A recommendation by the National Commission on Fiscal Responsibility and Reform to limit the mortgage interest tax deduction has pushed a hot button within the real estate industry and could throw the housing market into further decline, some observers are warning.
The National Association of Realtors said the move would discourage homeownership, which has already fallen to a 10-year low with the high rate of foreclosures and tighter lending restrictions.
Brookings Institution senior fellow Alan Mallach stirred the controversy during an October lecture at University of Nevada, Las Vegas, when he supported the commission’s plan to reduce, or even eliminate, the tax deduction for homeowners.
He said lower-income households typically aren’t able to take advantage of mortgage deductions and end up subsidizing wealthier people who have larger, more expensive homes. It’s also a myth that the tax deduction encourages renters to buy homes.
"There’s been quite a bit of economic research done on it," Mallach said Monday in a follow-up interview from Washing-ton, D.C. "When you look at comparative statistics internationally, does it increase homeownership? The answer is consistently ‘no.’ The most you can say is there’s no evidence at all that the deduction affects homeownership. Why should it?"
Fourteen of the 25 European Union countries have a higher homeownership rate than the United States, including the United Kingdom and Ireland, where the rate is 70 percent with no deduction, Mallach noted.
He said the mortgage interest deduction artificially pushes up U.S. housing prices because people are willing to buy more home than they normally would without the deduction.
That’s why real estate agents and homebuilders love the deduction, he said. Higher home prices are more profitable for the entire real estate industry.
Frank Nason, president and broker of Residential Resources in Las Vegas, said he philosophically opposes the deduction because it interferes with the free market. However, he disagrees with Mallach’s contention that it does nothing to spur home sales.
"At least from a real estate agent’s perspective, the tax deduction is used often to show the difference in renting versus buying by subtracting the tax relief from the monthly payment," Nason said. "It doesn’t always work in favor of buying versus renting, but when rates are high, it usually does."
Irene Vogel, executive vice president of the Greater Las Vegas Association of Realtors, said the mortgage deduction is extremely important for homebuyers and that Democrats would be "shooting themselves in the foot" if they were to eliminate it.
President Obama established the 18-member bipartisan commission in February to address the projected $8 trillion budget deficit for the next decade. The commission issued a 50-page draft document in November that provided $200.3 billion in domestic and defense savings by 2015.
The section on comprehensive tax reform laid out three options to reduce the deficit, including one that would eliminate the alternative minimum tax and Pease and PEP, and another that would limit mortgage deductions to exclude second homes, home equity loans and mortgages exceeding $500,000.
Pease, named for its architect, the late U.S. Rep. Donald Pease, D-Ohio, limits itemized deductions. PEP, the personal exemption phase-out, is a provision that starts cutting the value of personal exemptions.
The mortgage-interest deduction, which allows homeowners to deduct principal mortgage interest from their federal tax bill, has been challenged by flat-tax reformists several times since its inception in 1913.
"We need to kill this idea now before it takes on a life of its own," Henderson homeowner Vivian Scott wrote in a letter to the editor published Nov. 1 in the Las Vegas Review-Journal. "Otherwise, the government will proceed to put the final nail in the housing market coffin — and in homeowners."
Analysts estimate tax savings from mortgage deductions to be $130 billion for 2012, though the amount varies from state to state, a study by the Tax Foundation, a nonpartisan Washington, D.C.-based tax research group showed.
California had the highest average mortgage deduction among all returns in 2008 at $5,520, compared with the U.S. average of $3,279. Nevada ranked fifth at $4,580, the foundation reported.
Savings vary for two primary reasons. First, some states have higher average incomes and people in those states take out larger loans on more expensive homes. Their monthly mortgage payments are larger and some pay interest only. This maximizes the amount deducted and since high-income earners fall into a higher tax bracket, the deduction saves them substantially more.
Secondly, in places like New York City, the existence of expensive homes is outweighed by the large number of people claiming no deduction because they rent. New York is ranked No. 23 in mortgage deductions at $2,897.
Mallach said people in the lower end of the housing market seldom take the deduction. Only 4 percent of homeowners earning less than $20,000 a year claim the deduction, while nearly 80 percent of those making over $100,000 take the deduction, he said. Homeowners must file IRS Form 1040 with itemized deductions on Schedule A to claim the deduction.
"What it says is lower-income homeowners don’t take the deduction, but they’re getting hit with higher home prices because the deduction exists," Mallach said.
Whether or not lower-income bracket households choose to claim the mortgage deduction, the opportunity to take it is critical to the financial decision for those seeking the American dream of homeownership, said Sean Fellows, government affairs director for the Greater Las Vegas Association of Realtors.
"The mortgage interest deduction is one of the greatest creations of personal wealth," he said.
The National Association of Realtors estimates that any paring back of the mortgage interest deduction, whether at once or over time, would reduce home values by an average 15 percent.
In a November letter to the national commission, National Association of Realtors President Ron Phipps called that level of wealth destruction "unacceptable," particularly since "this loss of value is never fully recouped" and it would come when the U.S. economy can’t turn around without a stable housing sector.
"Given the fragile state of the nation’s housing market, now is not the time to be scaling back incentives for homeownership," Mortgage Bankers Association Chairman Michael Berman said in a statement. "The mortgage interest deduction is one of the pillars of our national housing policy, and limiting its use will have negative repercussions for consumers and home values up and down the housing chain."
Contact reporter Hubble Smith at email@example.com or 702-383-0491.