By Vaheh Manoukian
The mortgage interest deduction is one of the most prominent features of the Internal Revenue Code. After state taxes, it is the most common deduction Americans make. The mortgage interest deduction allows homeowners with a mortgage to deduct the interest from the mortgage on their taxes, potentially saving them thousands of dollars. Until recently, Americans could deduct up to $1 million in mortgage interest. Now, the Tax Cuts and Jobs Act (TCJA) allows homeowners deduct their mortgage interest for only $750,000 worth of debt. Under the previous system, about 44 percent of U.S. homes benefitted from the mortgage interest deduction. It is projected that less than 15 percent of homeowners will find it financially advantageous to itemize deductions under the TCJA. While the stated policy goal of the mortgage interest deduction is to “encourage home ownership,” these changes will likely deteriorate the housing market, especially in expensive coastal areas.
While the stated policy goal of the mortgage interest deduction is to “encourage home ownership,” these changes will likely deteriorate the housing market, especially in expensive coastal areas.
The Mortgage Interest Deduction Impacts Income Distribution
The mortgage interest deduction under the TCJA impacts income distribution because property values will rise less than they otherwise would. Higher-income individuals historically have reaped a larger benefit from the mortgage interest deduction because they have been more likely to own homes and incur home-mortgage interest.
In the current market, the supply of homes for sale on the market, both newly built and existing homes put up for sale, is falling for the nation as a whole. With less supply, the prices of homes on the market have been increasing. This change to the mortgage interest deduction alone has not increased the price of houses on the real estate market for the majority of home buyers because most homes are worth far less than $750,000. However, buyers who live in expensive housing markets where the prices of homes exceed $750,000 are negatively affected because they potentially forfeit thousands of dollars in comparison to the previous tax law.
Under the TCJA, current homeowners are being treated better than future buyers, given that most of the benefit from the mortgage interest is taken in the early years of the mortgage. This could potentially limit the turnover of homes on the market because potential homeowners may not be able to afford a new home without the financial advantage of deducting their mortgage interest. Further, this will likely benefit a collection of higher income homeowners over new purchasers who would had benefited under prior law by being able to afford higher mortgages. This is amplified considering that one of the effects of the TCJA has been to transfer capital from the mortgage interest deduction subsidy to corporate stock reform.
Encouraging Stock Activity over Real Estate
Under the TCJA, corporations have gained significantly because the corporate tax rate has been cut from 35 percent to 21 percent. One possible advantage of the corporate tax cut coupled with the slowing housing market is the incentive for more Americans to put more of their capital into the stock market.
The current generation of eligible homeowners are not taking advantage of the perks of homeownership and the current system capitalizes on this trend by incentivizing stock activity over homeownership. The homeownership rate among millennials ages 25 to 34 is around eight percentage points lower than previous generations was at the same age. Further, in 2016, the top 10 percent of American households, as defined by total wealth, owned 84 percent of all stocks. Rather than investing their net worth in real estate, under the TCJA, current and future generations may find it more appealing to rent their residence and invest their remaining worth in the stock market.
Besides affordability, renting has several distinct advantages over owning a home. Renters do not have much worry about qualifying for a mortgage and do not have to drain their savings towards a down payment on a mortgage. Renting agreements are shorter term than mortgages and homes and apartments are generally available in for rent in suburbs across America, so renters are more likely to be amenable to mobility, especially when considering moving for a new job opportunity. Under the rental system, renters should have more money in their bank account, can move more easily, and have a stronger stock market for investment rather than homeownership.
Switching to a Tax Credit
While renting has its benefits, the stated policy goal of the mortgage interest deduction is to encourage homeownership. A more practical approach to the current system replaces the deduction with tax credits. Although replacing the mortgage interest deduction with a tax credit is not novel, its implementation is one of much debate. The optimal tax credit should be calculated to assist middle-income taxpayers by utilizing a tax credit that is tied to home ownership. Rather than allowing homeowners to make deductions based on the size of a homeowner’s mortgage indebtedness, a tax credit can shift the focus to homeownership, which will reduce the incentive to over-borrow.
