WASHINGTON — Fifteen years ago, Carol Nietmann and her husband bought a spacious house in Calvert County near the Chesapeake Bay. And thanks to the time-honored tax deduction for mortgage interest, she says, their new place was a little bigger and a little nicer than they otherwise would have been able to afford.
Perhaps the most sacred of all the sacred cows in the tax code, the home mortgage deduction has long been seen as critical to a major element in the American dream — owning your own home. It's also a boon to home builders, construction workers, the financial services industry and local governments that benefited from fatter real estate tax revenue.
But after nearly a century, the mortgage deduction may face a day of reckoning. Though out of the spotlight for the moment while the lame-duck Congress thrashes to an end, the mortgage deduction issue is likely to resurface next year when new representatives — including a lot more deficit-hawk Republicans — take their seats.
In part, the hoary deduction has a target on its back as a result of policymakers' rethinking the whole issue of home ownership. After the havoc that followed the bursting of the housing bubble — a calamity that still shadows the U.S. economy and will for years — it's no longer clear that near-universal home ownership should be a paramount goal.
More important, despite the deduction's grip on the public and politicians, changing it as part of a package of other revisions offers Washington a chance to do something meaningful about the surging federal deficit — generating billions of dollars more in federal revenues that could be used to cut the deficit while inflicting surprisingly little pain on most middle-class homeowners.
However, the National Association of Realtors is already running ads warning that tampering with the deduction would hurt "hard-working American families.'' The ads point out that 65 percent of the taxpayers who took the deduction made less than $100,000.
What the group doesn't say is that about 75 percent of the entire $85.5 billion that people saved in taxes from the mortgage interest deduction in 2008 went to individuals or couples making $100,000 or more, according to an analysis by the congressional Joint Committee on Taxation of the latest data available.
Based on the committee's numbers, taxpayers who took the mortgage deduction on average saved $2,330 in 2008. But for those reporting incomes of $200,000 and over, the average savings were nearly triple that amount.
In fact, only about one-half of all homeowners in the United States — and just one-quarter of all taxpayers — benefit from the mortgage interest deduction at all. That's because most people don't have home loans or don't pay enough in mortgage interest to take advantage of the benefit.
Also left out are many homeowners in cheaper housing markets, though people with pricier homes and larger mortgages — many of them affluent younger Americans in cities on the East Coast and in California — reap a disproportionately large share of the tax savings.
Not surprisingly, this geographical and financial divide can be seen in people's reaction when asked how they would feel if the home mortgage deduction were scaled back — or replaced by a tax credit, as President Barack Obama's deficit commission recently proposed as part of a broad overhaul of the tax code.
"I don't have a problem with it," said Sterling Hyden, 51, an insurance agent in Corsica, Texas. Home prices in his town, about 50 miles from Dallas, average less than $100,000, he says. With a mortgage just over $60,000 on their ranch-style house, Hyden and his wife don't pay nearly enough mortgage interest to enjoy the tax deduction.
(Last year couples filing joint federal returns needed mortgage interest and other deductions exceeding $11,400 to make it worthwhile to file itemized tax returns and take advantage of this tax preference.)
The deficit commission's plan would do away with itemized deductions altogether and allow every homeowner to get a tax credit in the amount of 12 percent of interest paid on mortgages up to $500,000. So Hyden, who's making about $3,300 in interest payments this year, would stand to get a home mortgage tax credit of nearly $400, as opposed to nothing under the current system.
"As long as it's something fair across the board, I wouldn't mind it at all," Hyden said.
Much the same would be true in many parts of Pennsylvania, Illinois, Florida, California and other states — at least outside their priciest urban areas. According to the Federal Housing Financing Agency, the average mortgage loan as of October was $215,000.
On the other hand, many homeowners in high-end markets dread the idea. Take Hyun K. Chung of Orange County, Calif.