With Republicans reluctant to raise tax rates on any portion of the population, and Democrats insisting on revenue increases to address the deficit, the mortgage interest deduction has found itself center stage during the fiscal cliff negotiations. Will that popular deduction survive those negotiations?
It's too early to count the mortgage interest deduction out -- not only is it popular with individual Americans, but it does have some powerful lobbies behind it (i.e., the real estate and banking industries). However, suppose this deduction were eliminated; would that be so terrible?
Three reasons not to worry about the mortgage deduction:
- Mortgage rates would still be an extraordinary bargain. Until the past decade or so, mortgage rates of around 8 percent or more were the norm. So ask yourself this: Would you rather have an 8 percent mortgage rate with a deduction on the interest or a 3.5 percent rate with no deduction? Remember, the U.S. government, in the form of the Federal Reserve, has been instrumental in providing the lowest mortgage rates on record, and that should more than compensate for that same government removing the mortgage interest deduction.
- Deductions are a zero-sum game. Deductions are used to encourage certain types of behavior by taxpayers, but those incentives aren't free. Whatever break mortgage borrowers get on their taxes has to be made up by other taxpayers. Perhaps the most fair proposal that has been floated is to eliminate or limit all deductions. After all, why favor one segment of the population over another?
- Encouraging borrowing may not be the best policy at this time. Speaking of tax policy encouraging certain behaviors, it should be noted that borrowers don't seem to need any extra encouragement. Federal Reserve figures show that non-mortgage consumer debt -- which does not benefit from a tax deduction -- recently reached a new high. Continuing to encourage borrowing may prove to be dangerous.
One of the questions that is sure to give politicians some pause before they eliminate the mortgage deduction is whether the housing market could stand this potential disruption in demand. However, if housing prices are dependent on both the lowest mortgage rates ever and a tax break, it may well be that policy makers are simply propping up artificially high prices, which is never a good idea in the long run.