There have been many proposals to reform or eliminate the mortgage interest deduction, from eliminating it for second homes to limiting it to lower mortgage amounts. These and other proposals would help right the deduction’s “upside-down” effect.
The National Commission on Fiscal Responsibility and Reform recently proposed to transform the deduction into a nonrefundable tax credit equal to 12 percent of mortgage interest paid. That would give homeowners in all brackets the same tax savings that a household in the 12 percent bracket would receive from the current mortgage interest deduction. The commission also proposed to lower the debt cap for the deduction from its current level of $1.1 million to $500,000. Under the commission’s plan, there would be no credit for interest on home equity lines of credit or second-home mortgages.
But reform is difficult. Eliminating the subsidy abruptly would be very harsh on homeowners who determined how big a mortgage they could afford with the assumption that they would receive this tax break. In addition, the deduction has probably driven up home prices. Eliminating it would lower home values to the detriment of current homeowners—although future owners could see lower prices. Particularly right now, when falling home prices have hurt the overall economy, this could have an adverse affect on economic growth.
The mortgage interest deduction is closely associated with homeownership and, by extension, the American Dream. But as a $100 billion government spending program, it deserves as much scrutiny as any program of similar magnitude.
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