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A proposal that hits home

October 14, 2005

THERE ARE 74 MILLION HOMEOWNERS in the United States, and if they could find an issue they all agree on, they would be the most powerful voting bloc in the country. So President Bush's tax reform commission deserves credit for taking aim at the thing this group holds most dear: the home-mortgage tax deduction.

The presidential advisory commission has been studying tax reform for months, and on Tuesday it made a startling proposal: The cap on mortgage debt eligible for a deduction, which stands at $1 million, should be lowered.

Targeting the mortgage deduction is admirable, if politically unlikely. The deduction exists because of a deeply held conviction that owning a home is the ultimate expression of the American dream and that it makes people better citizens. But there are aspects of the tax code that do nothing to spur homeownership and may actually discourage it.

Buyers can deduct the interest paid on mortgages for second homes, for example, which simply encourages real estate speculation, drives up prices and shuts out other buyers by restricting the supply of housing. They can also deduct the interest paid on home equity loans, which aren't always used for home improvements; if a person finances a car with an equity loan, how does that encourage homeownership? And one can argue that home prices currently reflect the mortgage interest deduction, so without it, home prices would fall -- and the lower prices would make up for the loss of the deduction.

Unfortunately, the commission didn't discuss phasing out the deduction on second homes or equity loans, though both are still up for debate. Its proposal to lower the ceiling is more problematic because it could disproportionately affect people in California, New York and other states with high home prices.

The nationwide median home price is estimated at $268,000; if the ceiling were lowered to, say, $350,000, it would only affect buyers of high-end homes in most of the country. But in California, the median price is $569,000, so even middle-class buyers would be hit. If the final proposal does call for a lower cap, it should vary based on local housing prices.

The tax reform commission is looking to trim deductions because its recommendations can't result in lower tax receipts, and it has to make up for the fact that it sensibly wants to do away with the alternative minimum tax. This was imposed in 1969 to prevent very wealthy individuals from sheltering all of their income from taxes. But its provisions aren't adjusted for inflation, so over the years it has come to affect more and more middle-income people.

Any effort to reduce the home-mortgage deduction may be doomed politically. But given the growing public concern over the widening budget deficit, there may never be a better time to try.

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