'Accidental' mortgage interest deduction

Monday, Nov. 16
Posted 2 p.m. EST

Residences are inextricably tied to the U.S. tax code. The breaks are many and in recent sessions of Congress have been expanded.

The granddaddy of home-related tax breaks is the mortgage interest deduction, but when it was first created, no one had any idea that it would go from "accident to birthright."

Dennis J. Ventry Jr., acting professor of law at the University of California, Davis, School of Law examines this popular tax break in his paper "The Accidental Deduction: A History and Critique of the Tax Subsidy for Mortgage Interest."

Accidental?

Technically, writes Ventry, the mortgage interest deduction has been part of the U.S. tax law from the very beginning. But the Revenue Act of 1913 contained no specific mention of a deduction for interest paid on owner-occupied residences. Instead, it provided a general offset for "all interest paid within the year by a taxable person on indebtedness."

There's no clear record of why Congress allowed a deduction for personal interest almost a century ago, says Ventry. But he says one thing is clear: Congress did not see it as a way of promoting homeownership.

Even more amazing, especially in light of today's tax policy carrots and sticks, is Ventry's observation that in the early days of the modern tax code, "Congress had yet to embrace taxation as a vehicle for rewarding or encouraging certain kinds of behavior."

Birth and continuing growth: Ventry's paper follows the mortgage interest deduction through the Great Depression, the post-World War II housing boom and periodic attacks on the deduction until it received an official presidential imprimatur in the mid-1980s.

It was during debate leading up to the Tax Reform Act of 1986 that President Ronald Reagan effectively "immunized" the mortgage interest deduction.

The 1986 tax changes were monumental tax, but they actually fell short of what was originally envisioned. In his 1980 inaugural address, Reagan indicated that when it came to tax reform, everything was on the table.

But with elections looming in 1984, writes Ventry, the president cleared some items off the tax reform table. He instructed the Treasury Department to "preserve that part of the American dream which the home mortgage interest deduction symbolizes."

Reagan's orders were followed. Then in 1987, notes Ventry, Congress enacted the tax allowance for home equity loans, "turning houses into $100,000 credit cards."

Things haven't slowed down. The incentive to view one's home purely as a tax-subsidized, variously collateralized capital investment has increased over the last two decades, writes Ventry, as politicians and presidents sought to increase rates of homeownership among Americans.

Good for buyers, bad for the economy?

In addition to the mortgage interest deduction that some say has encouraged ill-advised property purchases, we have the capital gains exclusion -- the $250,000 profit (or $500,000 if you file a joint return) you don't have to pay taxes on when you sell your residence -- that's been called an economy killer.

"Housing tax policies fueled the boom and exacerbated the bust," says Ventry. "The mortgage interest deduction played a particularly insidious role in the crisis by explicitly promoting overinvestment in housing."

So have we, and by we I include denizens of Capitol Hill, learned anything? Apparently not.

In recent years, many residential tax breaks have been created or expanded, from deductions for private mortgage insurance to property taxes as a standard deduction add-on to the broadening of the first-time homebuyer credit.

Sure, some stabs have been taken at stemming the tax code's growth. But housing issues posed problems there, too.

George W. Bush created a blue ribbon panel to examine tax reform. One of the group's key recommendations was to eliminate the mortgage interest deduction and replace it with a more widely available homeowner credit. Dubya shelved the panel's report a few weeks later.

Did the mortgage interest deduction play a part? You decide. But it's no secret that many were not happy with the panel's assessment that "the tax preferences that favor housing exceed what is necessary to encourage home ownership or help more Americans buy their first home."

Now Barack Obama has his own economic panel looking, in part, at ways to make our tax system simpler.

Lot's of luck there, Mr. President. When your panel hands you its recommendations, if it seeks to trim housing related breaks remember that on Nov. 6 you signed the bill that expanded the first-time homebuyer credit.