Eliminating the mortgage interest deduction will require a “phasing out” period, which will give the real estate market and all its contributors time to adjust. Homeowners will be able to continue to enjoy the benefits of the deduction while it is being phased out, given that most of the benefit of the mortgage interest deduction accrues in the early years of the mortgage. A September 2013 analysis by the nonpartisan Congressional Budget Office found that switching to tax credits were a better option. This option would have been phased in over six years, beginning in 2014. From 2014 through 2018, the deduction would still be available, but the maximum amount of the mortgage deduction would be reduced by $100,000 each year. This option could have raised $52 billion through 2023, according to estimates by the staff of the Joint Committee on Taxation.
Ironically, a lower income taxpayer is the individual for whom a government subsidy in favor of homeownership may be most impactful.
Another projection utilizes a 0.5 percent tax credit based upon the purchase price of the home up to $500,000 (or $2,500). In this projection, if the income of the home is at around $66,000, the proposed credit will reduce the middle-income taxpayer’s liability from 11.96 percent to 9.66 percent. A household of income of less than $34,000 receives no benefit from the home mortgage interest deduction under the prior or current law. Ironically, a lower income taxpayer is the individual for whom a government subsidy in favor of homeownership may be most impactful. The proposed tax credit of $750 to the debt of $150,000 will reduce the low-income taxpayer’s liability from 7.11 percent to 4.86 percent. Consistent with the stated policy goal of the mortgage interest deduction, this tax credit will encourage homeownership by relieving low and middle-income homeowners of tax liability. Thus, Americans will have more variety in available investment options, along with more spending power and a stronger real estate market,
Under the Tax Cuts and Jobs Act, the amount of interest a homeowner can deduct from the mortgage interest deduction subsidy has been restricted to $750,000. This restriction impacts income distribution, given that many middle-class Americans have their net worth tied up in real estate. One major advantage of the current system is that it incentivizes Americans to rent their place of living and spend more of their wealth on corporate stocks and bonds rather than real estate. Yet, a more practical approach replaces the mortgage interest deduction with a tax credit, which fairly subsidizes American homeowners across the spectrum.
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 See, e.g., Rebecca N. Morrow, Billions of Tax Dollars Spent Inflating the Housing Bubble: How and Why the Mortgage Interest Deduction Failed, 17 Fordham J. Corp. & Fin. L. 751, 795 (2012) (reporting that higher income homeowners are also more likely to have mortgages on their homes than lower income homeowners).
 Diana Olick, Southern California Home Sales Crash, a Warning Sign to the Nation, CNBC (2018), https://www.cnbc.com/2018/07/24/southern-california-home-sales-crash-a-warning-sign-to-the-nation.html (last visited Oct. 28, 2018).
 See id.
 The Tax Cuts and Jobs Act – What it Means for Homeowners and Real Estate Professionals, NAR REALTOR, https://www.nar.realtor/tax-reform/the-tax-cuts-and-jobs-act-what-it-means-for-homeowners-and-real-estate-professionals (last visited Oct 28, 2018).
 The Role of the Interest Deduction in the Corporate Tax Code, MERCATUS CTR (2018), https://www.mercatus.org/publications/federal-fiscal-policy/role-interest-deduction-corporate-tax-code (last visited Oct. 28, 2018).
 See id.
 Annie Nova, Here’s Why Millions of Millennials Are Not Interested in Being Homeowners, CNBC (2018), https://www.cnbc.com/2018/08/09/millions-of-millennials-are-locked-out-of-homeownership-heres-why.html (last visited Oct. 28, 2018).
 Edward N. Wolff, Household Wealth Trends in the United States, 1962 to 2016: Has Middle Class Wealth Recovered, NBER (2017), http://www.nber.org/papers/w24085 (last visited Oct. 10, 2018).
 The 2013 Long-Term Budget Outlook, Cong. Budget Off., https://www.cbo.gov/publication/44521 (last visited Oct. 10, 2018).
 See id.
 Austin J Drukker, et. al, The Mortgage Interest Deduction: Revenue and Distributional Effects, URB. INST., 12–18 (2017).
 See id.