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Mortgage Deduction Could Be a Gut Check for Tax Reformers

Posted on August 29, 2017 by Luca Gattoni-Celli

As Republican tax reformers consider reducing caps on the home mortgage interest deduction to offset lower statutory tax rates, some observers say leaving the provision untouched would signal a potentially crippling intolerance of political risk.

A tax lobbyist told Tax Analysts that he received confirmation from Capitol Hill sources that the deduction was in play, and media reports indicate that tax reform negotiators are considering a cap of $500,000 or $600,000. “I think it is a given that at least the first draft of [the home mortgage interest deduction reforms] will propose a serious reduction for higher-value homes,” said the lobbyist, who requested anonymity.

Gordon Gray of the American Action Forum said that tax reform is unlikely, but that if it does happen, he hopes it will curb the deduction, a change he equates with more productive tax reform.

Evan Liddiard, a tax lobbyist for the National Association of Realtors (NAR), explained that under current law, most individuals may deduct interest paid on up to $1 million of so-called home acquisition debt and up to $100,000 of home equity debt. Those caps are halved only for married taxpayers filing separately, he said, citing Voss v. CommissionerNo. 12-73257, 12-73261 (9th Cir. 2015).

Liddiard said he has not heard from anyone on Capitol Hill that GOP tax reformers are definitely considering a lower cap on the home mortgage interest deduction. “I think it’s pure speculation,” he said, adding that if it is true, those involved would not want to alert his industry.

Lowering the caps “raises too much money, and blunts any criticism that a reform bill is simply a tax cut for the rich, for it to be ignored,” the first lobbyist said. “It's almost necessary.”

Gray said that any proposal to touch the mortgage interest deduction reflects willingness to take on political risk. If tax reformers leave the provision untouched, that means they “probably got scared off of it,” and thus every other tough fight that serious reform would entail, he said. And temporary or limited tax changes “would be worse than doing nothing,” said Gray, a former Senate staffer who advised the 2008 presidential campaign of Sen. John McCain, R-Ariz. He also extended that view to current talk in Washington of “futzing” with the budget window and temporary corporate rate cuts.

“And so,” Gray said, “I find myself, a good, tax-cutting Republican, defending the status quo.”

Wanting to get rid of the home mortgage interest deduction “is always about the money,” Gray said, adding that it is a matter of the tax expenditure’s opportunity cost, not of it being odious itself. A recent Tax Foundation analysis estimated that halving the deduction’s cap would generate roughly $300 billion of revenue over a decade.

Gray agreed the deduction is priced into the housing market, which he said in practice subsidizes home prices, not home buyers. Policy experts across the ideological spectrum think the home mortgage interest deduction is poorly targeted to promoting homeownership and squanders budgetary resources, he said.

In a 2013 report exploring options for reforming the home mortgage interest deduction, Eric J. Toder of the Tax Policy Center said the deduction mostly benefits upper-middle-income households and does not efficiently encourage homeownership among low- to middle-income taxpayers.

‘The American Dream’

However, the “Big Six” group of Republican leaders attempting to negotiate a unified tax reform plan have consistently said the itemized deduction for mortgage interest is safe. One member, House Speaker Paul D. Ryan, R-Wis., said May 24 that it may be altered, but took pains to assuage voters’ concerns.

“We recognize, acknowledge, and believe you need to maintain the mortgage interest deduction,” Ryan told CNBC in an interview. “Whether it can be improved and how it works — that’s a decision and the discussion we’ll have on an ongoing basis, and that’s what the [House] Ways and Means Committee has all their hearings and process for.”

Former Ways and Means member Jim Gerlach, Gray, and the first lobbyist all invoked “the American Dream” when asked why the deduction is almost untouchable politically, explaining that it is synonymous with homeownership.

Liddiard did not employ that phrase himself, but he did cast homeownership as an attainable and uniquely valuable means to build capital and buy into a large financial asset.

Lawmakers seeking reelection in competitive districts will be particularly attuned to the home mortgage interest deduction because of its wide-ranging economic impact on home buyers, builders, sellers, and others, said Gerlach, a Republican who left Congress in 2015. He noted that his Pennsylvania district slanted Democratic through his penultimate term.

Gerlach said voters and interest groups are primed to view any proposed change to the home mortgage interest deduction with suspicion. “Whether a code revision would actually affect them or not, a change in [the deduction] would be perceived by most homeowners, at least initially, as losing a benefit they have relied on to get where they are and they would not be happy about it,” he added. “Depending on the particular [deduction] change, perhaps a year or so post-change, they would realize that from an overall tax standpoint, they weren’t hurt.”

“But a congressional election might certainly intervene between” the change and that realization, Gerlach said. “And most legislators don’t want face the voters when they are angry.”

The National Association of Homebuilders and the NAR have been “aggressive stewards of this tax benefit,” said Gray. Those groups are certainly effective at mobilizing their members, he said, adding that he expects that homebuilders and realtors will visit lawmakers on Capitol Hill this fall.

“That doesn’t mean it’s good tax policy,” Gray added.

The NAR seems ready for a full-court press. “Capping the mortgage interest deduction amounts to a de facto tax increase on current or future homeowners and puts homeownership further out of reach for prospective buyers,” said NAR President William E. Brown in an emailed statement. He added that his group and the 1.2 million Realtors it represents “have strong objections over any effort to” limit the deduction.

Asked to summarize his industry’s perspective, Liddiard said that the NAR is not against tax reform, which it considers important and potentially beneficial. But tax reform that takes away the benefits of homeownership is a problem, especially since the code has encouraged it for more than 100 years, he said.

Liddiard said those benefits also include the state and local tax deduction. And if Republicans follow through with their proposal to nearly double the standard deduction, most taxpayers will have no incentive to itemize, rendering the home mortgage interest deduction moot — which would depress home values, he said.

Even if the deduction cap remains untouched, the NAR expects tax reform to undercut the tax benefits of homeownership, thus reducing home values, putting perhaps millions of homeowners underwater with their mortgages and potentially causing a recession, Liddiard said.

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