This morning President Obama unveiled a new $3.73 trillion spending plan (warning: link goes directly to a large PDF, see page 40) that would seek to reduce the federal deficit by increasing taxes and cutting spending in certain areas. While much of this falls outside the purview of this blog, there is one very relevant proposal: the new budget would seek to limit the mortgage interest deduction for the wealthy.
“Currently, if a middle-class family donates dollar on mortgage interest, it gets a 15-cent tax deduction, but a millionaire who does the same enjoys a deduction that is more than twice as generous. By reducing this disparity and returning the high-income deduction to the same rates that were in place at the end of the Reagan Administration, we will raise $291 billion over the next decade.”
At the beginning of the income tax in 1894, all forms of interest were tax-deductible. Consumer credit was relatively rare at the time, so the thinking was that most interest payments were business-related, and were exempted for this reason. It is important to realize that the mortgage interest deduction is more of a vestige of this time than anything else, it was not originally intended to promote homeownership or prop up the housing market, although people frequently view the deduction through that prism these days.
As the part of the new budget, the personal itemized deduction phaseout would be re-instated for high-earning individuals. The phaseout is pretty complex, and essentially means that itemized deductions are phased-out at higher income levels. (I am not a tax expert and don’t want to get bogged down in tax talk. Here is a pretty good article by Mary Gallagher that explains the issue in more depth if you are interested in further information). The takeaway is that homeowners with mortgages that make over $250,000 as a household, or $200,000 as an individual would see their mortgage interest deductions decreased under the plan.
It is not entirely clear to me how this would impact the housing market, as it would only impact a limited number of households. As of 2008, only about 2% of the population makes over $200,000 per year. I would imagine that removing the income tax deduction on high earners would put some downward pressure on the sale of more expensive homes, which would mean that certain high cost areas (e.g. Washington, D.C., Miami, New York City) would be affected more than others. That said, it would probably be difficult to isolate the impact of removing the mortgage interest deduction because home prices are expected to decline next year anyway.
I am sure the budget will see significant changes as it makes its way through Congress, especially as it moves through the Republican-controlled house. It will be interesting to see if the limitation to the mortgage interest deduction is passed. My initial guess is that the Republicans will probably attempt to remove it in an effort to appease their base. We will see.