More Pressure on Mortgage Interest Deduction?

Strapped Governments
Look for "Honey Pots"

"Because that's where the money is."

--bank robber Willie Sutton, explaining why he targeted banks

For the same reason Willie Sutton robbed banks, financially strapped governments (federal and state) inevitably are going to revisit the home mortgage interest deduction as they seek to close record deficits. (Also getting scrutiny: deductions for state property taxes.)

According to some estimates, doing away with the mortgage interest deduction completely could raise as much as $100 billion in additional revenue annually (read, taxes).

As policymakers try to restrain themselves, though, they should ask: what will that do to housing prices?

Given that the cumulative value of all U.S. housing is something like $16.5 trillion, according to Freddie Mac, even a 1% drop would destroy $165 billion in value, swamping the "benefit" of increased tax revenues.

Even that arguably understates the damage, due to a phenomenon called the "wealth effect" -- basically, economic-speak for people consuming more (or less) as their wealth fluctuates.

So, the ultimate economic hit would likely be a multiple of the $165 billion drop in home prices.

In view of the foregoing, what's far more likely is some combination of a cap on deductions, means testing, and the like.

P.S.: our legal system has a principle, called stare decisis, that requires judges to defer to -- rather than disturb -- established precedent. Literally tens of millions of Americans going back decades have bought homes with the expectation that the mortgage interest deduction would be respected.

If that isn't long-established precedent -- I don't know what is!

Residential Housing: How Good a Long-Term Investment?

Pop Quiz

Want to test your knowledge of the housing market?

Just answer the following question:

How good a long-term investment is residential housing?

A. Terrific.
B. Mediocre, at best.
C. Both A. and B.

Correct answer: C.

Huh?

"Mediocre" Camp

Like the three blind men (maybe they were economists?) and the elephant, it depends what you focus on.

The "mediocre return" camp focuses on housing's appreciation rate relative to inflation.

Depending on your time frame and geographic focus, most studies conclude that housing's long-term rate of appreciation just barely outpaces inflation.

"Terrific" Camp

The "stellar return" camp instead focuses on such things as imputed rent, leverage (now a dirty word), and housing's favorable tax treatment.

Imputed Rent. Although it sounds complicated, "imputed rent" is really nothing more than the housing benefit you derive from owning your own home. In fact, it's arguably more than just what you would have paid to rent your home; it also includes the psychic and emotional benefits that come with home ownership.

If you omit imputed rent from housing's long-term return, its performance is unimpressive; if you assign even a modest number -- say, 6% annually (tax-free, by the way) -- housing's suddenly a standout performer.

Leverage. The way Wall Street uses leverage, the term truly is an obscene word.

However, used conservatively by homeowners to acquire a long-term asset, leverage is a financial wonder.

Assume Bob and Sue Smith bought a home 20 years ago for $150,000, putting down 20%.

Next assume that their home appreciated an average of 3.7% annually over that period -- respectable, but certainly not amazing.

Today, their home would be worth $300,000, or double what they paid.

But what did the Smiths really pay?

If you base their return on the $30,000 they initially put down, suddenly their investment has appreciated 10x, at least on a nominal basis (that is, before accounting for inflation).

Preferential Tax Treatment.

When it comes time to sell, the Smiths' gain looks even better, because couples don't pay capital gains unless their home has appreciated more than $500,000 (the corresponding number for singles is $250,000).

So, the Smiths' gain is $300,000 less $150,000, minus another 7% for selling costs (of course, they used a reputable, full-service Realtor!).

That comes to about $130,000, tax-free.

If you want to carry the analysis further, you'd also want to take account of (deductible) real estate taxes; repairs and maintenance; what you would have made investing the money you instead put into your mortgage and related housing costs; and the value of the tax deductions associated with paying mortgage interest.

All those factors can "push the dial" a bit, in either direction.

However, it's probably safe to say that for the majority of long-term homeowners, how they did financially is secondary to the gratification they got from living in their own home all those years.

Tax Trial Balloons

Gov't. Financial Squeeze = Homeowner Squeeze?

The mortgage-interest deduction has been a political no-go zone for decades. The same for local property-tax write-offs. But with billowing deficits and the need to raise trillions to help pay for health-care reform and the economic stimulus bills, somewhere, somehow, Congress is going to be pressed to raise revenue.

--Kenneth Harney, "Going Where Congress Hasn't Gone"; The Washington Post (8/29/09)

Kenneth Harney's column today makes the (valid) point that just because Congress is in recess, doesn't mean that policy shifts aren't afoot.

In fact, Congressional staff are right now busily proposing all sorts of revenue-raising ideas to close gaping budget deficits as far as the eye can see.

"That's Where the Money is"

At the top of the list: various proposals to limit the size of mortgages that qualify for interest deductions; eliminating the itemized deduction for state property taxes; and raising capital gains taxes.

To "lessen" the impact of the foregoing, Congress would employ incremental phase-in's (for higher taxes) and phase-out's (for deductions).

Locally, the City of Minneapolis is floating the idea of annual, 10%-15% property tax increases practically off into the sunset.

Why are homeowners such fat targets?

To paraphrase what Willie Sutton said when asked why he robbed banks: 'because that's where the deductions are.'