Trim the mortgage-interest deduction

The deduction for mortgage interest is the "third rail" of tax reform. President Reagan tried to get rid of it in 1986, but real estate interests stopped him. Now, President Bush's tax advisory commission suggests limiting its use. Good idea, I say, and good luck.

The mortgage-interest deduction is bad economic policy. It encourages consumption, rather than saving. People take out big mortgages to free up spending money. (They convince themselves not to worry about all the borrowing because the interest on the loan can be tax-deductible.) An unhealthy economic incentive, the deduction is also expensive. It cost the Treasury $63 billion last year in needed revenues. The entire budget of the US Department of Housing and Urban Development was $35 billion.

The deduction is bad social policy. It discriminates against renters, and even homeowners of moderate means.

"The people who have the biggest homes, who make the most money are the greatest beneficiaries of this tax subsidy," says Nicolas Retsinas, director of the Joint Center for Housing Studies at Harvard University. "If you rent, you don't get the deduction. Even if you own a home and have a modest income, you're likely to take a standard deduction, which means you don't get it."

The mortgage-interest deduction is a boulder in the stream of tax reform. A lot of people say they want a "flat tax" - a single rate for all incomes, with no deductions, exemptions or loopholes allowed. A flat tax could cure the annual migraine of filling out IRS forms. But there can be no honest flat tax that makes an exception for a break that benefits the well-to-do.

In recommending tax reform, Bush's advisory panel has to offset any cuts with new revenues. It rightly wants to kill the alternative minimum tax, and suggests limiting the mortgage-interest deduction as a way to replace some of the lost revenue. (The alternative minimum tax was designed 35 years ago to ensure that the rich pay their share. Not adjusted for inflation, the tax is rampaging through the middle class and has to go.)

The commission has been talking about ways to limit the mortgage-interest deduction without stepping on too many toes. Right now, Americans can deduct all the interest paid on mortgages written for up to $1 million. The panel is considering whether that cap might be reduced to the size of the biggest mortgage currently insured by the Federal Housing Administration. Nowadays, that means a mortgage of about $313,000 in expensive communities, or a national average of $244,000.

The average American mortgage weighs in at about $155,000, so this lower limit would not change the calculus for most of us peasants. However, the cap would pinch some nerves in trophy house territory. The real estate industry would not like that at all. The bigger the mortgage people can afford, the more they can pay for a house, and the more real estate brokers and developers rake in.

A more noble concern over altering the mortgage-interest deduction centers on America's wildly divergent costs of living. The median price of a home is about $220,000 in the United States, but $550,000 in San Francisco. A $400,000 mortgage, while amazing to most Americans, would not be a rarity on Nob Hill. Any proposal to limit the mortgage- interest deduction has to be very sensitive to these issues.

But should we even bother thinking about the details at this point? The odds are not wonderful that Congress will summon the courage to trim this deduction. If the past is any guide, the meekest attempt will fire up the real estate industry's propaganda mills. Soon, Americans not even remotely affected by the proposed changes will believe in their bones that they are losing some beloved tax deduction.

That's a cynical view, but unavoidable. Our government seems incapable of asking the smallest sacrifice of the biggest incomes. Here is a tax break that favors the upper brackets while hurting economic growth, and we can't get a consensus in Washington that it is a bad thing.

Reagan was right on this one. And so is Bush's tax advisory commission. Is there a brave political soul out there looking for a good policy?

Froma Harrop is an editorial writer at The Providence Journal. ©2005 The Providence Journal. Distributed by Creators Syndicate, Inc.

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