Ramifications of Eliminating the Mortgage Tax Deduction

Monday, November 21, 2005 | 07:06 AM

What are the economic ramifications of the Mortgage deduction being eliminated? How likely is it that such a significant tax change is actually enacted?
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Ever since the President's tax reform policy suggested capping the mortgage deduction at significantly lower levels, I've been wondering what the economic ramifications of this would be. Especially now, coming at the tail end of a huge Real Estate cycle.

The entire issue may be moot -- at least for now -- given the present political situation. Perhaps if President Bush were at full political strength, if he wasn't dealing with numerous crisis and scandals and staff indictments and the fading support for the war in Iraq, while still smarting from the rejection of social security reform, and if his own polling numbers were not at an all time low in popularity -- if all that were not weighing against him, the chance of eliminating or greatly modifying the home mortgage deduction might be 15-25%. Given his current predicament*, my expectations are that eliminating this extremely popular -- even beloved -- deduction are all but impossible. (Its surprising the opposition has not made more hay over this).

The home mortgage deduction is so ingrained into the economic fiber of the country, that the potential consequences of altering this are ginormous. The risk to overall economy, if this were to be even slightly mishandled, would be devastating. As is, the impact would be very significant, given Real Estate's contribution to the economy.

This is especially true, given the factors which have been driving the Real Estate boom.   

Recall that back in May of this year, we referenced Northern Trust's Asha Banglore, whose research showed that from 2001 to April 2005, 43.0% of private sector jobs were housing related. In this week's Sunday Times, Daniel Gross further explored the correlation between Hosuing and Job creation (As the McMansions Go, So Goes Job Growth):

These data points are potentially worrisome, and not only for the legions of real estate brokers and Sheetrock layers toiling in offices and job sites across the country. In recent years, economists from Alan Greenspan on down have been discussing the way rising home prices and the growth of home-equity borrowing have fueled consumer spending, the piston that drives the country's economic engine. But in recent years, housing, real estate and the related industries have become a huge factor in another crucial economic area: employment growth.

After the brief and shallow recession of 2001, the resilient United States economy stubbornly failed to create payroll jobs at the rate of past recoveries. Economists and politicians blamed factors and trends like outsourcing, global trade, high benefit costs and productivity growth. But amid the gloom, the real estate sector shouldered the burden of job creation . . .

As a result of the boom, the economy is more concentrated on housing than ever before. "Residential investment as a share of gross domestic product is at the highest level in 50 years," said Jan Hatzius, senior economist at Goldman, Sachs."

When discussing these data points just 6 months ago, I found the pushback significant. There has been less reluctance to acknowledge this issue more recently. Its intriguing to see how these ideas have slowly come to be accepted by the mainstream.

An earlier NYT article looked at another aspect of the proposd Tax changes: How they fall on people, based upon various economic classes:

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Possibly the greatest NYT graphic ever:
click for larger graphic

Nyt_playmoney_1



Was there a nefarious ulterior motive in the way this was executed?  In an earlier piece by Dan Gross, (Tax 'em Till They Turn Red) the elimination of the Mortgage deduction -- or more accurately, capping it at a much lower level than the present ~$ million dollars -- is a way to offset tax revenue losses from eliminated the Alternative Minimum Tax (AMT).

How much revenue? An expected $1.2 trillion over 10 years. And, as David Rosenbaum reported in an Oct. 19 New York Times article (which you now have to pay to read online), the panel came up with two simplification plans. Both would severely limit the size of the home mortgage deduction. Now the deduction applies to up to the first $1 million of a mortgage. The panel's plans would cut it down so that it would only apply to loans that are the "maximum that the Federal Housing Administration will insure." The sum varies by market, but the maximum is $312,895 and the national average is $244,000. Both plans would eliminate deductions for interest on home-equity loans or mortgages for vacation homes. And both would eliminate the deduction for state and local taxes paid, including property taxes.

Fascinatingly, Gross observes that the changes recommended by a commission appointed by the President will have much greater negative effects on taxpayers in Democratic regions. Its as if the tax changes are a form of economic gerrymandering whose impact will be to significantly reduce the net take-home pay of (surprise!) Democratic donors.

He proposes quite a fascinating thought experiment:

"Go to Realtor.com, punch in your ZIP code and a price point, then punch in another ZIP code in a different part of the country and the same price point, and check out the astonishing difference in what you get."

Doing so reveals that the so-called Blue states are high level of Government services, higher income, higher state and local taxes. Property values are significantly higher. The mortgage deduction in these regions is worth quite alot more than it might be in the lower tax/lower property value Red states.

Fascinating analysis  . . .





Sources:
As the McMansions Go, So Goes Job Growth
DANIEL GROSS
NYT, November 20, 2005
http://www.nytimes.com/2005/11/20/business/yourmoney/20view.html

What's Behind the Boom
JAMES R. HAGERTY
THE WALL STREET JOURNAL, November 21, 2005; Page R4
http://tinyurl.com/8t5yq

Goodbye, My Sweet Deduction
EDUARDO PORTER and DAVID LEONHARDT
NYT, November 3, 2005
http://www.nytimes.com/2005/11/03/business/03tax.html

Tax 'em Till They Turn Red
The Bush tax panel's plan to screw Democrats.
Daniel Gross, moneybox
Slate, Posted Monday, Oct. 31, 2005, at 5:02 PM ET
http://www.slate.com/id/2129113/

________________________

*    I am going to venture outside of my area of expertise and make a broad political observation:  Typical Presidents get to make only 2 grand efforts during their terms:  Oftentimes, one is a rhetorical jawboning ("Mr. Gorbachev, tear down this wall!") while the other is actual legislation. President Bush 's two efforts are the War in Iraq and Tax Cuts, and they will likely be his legacy. (the Medicare Prescription Drug Plan was a secondary program). Its hard to imagine that tax reform, social security privitization, or another military effort will gain any traction.

Monday, November 21, 2005 | 07:06 AM | Permalink | Comments (15) | TrackBack (3)
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Comments

I do have a couple of thoughts. One, with interest rates so low, how significant is this deduction? I wonder if a lot of people did not lose their deduction when they refinanced at lower rates.

Two, I would wonder if people quit using their credit cards when the credit card interest deduction was removed. It seems they charge more now than ever.

Posted by: me | Nov 21, 2005 10:32:13 AM

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