Kill the Mortgage Deduction? Good Luck With That
Republicans in Congress have signaled that it’s high time to get rid of the mortgage-interest deduction, or MID. In the draft bill released last week, they attacked this sacred cow from two angles. They doubled the standard deduction, which eliminates the incentive to itemize for homeowners of modest means. At the same time, the cap on qualifying mortgages would drop from $1 million to $500,000, effectively obliterating the MID for most wealthy homeowners.
Will Speaker Paul Ryan actually pull this off? From its dubious beginnings a century ago, the MID has shown a remarkable resilience, frustrating generations of idealistic reformers. If there’s a mindless zombie in the tax code, this is it: a purposeless tax break that just refuses to die, no matter how many opponents try to bury it.
Defenders of the MID claim it was established to promote homeownership in the U.S. But as law professor and tax historian Dennis Ventry has rightly observed, its peculiar ancestry belies that heartwarming story. It dates back to the Revenue Act of 1913, which established the country’s modern income tax. That statute stipulated eight different deductions that could be used to lessen taxable income. None of them referred to interest on mortgages.
But one of them did refer to “consumer interest,” which was a concession to the fact that it was difficult, if not impossible, to differentiate between business debt and household debt among small business owners, farmers and family firms. But in the debates over this provision, almost no one mentioned interest on mortgages: the new income tax only targeted wealthy taxpayers, and most of them didn’t resort to debt to buy their homes. (Far fewer people owned their own homes at this time: the U.S. was a nation of renters.)
In the succeeding decades, homeownership rates crept upward, abetted by new federal policies during the New Deal, and again after World War II, when the GI Bill put homes within reach of returning veterans. At the same time, Congress broadened the income tax to pay for growing expenditures, and the income tax began touching ordinary Americans for the first time. Inevitably, some of them claimed the MID.
Federal housing officials didn’t view the MID as a means of promoting home ownership. Landmark studies of homeownership and housing policies from the 1950’s failed to mention the MID. But as growing numbers of Americans began itemizing their returns and taking advantage of the MID, a handful of policy analysts belatedly realized that the tax break was effectively underwriting the democratization of homeownership.
But the MID had few defenders at this point, largely because it seemed to add to the inefficiency and arbitrary nature of the income tax. By the 1960s, many tax reformers began building a case to the American public for comprehensive tax reform, promising to eliminate preferential provisions that only benefited some groups in exchange for lower rates benefiting all groups.
All the familiar arguments for abolishing the MID poured forth. One witness before Congress argued that the MID “discriminated against the tenant” in favor of property owners; others noted it was “inefficient in the sense that aid in acquiring a home is most needed by persons in the lower brackets” yet the subsidies supplied by the MID were “greatest at the top of the income scale where the need for such a stimulus is least.”
In 1963, the Treasury Department released a plan that would have capped all itemized deductions to the amount exceeding five percent of a taxpayer’s adjusted gross income. This direct attack on the MID, to say nothing of charitable contributions, state and local taxes, and other cherished deductions tabulated on Schedule A, generated an immediate backlash.
The forerunner of today’s National Association of Realtors immediately spoke out against the idea. “The brunt of the proposal would fall on the homeowner, who now can deduct interest on his mortgage,” it declared. The drive for reform soon faltered.
Frustrated, the Treasury Department tried a new strategy. Rather than attack the MID directly, they argued for a significant increase in the standard deduction, effectively undercutting incentives to itemize deductions. This idea, included in a massive four-volume report published by the Treasury Department in 1969, made it into the Tax Reform Act signed into law that same year.
In two years, the percentage of taxpayers itemizing their returns dropped from 48 percent to 35 percent. But Congress proved unwilling to tackle the MID, confirming its now sacrosanct place in the tax code. Indeed, a poll taken in 1978 found that 90 percent of respondents favored keeping deductions for mortgage interest, despite the fact that only 25 percent of taxpayers itemized their returns -- and not all of them took the MID.
After Ronald Reagan’s election in 1980, reform seemed far more likely, even necessary. Budget deficits began spiraling out of control, and Congress found itself hard pressed to eliminate tax breaks like the MID. Reformers got a big boost in 1984, when Ronald Reagan made fundamental, sweeping tax reform a priority, declaring in that year’s State of the Union speech that he wished to “simplify the entire tax code.”
Suddenly threatened, the real estate industry quickly mobilized to protect the MID, a message that didn’t take long to get to the president. In a campaign speech to the National Association of Realtors (NAR), Reagan declared that while tax reform remained a priority, he had instructed the Treasury Department to “preserve that part of the American dream which the home mortgage interest deduction symbolizes.” Reagan kept his promise.
The Tax Reform Act of 1986 further cemented the MID’s place in the tax code by creating a new section of the Internal Revenue Code that explicitly defined the deduction. Presidents after Reagan bowed before the MID: Bush, Clinton, Bush. The last went another round on tax reform, but steered clear of tackling the MID.
Now Ryan wants to slay this sacred cow. Perhaps he’ll succeed. More likely, though, he’ll find out what generations of failed reformers already know: mess with the housing bull, and you’ll get the horns.
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