If mortgage interest deductions were cut, who would notice?

The deduction for interest on home mortgages may be the most beloved of all tax subsidies. A politician needs only to muse about repealing or restructuring the deduction to be set upon by suburban mobs (led, perhaps, by real estate agents and mortgage lenders).

But a new analysis by my Tax Policy Center colleagues Ridathi Chakravarti and Dan Baneman finds that most taxpayers would barely notice the change in their tax bill even if Congress dramatically restructured the subsidy. And with some changes, many of us would end up paying lower taxes than we do today.

In the unlikely event Congress simply repeals the mortgage deduction, the average tax bill would increase by $710. But those who earn between $30,000 and $40,000 would pay an average of about $70 more while those making more than $1 million would pay an additional $4,000.

But the deduction isn’t going to be repealed. And if it was, some of the added revenue would surely be used to buy down income tax rates. More likely, Congress will scale back the deduction or replace it with a new design such as a tax credit. With some of these alternatives, typical middle-income households would likely pay less tax, not more. And many will see no change at all.

What’s going on? Mostly, the mortgage deduction is the classic upside-down tax subsidy. It gives the biggest tax breaks to the highest earners who borrow the most money to buy the most expensive houses. Because it is a deduction, someone in the 35 percent tax bracket pays an after-tax cost of only $65 for every $100 they borrow (even less if you figure state taxes). But someone in the 10 percent bracket pays $90—if they itemize. However, because the deduction is only available to those who do itemize and a surprising number of moderate-income homeowners don’t, many taxpayers get no subsidy at all.

Let’s look at a couple of reform options. Say Congress caps the mortgage deduction at $500,000 and allows it only for primary residences (today, you can deduct mortgages up to $1 million and use the write-off for second homes). Since very few middle-income people have $1 million mortgages, you won’t be surprised to learn that almost no households making $100,000 or less would pay higher taxes. Even among those making $100,000 to $200,000, only about 12 percent would pay more. A typical household in this income class would pay about $185 more.

By contrast, about one–quarter of those making $200,000 to $500,000 and 28 percent of those making $500,000 to $1 million would pay higher taxes. If you are pulling in $500,000 to $1 million, (fewer than 1 percent of all taxpayers do) you’d typically pay about $1,900 more in taxes.

What if Congress decided to not only limit the subsidy to $500,000 loans but also turned the deduction into a 20 percent non-refundable credit? Since the credit benefits moderate-income households and most of them would be unaffected by the cap, the vast majority of taxpayers would be paying roughly the same tax bill as they pay today.

For instance, those making $50,000 to $75,000 would pay on average $80 less. Only those making more than $100,000 would pay significantly more. Households in the $100,000 to $200,000 range would pay about $650 more on average, although interestingly only half would face any tax hike at all. Those making more than $1 million would pay an extra $2,800 on average. Of course, some would pay much more.

All of these estimates assume current law where the Bush-era tax cuts expire at the end of next year. But the pattern is the same if you assume the tax cuts are extended. Indeed, typical middle-class households would do even better under the cap and credit if the 2001 and 2003 tax cuts are extended.

Higher taxes, of course, are only one result of these changes. Homeowners would likely see at least a short-term adjustment in the value of their homes as well. But it is hard to know how much and for how long. And research by TPC’s Ben Harris suggests it would depend a lot on where you lived. Of course, a cap and credit would probably result in somewhat higher prices for moderate-priced homes but lower prices for mini-mansions. The price of real mansions might not change much at all since the increase in taxes would be trivial for many uber-rich buyers.

So before you grab a pitchfork at the mere mention of a change in the mortgage deduction, take a look at TPC’s analysis. You may be surprised.

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