It’s not often that I agree with the IMF (in fact, this might be the first time), but yes, the mortgage interest deduction is a regressive tax, and it should be phased out. This is also a good way of checking housing inflation, and if we’d cut it years ago, we wouldn’t have had such a huge housing bubble. Should it happen right this minute, when the housing market is still so fragile? No. But it should happen, and we should plan for it now:
The U.S. should consider capping or cutting the popular tax deduction for mortgage interest as it prepares to debate what should replace mortgage giants Fannie Mae and Freddie Mac, the International Monetary Fund said Wednesday.
The IMF, in an analysis of housing finance systems around the world, said an Obama administration paper released earlier this year makes progress toward needed changes in the U.S. mortgage system. But the report criticized the U.S. for not tackling the popular tax deduction for mortgage interest, which the report termed “expensive and regressive.”
The U.S. government’s support of the housing market “has been pervasive but has not yielded many of the expected benefits to prospective or existing homeowners,” the report said. “It is clear that an overhaul is needed.”
“As a first step, we would very much recommend that the U.S. would at least cap the mortgage interest deductability,” said Ann-Margret Westin, an IMF senior economist and one of the authors of the housing report. She approved of the recommendation by the U.S. fiscal commission to halve the mortgage limit for deductions and to let it apply only to private residences, but the IMF said any such move would have to be undertaken over time.
Why is this a good idea?
It’s a $131 billion break for the wealthy. That’s the White House’s official estimate of the 2012 revenue cost of the mortgage interest deduction. A study that looked at proposals to reform the mortgage deduction put out by the Tax Policy Center at the Urban Institute points out that sum is “much more than the total of all outlays by the Department of Housing and Urban Development ($48 billion).” And studies show that most of the benefit goes to taxpayers in the top 20 percent of the income distribution ladder. Significantly, you need to itemize your deductions to claim the break, a step that only about one-third of Americans take. According to the Tax Foundation, for the 2008 tax year, just 26.8 percent of tax returns claimed the mortgage interest deduction. Among the returns that claimed the deduction, the average amount was $12,221.
The Catfood Commission proposal exempts houses under $500,000, in case you were hyperventilating. In most places, for all practical purposes, this will only affect the well-to-do. And in areas that saw extreme bubbles, we can use tax credits to protect those homeowners.