Reporting from Washington — Fifteen years ago, Carol Nietmann and her husband bought a spacious house in Maryland near Chesapeake Bay. And thanks to the time-honored tax deduction for mortgage interest, she said, their new place was a little bigger and a little nicer than they would otherwise have thought they could afford.
Much the same has been true for millions of Americans up and down the income scale. Perhaps the most sacred of all the sacred cows in the tax code, the home mortgage deduction has long been seen as crucial to a major element of the American dream — owning your own home.
It has also been a boon to home builders, construction workers, the financial services industry and local governments that benefited from fatter real estate tax revenue.
But nearly a century after coming into existence, the mortgage deduction may face a day of reckoning. Although out of the spotlight while the lame-duck Congress thrashes to an end, the mortgage deduction issue is likely to resurface next year when the new Congress — including a lot more deficit-hawk Republicans — takes over.
In part, the hoary deduction has a target on its back as a result of policymakers rethinking the whole issue of homeownership. In the wake of the havoc that followed the latest housing bust — a calamity that still shadows the U.S. economy and will for years to come — it's no longer so clear that near-universal homeownership should be a paramount goal.
Scholars have long argued that the mortgage deduction and other tax subsidies supporting housing, including a deduction for property taxes and tax exemptions for profits on home sales, are neither equitable nor economically efficient. Some say they've helped skew the economy's reliance on an industry that has little export potential and often encourages over-consumption.
"It's fair to ask whether [government money] is best spent on housing or plants and equipment or other investments," said Richard K. Green, director of the USC Lusk Center for Real Estate.
More important, despite the deduction's grip on the public and politicians, changing it as part of a package of other revisions offers Washington a chance to do something meaningful about the surging federal deficit: generate billions of dollars more in federal revenue that could be used to cut the deficit while inflicting surprisingly little pain on most middle-class homeowners.
The National Assn. of Realtors already is running ads warning that tampering with the deduction would hurt "hard-working American families." The ads point out that 65% of the taxpayers who took the deduction made less than $100,000.
What the group doesn't say is that about 75% of the entire $85.5 billion that people saved in taxes from the mortgage interest deduction in 2008 went to individuals or couples making $100,000 or more, according to an analysis by the congressional Joint Committee on Taxation of the latest data available.
Based on the committee's numbers, taxpayers who took the mortgage deduction saved, on average, $2,330 in 2008. But for those reporting incomes of $200,000 and more, the average savings were nearly triple that amount.
About half of all homeowners in the U.S. — and just a quarter of all taxpayers — benefit from the mortgage interest deduction at all. That's because most people don't have home loans or don't pay enough in mortgage interest to take advantage of the benefit.
Also left out are many homeowners in cheaper housing markets, though people with pricier homes and larger mortgages — many of them affluent younger Americans in coastal cities in California and on the East Coast — reap a disproportionately large share of the tax savings.
Not surprisingly, this geographical and financial divide can be seen when homeowners are asked how they would feel if the mortgage deduction were scaled back — or replaced by a tax credit, as President Obama's deficit commission has recently proposed as part of a broad overhaul of the tax code.
"I don't have a problem with it," said Sterling Hyden, 51, an insurance agent in Corsicana, Texas.
Home prices in his town, about 50 miles south of Dallas, average less than $100,000, he said. With a mortgage of a little more than $60,000 on their ranch-style house, Hyden and his wife don't pay nearly enough mortgage interest to benefit from the tax deduction.
Last year, couples filing joint federal returns needed mortgage interest and other deductions exceeding $11,400 to make it worthwhile to file itemized tax returns and take advantage of this tax preference.
The deficit commission's plan would do away with itemized deductions altogether and allow every homeowner to get a tax credit equal to 12% of interest paid on mortgages up to $500,000.
So for someone like Hyden, who is paying about $3,300 in interest this year on his mortgage, he would stand to get a tax credit of nearly $400, as opposed to nothing under the current system.