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Tax deduction for mortgage interest could be on the chopping block

It's been around since 1913, but its time may be up. Such a change would generate billions of dollars in federal revenue that could be used to cut the deficit while inflicting little pain on most middle-class homeowners.

December 20, 2010|By Don Lee, Los Angeles Times

"As long as it's something fair across the board, I wouldn't mind it at all," Hyden said.

Much the same would be true in the vast majority of the country. Even in big coastal states, many people don't live in high-priced housing markets. For example, about a third of Californians live in counties where home prices average $200,000 or less — and many others, especially older homeowners, have relatively small mortgages.

The average nationwide mortgage loan as of October was $215,000, according to the Federal Housing Financing Agency.

On the other hand, younger homeowners in wealthier areas are likely to feel the biggest pinch. Take Hyun K. Chung of Orange County.

The 37-year-old occupational therapist has a mortgage of about $500,000 on her house, which she bought at the peak of the market in 2006. Her loan carried an interest rate of 6.4% last year, putting her interest payments at about $32,000.

Chung doesn't remember how much her mortgage deductions saved her in taxes, but based on rough estimates, it was probably about $6,600, said James Nunns of the nonpartisan Tax Policy Center.

The deficit commission's plan would slice that to about $3,800, though Nunns said the difference could be significantly offset by lower tax rates and other changes under the commission's proposal. The possible tax changes are still too imprecise to calculate exactly how they would affect people.

Replacing the mortgage deduction with a tax credit "would reduce the tax subsidy by a decent amount for a small fraction of the population and increase it by a small amount for a large number of lower-income households," said Todd Sinai, a real estate and taxation specialist at the University of Pennsylvania's Wharton School.

He predicted that the upper-end housing market could see a decline of a few percentage points relative to what would happen without a change in the tax code. That means home prices wouldn't necessarily drop as a result, but if values in those markets increased 10%, they would grow a few points less.

Even that may be too much for the banged-up housing market to absorb, homeowners and industry executives fear. With prices still depressed and more than one-fifth of homeowners owing more than the value of their properties, reducing or eliminating the mortgage deduction would be disastrous, they said.

Nietmann, the southern Maryland homeowner, worries about what the change would mean for the next generation. She said the mortgage on her home was mostly paid off, so the loss of the deduction would have little bearing on her and her husband. Still, she wants to keep the status quo. "For my children," she said.

Many experts don't think an elimination of the mortgage deduction will hurt homeownership, though they say it is likely to influence the size of homes people buy — and eventually what builders put up — as well as other personal financial decisions. More people may pay down their mortgages or invest in bonds or stocks if they see less tax benefits to keeping a big home loan.

Analysts point out that other countries, such as Canada and Australia, have high homeownership rates similar to the U.S., currently at 67%, without such housing tax subsidies.

Even so, it won't be easy for policymakers to discard the mortgage interest deduction. It's been around since 1913, having survived Washington's last big tax overhaul in 1986 and subsequent efforts that would have eliminated the provision.

Even without the current intense partisan divide, the issue pits lawmakers in high-end housing districts against those representing less expensive areas. Americans have never been comfortable with governmental redistribution of income, yet many are growing increasingly uneasy about the widening gap between the rich and poor.

Alice Rivlin, a former top budget official in the Clinton administration and a member of Obama's deficit commission, said any big change in the mortgage deduction wouldn't happen by itself. It'll be part of a broader makeover of a tax system that she and leaders in both parties agree is too complicated and riddled with special deductions and exclusions.

"It's got to be a wholesale reform," she said. Though reluctant to assess its chances, Rivlin said the time might finally be coming because of the magnitude and urgency of the nation's budget deficits. "It's certainly possible," she said.

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