Falling house prices and a backlog of foreclosures have turned 2011 into the most desperate year yet for many American homeowners. The pain just keeps coming, and government programs have proven ineffective at assisting many of those in danger of losing their houses.
In the short run, now would be the worst time to strip away government subsidies that support many of those same beleaguered households. But over the long run, we owe it to ourselves and future generations to act on the unmistakable lesson of the housing bust: Uncle Sam has no business artificially pumping up the real-estate market. We need to make difficult decisions soon so that, in years to come, we can gradually undo the dangerous web of government interventions that did so much to set up our nation for its big fall.
That means we need to keep interest rates at rational levels. We need to largely privatize Fannie Mae and Freddie Mac, which pool mortgages into investment securities. The cruelest cut of all: We need to slash the tax giveaways that encourage Americans to buy too much house at too high a price.
Yes, that includes phasing out the popular deduction for interest on home mortgages, as well as lesser breaks for local property taxes and residential capital gains. And, yes, we know we’re advocating this as millions of Americans prepare to file income tax returns that include mortgage interest calculations.
The mortgage-interest deduction should not be eliminated all at once. Canceling a substantial benefit abruptly during a housing crisis would be disruptive and unfair. Without the subsidy, the true cost of buying a home will be unmasked, exerting more downward pressure on real-estate prices. So we need to act cautiously, over an extended period.
Yet act we must. This giveaway saps an estimated $100 billion from federal coffers each year, with most of the lost revenue flowing to the wealthiest Americans.
Trade groups such as the National Association of Home Builders portray the benefit as a middle-class tax break. But it does a lot less for most Americans than those with a vested interest in promoting home sales would have you believe: If you rent, you get nothing. If you have reasons not to itemize deductions, you get nothing. If you pay off your mortgage to live debt-free, you get nothing.
Borrow a fortune for a McMansion, however, and the Internal Revenue Service provides a big discount, at the expense of every other taxpayer. More than three-fourths of the benefit from the mortgage-interest deduction goes to the 14 percent of tax filers reporting six-figure incomes. Almost one-third of the subsidy goes to the population reporting incomes of $200,000 or more. Those 3 percent of tax filers at the very top receive about the same amount as do the 86 percent earning less than six figures.
As a consequence, this deduction does little to promote homeownership ― supposedly its main objective. Data suggest that almost no one now benefiting from the break would flee the real-estate market. People just wouldn’t borrow as much to fund home purchases.
A better way to promote homeownership would be replacing the current web of tax breaks with a credit ― not a deduction ― that would help everyone, including those who pay low marginal tax rates and do not itemize. How might that work? The leaders of President Obama’s deficit commission proposed a credit for 12 percent of interest paid each year on mortgages up to $500,000. That credit would make a modest home affordable for some Americans who otherwise couldn’t swing it. And it would do away with the perverse incentive for wealthier households to take on huge mortgage loans.
Phasing out the mortgage-interest deduction over the coming decade could be done simply. We could start by slowly reducing the maximum size of mortgage debt eligible for deductions from the current $1 million, continuing year-by-year until we hit zero. That approach would allow plenty of time for individuals to adjust their finances, and for the marketplace to act on the new reality.
The phaseout could become a centerpiece of a deficit reduction plan featuring comprehensive tax reform, and lower rates. Tax reform along these lines would go a long way toward heading off a future crisis in the residential real-estate market. Let’s get it done.
(The Chicago Tribune, March 23)