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Tax Reformers Eye Breaks for Housing

Mortgage deductions and other benefits are costing more than forecast. With a rising federal budget deficit, they may be scaled back.

October 08, 2005|David Streitfeld | Times Staff Writer

Just as the nation's housing boom appears to be slowing, debate is starting among policymakers about reining in one of the most sacred cows of American public policy: the mortgage-interest deduction and other generous tax benefits granted to homeowners.

A presidential commission on tax reform will take up the subject for the first time Tuesday. "Everything's on the table," said Charles Rossotti, a panel member who was commissioner of internal revenue from 1997 to 2002.

The mortgage-interest deduction saved homeowners $61.5 billion last year. No one expects the commission to recommend its elimination.

Instead, the panel may consider scaling back the deduction for mortgage interest on second homes or home-equity loans, and changing the deduction for property taxes, among other things.

The stakes in such a discussion are huge.

Changing the tax benefits for homeowners, even if done slowly, could cause short-term convulsions in the market as buyers recalculate what they can afford. The tumult could be most pronounced for homeowners in states with the highest home prices, such as California. In the long term, housing could become more affordable as some of the stimulus that has sent prices soaring is removed.

Any proposed shift would encounter strong and possibly overwhelming resistance. But with a rising federal budget deficit, the prospects for change are much greater than they've ever been, say those involved in the debate.

Homeownership wasn't initially a favored child. When the individual tax code was created in 1913, all types of interest were deductible. Most fell away over time, but housing remained and became even more special.

Eight years ago, capital-gains taxes were eliminated for home sellers who had profit of as much as $250,000 (for individuals) or $500,000 (for couples). That has created a vast amount of wealth and helped power a housing boom that has seen prices double or triple in Southern California and other hot markets.

Some policymakers and analysts are beginning to wonder whether such breaks are providing the wrong incentives, giving hefty deductions to millionaires buying Beverly Hills estates as well as to speculators snapping up Las Vegas ranch houses, hoping to turn a quick profit.

U.S. Comptroller General David M. Walker said provisions such as the capital-gains exemption were costing the government much more money than anyone forecast when they were first proposed. In a new study, the Government Accountability Office calculated that the exemption drained $29.7 billion from federal coffers last year.

"We need to review the reasonableness, appropriateness and effectiveness" of such provisions, Walker said in an interview.

Presidents and members of Congress have long proclaimed the importance of homeownership, saying it gives people roots in a neighborhood and makes them better, more caring citizens. A home, not a college education or a fulfilling job, is the embodiment of the American dream. Politicians also are mindful of the fact that the nation's 74 million homeowners form one of its largest special-interest groups.

President Bush set up the President's Advisory Panel on Tax Reform in January to recommend changes in the tax code. The panel, led by former Sens. Connie Mack (R-Fla.) and John B. Breaux (D-La.), will submit suggestions to Treasury Secretary John W. Snow this fall. Bush will choose among the recommendations to propose to Congress.

Bush specifically charged the panel to take account of "the importance of homeownership and charity in American society."

That led many to conclude that the homeowner deductions were safe.

"The mother of all tax subsidies ... shall remain untouched," wrote economist and tax expert Martin A. Sullivan in Tax Notes.

This was good news for real estate agents, developers, home builders, contractors, home-improvement stores and speculators -- groups that heavily support the status quo. But unfortunately for them, the mood changed over the summer.

"There has been a growing expectation that the framework for taxing housing could be revised," said National Assn. of Realtors tax counsel Linda Goold.

One reason for the shift: the expected demise of the alternative minimum tax. Originally designed to make sure those with high incomes didn't deduct their tax liabilities away, the alternative minimum tax is not indexed for inflation.

As a result, the number of people who will have to pay the tax is expected to increase dramatically over the next decade, eventually incorporating much of the upper middle class.

At a meeting in July, the nine members of the tax reform panel agreed unanimously to recommend eliminating the alternative minimum tax as an unfair and poorly designed parallel tax system. Because their mandate is to be revenue neutral, that required them to come up with $1.2 trillion in other receipts over the next decade.

"The money has to be found by either raising rates or changing tax expenditures," panel member Elizabeth Garrett said.

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