Was the home mortgage deduction a large contributor to the foreclosure crisis, leading people to buy more house than they can afford and also cause them to not build any equity?
Q I'm curious as to your thoughts on the mortgage interest deduction. I have a theory that it was a large contributor to the foreclosure crisis. It seems to me that the deduction leads people to buy more house than they can afford and also causes people to not build any equity because they are convinced they need the mortgage to get that deduction.
When I started rapidly paying off my mortgage, many people told me that I shouldn't do it because I'd lose the deduction. Why do people think it's a good idea to pay $3 to $4 interest to a bank to save $1 in taxes?
A I agree with you. The value of the home mortgage deduction is usually exaggerated, especially for homeowners who aren't in the highest tax bracket.
You're also right about the risk of equity stripping. "Housing was a particularly attractive way for those of modest means to save, because they could live in the very piggy bank they were building," writes Richard Green, professor at the University of Southern California on his blog, Richard's Real Estate and Urban Economics. But frequent drawing down of equity when homes are appreciating means someone can live in a home for 20 years and still have very little equity.
It looks like the mortgage interest deduction could get a skeptical look in coming years. The reason is figuring out how to deal with America's national debt. Most proposals for addressing it include a call for major tax reform: Eliminate all or as many deductions and credits as possible in return for lowering tax brackets.
The co-chairs of the bipartisan National Commission on Fiscal Responsibility and Reform -- former Clinton White House Chief of Staff Erskine Bowles and former Sen. Alan Simpson, R-Wyo. -- have proposed eliminating the mortgage interest deduction. The competing bipartisan Debt Reduction Task Force -- led by former Sen. Pete Domenici, R-N.M., and former head of the White House Office of Management and Budget Alice Rivlin -- proposes turning the deduction into a 15 percent credit for home mortgage interest expenses on a principal residence up to $25,000. The move would increase the number of mortgage holders who qualify for subsidized interest, but would reduce the subsidy rate for high-income owners.
The U.S. tax code has far too many provisions that favor housing. For instance, it makes no sense for homes to get preferable tax treatment over stocks. Why should the first $500,000 in profit on the sale of the home be exempt from capital-gains taxes for a family while realizing a $500,000 gain from investing in a wealth-generating technology firm means paying a 15 percent capital gain? The playing field should be level.
Chris Farrell is economics editor for "Marketplace Money." Send questions to email@example.com.