The Real Deal New York

Ken Harney – Taking aim at the top tax bracket

Budget proposes new limits on mortgage interest

March 31, 2009
By Ken Harney

Call it the third rail of the federal tax system: the politically untouchable cluster of special benefits and subsidies set aside exclusively for homeowners, including deductions for mortgage interest, local property taxes and capital gains exclusions on up to $500,000 in sale profits.

Is the Obama administration serious about beginning to clamp limits on at least some of these subsidies? The administration isn’t commenting on anything beyond what was proposed in its first budget, submitted at the end of February, but housing and banking trade groups are worried that the initial proposal to cut back on the ability of upper-income families to write off mortgage interest and other expenses is just the opening move in a longer-range effort to reform the federal tax code.

They also argue that since tax subsidies are now embedded in home prices in most segments of the market — not just the upper end — removing them even partially would cause housing values to drop across the spectrum.

What should homeowners make of all this? Is there a real possibility that Congress would take away tax breaks that millions of people have come to consider an essential part of the home-buying equation? Here’s a quick overview of the issue:

What did the Obama budget propose specifically on mortgage interest and property tax deductions?

Starting in 2011, homeowning households with adjusted gross incomes of $250,000 and above could only take write-offs at a 28 percent marginal tax bracket rate. To illustrate, say you’re in the 35 percent bracket and have $20,000 of mortgage interest, property tax and charitable deductions, all of which are targeted in the Obama proposal. This year you’d be able to write off 35 percent of the $20,000, or $7,000. If you were capped at a 28 percent rate, you could only write off $5,600. Your tax bill would go up by $1,400.

Why cut these deductions? Very simply, to raise tax revenues so the government can spend the money elsewhere, such as for health care. Mortgage interest and property tax write-offs cost the Treasury massive amounts annually. In a report last October, the bipartisan congressional Joint Committee on Taxation estimated that in 2009, the mortgage interest deduction alone would cost the government $89.4 billion in uncollected taxes. Between 2008 and 2012, according to the committee, the interest write-off in its current form will cost the Treasury $443.6 billion. Property tax deductions will cost another $112 billion over the same period.

What impact might these — and possibly further-reaching future changes — have on the housing market? Homebuilding, realty brokerage and banking industry leaders passionately oppose the deduction cutbacks because they believe they could lower property values and are ill-timed in terms of the vulnerable state of the market. John Courson, president of the Mortgage Bankers Association, said even two years in advance of the actual starting date of the Obama plan, buyers will start “pricing in” the lower tax benefits — discounting what they are willing to pay for a house given lower future deductions.

Lawrence Yun, chief economist for the National Association of Realtors, said the devaluation ripple effect would extend to the lower- and middle-income segments as well.

Joe Robson, chairman of the National Association of Home Builders, said, “financing health care reforms by chipping away at the mortgage interest and real estate tax deductions … will only hurt the ailing housing market and U.S. economy.” No trade group has offered specific projections of price or sales reductions attributable to the cutbacks, however.

Is there a longer-range plan here? Obama himself has not referred to a broader agenda, but some of his top economic advisers have advocated major reforms of the federal tax system. For example, his budget director, Peter Orszag, is on record favoring scrapping current tax deduction incentives and replacing them with a system of “refundable tax credits.” The credits would provide the identical dollar amounts to homeowners at all income and price brackets. The advantage of a uniform tax credit approach, Orszag argued in a 2006 paper for the Brookings Institution, is that it is usable by lower-income and higher-income taxpayers alike, whether they itemize or not. The credits would be “refundable” in that households that pay little or no income taxes could receive them as income supplements.

Could Congress agree with this year’s budget proposals on tax write-offs? Given how deeply rooted the write-offs are in politics and the economy — plus the fragile state of housing — the odds would appear to be against it. But Obama is at the height of his game, and needs to come up with revenue to pay for health care reform from somewhere. So don’t count him out.

Ken Harney is a real estate columnist with the Washington Post.

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