Why a tax break for mortgage interest?
The deduction was presumably created by the government to encourage home ownership. Home ownership, the theory goes, lowers crime and makes for nicer neighborhoods because homeowners have been shown to be more invested in their communities than renters. Incentivizing home ownership via a tax break is supposed to help.
However, the data suggests that mortgage deductions don't make home ownership cheaper - cheaper financing just allows home prices to increase, and instead of all homeowners getting the extra money, only home sellers get it instead. In a 2007 report, the Urban-Brookings Tax Policy Center claimed that the deduction just drives up land and housing prices. It recommended limiting a tax credit and subsidized savings program to first-time homebuyers instead. Furthermore, it's been shown that American home ownership rates have hardly changed over decades, even though changes in taxation caused the value of the deduction to vary widely.
How about a tax credit?
The mortgage interest deduction benefits wealthier folks the most - people who would probably buy homes anyway. Those with the lowest incomes don't generally itemize, so they get no benefit at all from a tax deduction. Deductions have been shown to be ten times more valuable to those making $250,000 a year than they are for those earning $50,000. But a credit works more even-handedly: a 20-percent credit on $5,000 of interest is $1,000 regardless of your tax bracket or whether you itemize.
It could happen....
The administration's latest budget proposal includes a reduced mortgage interest deduction. For high-income filers ($250k for married couples and $200k for individuals), mortgage interest as well as charitable contributions, real-estate taxes and other expenses would be deductible at 28 cents for each dollar spent instead of the 35 cents it is today. Could this be a first step in unwinding a long-standing policy?
However, the deduction still appears to be an untouchable far as Congress is concerned. Those who benefit most from such a deduction (upper middle class voters who generally own homes, itemize their deductions, and pay lots of mortgage interest), have considerable political pull. They're joined by the influential real estate lobby, including mortgage brokers and home builders. And right now, everyone is afraid of hurting housing any more than it has been. The National Association of Realtors has vowed to give anyone who wants to touch the mortgage deduction the fight of their lives - and few seem to have the stomach for such a duel.