by this are homeowners that claim an interest deduction on their mortgages.
The news that these homeowners may lose this deduction has caused quite a stir. What homeowners are hearing is that the housing market that is finally starting to recover will suffer a major setback, the sale of homes will begin to decline, and middle class families will be affected the most.
Middle class homeowners can take a breath, however, because this is not a realistic view. The deduction actually assists the wealthy much more than the middle class, and at this time, there is no evidence that points to this alleged decline.
The mortgage interest deduction goes back to when Federal Income Tax was first established in 1913, however there is minimal evidence that can prove that Congress was considering the deduction as any kind of incentive that would encourage individuals to purchase homes. In 1913, only the wealthy paid any sort of taxes due to the fact that most types of interest were deductible and the standard deduction was extremely high.
The narrative did change for future generations, and following World War II, people that were building homes felt that the deduction was the link to obtaining middle class status.
Today, the reality is that this deduction simply does not assist that many American home owners. A large number of low-income homeowners don’t even claim the credit, and renters are not eligible, as well as homeowners that have paid off their mortgage. According to the nonprofit Tax Foundation, 2010, only 1 in 4 American homeowners claimed this benefit on their taxes.
About two thirds of the individuals who claimed the benefit made less than $200,000 and homeowners in higher income brackets saved a lot more on their 2010 tax bills.
Homeowners that claim this deduction with incomes between $40,000 and $75,000 typically save an average amount of $523 each year in taxes, according to a study done by economists at the University of Pennsylvania. That’s literally less than $50 a month in savings, while homeowners with incomes greater than $250,000 that claim the deduction will save approximately $5,459 on their tax bills, allowing for savings of up to $500 a month.
The reality is, that the higher the loan and the more expensive the house, the savings will ultimately be greater. The Huffington Post recently reported that President Barack Obama and his wife Michelle claimed a deduction of $47,564 for their home mortgage interest on their Chicago home, which was purchased in 2005 for $1.65 million. Their total tax bill savings is approximately $13,000.
Obama’s former economic adviser stated this past week on “Morning Joe” that phasing out the credit over a lengthy time period would give the home buyers incentive to take advantage of homes for sale, which could possibly spur a buying trend. This is a way to slowly ease into eliminating the credit while providing a short term financial boost.
One scenario that was proposed by supporters of the deduction is that its elimination may direct prospective home buyers to rent instead of buy, lowering the rate of homeownership throughout the country. These supporters stated that this would be a huge blow to what has been marketed for many years as one of the pillars of the American Dream.
Housing experts state that they do not believe that potential home buyers make their decision based on the fact that they may be able to claim a tax deduction each year, and they question whether or not promoting homeownership is helpful to government policy.
There is also the historical precedent suggesting that individuals simply will not stop borrowing money to purchase a home based on the fact that they cannot write off the home’s interest. When Congress eliminated interest deductions in 1986 on both auto loan and credit card debt, there was no change in the market, and credit card debt continued to grow over the next 20 years.
Additionally, in various countries where homeowners are not offered a tax break, the rates for homeownership are just about the same as the United States.
Chances are the deduction will stay on in one way or another. The deficit reduction commission that is led by Erskine Bowles, former White House Chief of Staff, and former Senator Alan Simpson proposed a possibility of limiting the deduction to $500,000 of the home’s total value, which is currently at $1 million, as well as eliminating the tax deduction on second homes. These options are realistic, and will most likely have their share of supporters.
For households that are considered high income, The Obama administration has proposed a cap on deductions at 28 percent. This cap could force homeowners to make the choice between claiming a mortgage debt or another type of tax deduction. In both scenarios, all middle class homeowners would get to keep their tax credit.
While the elimination of the deduction won’t have any positive affect on renters and low-income homeowners, this realistic option could at least put a significant dent in the billions of dollars that this deduction costs the government every year, allowing even low-income homeowners to once again believe in the American Dream.