Looking for spending cuts? Don't forget home mortgage deduction

January 25, 2011|By John O. Fox

As Congress considers "spending cuts" to address our massive annual deficits, lawmakers should acknowledge what their own nonpartisan Joint Committee on Taxation has revealed for decades: Most nondefense discretionary spending occurs through tax breaks, thanks to our federal income tax laws.

Recently termed "earmarks" by President Barack Obama's bipartisan National Commission on Fiscal Responsibility and Reform, more than 100 tax breaks save households about $1 trillion annually in federal income taxes. They ought to be part of any debate over spending cuts, particularly because the vast majority help people most who least need help, and help people least who need it most.

I'm not talking about business expenses, such as an employer's deduction for paying an employee's family health insurance premiums, or for property taxes on a building used in a business. But an employee's right to exclude those insurance premiums from taxation is a tax break, as is the deduction for property taxes on a family's home and ski condo.

The Joint Committee on Taxation describes these tax breaks as "analogous to direct outlay programs." To understand why, consider the most sacred of all, the deduction for home mortgage interest on up to $1 million of loans for one or two homes used personally. A third rail of American politics, the deduction will save homeowners this year about $120 billion in federal income taxes. But, despite rumors, it is not protected by the U.S. Constitution.

To the contrary, the 16th Amendment empowers Congress to tax all income without limitation. Thus, Congress has discretion whether to grant relief for expenditures such as for personal health insurance, property taxes on our homes, and home mortgage interest.

Consider this hypothetical example to help illustrate how tax breaks are indirect forms of government spending: For 2011, Congress eliminates the home mortgage interest deduction but authorizes the Department of Housing and Urban Development (HUD) to make tax-free grants totaling $120 billion to homeowners in proportion to the tax savings they would have enjoyed from the deduction. Either way, homeowners have $120 billion, and the U.S. government is out $120 billion, which means that the home mortgage interest deduction deserves the same scrutiny as any direct HUD expenditure.

So what justifies the deduction today, and what are its actual effects?

Most Americans would say that the deduction promotes homeownership — the American dream — and stable households and encourages their investment in the life of their communities.

But who receives that $120 billion? We can find answers in Joint Committee reports that list the distribution of the tax savings according to household income. (The latest figures, for 2008, should be roughly comparable to those for 2011.) Imagine, then, that the $120 billion were distributed by HUD through homeowner grants equivalent to what homeowners would have saved from the deduction, and that Congress arranged for broad media coverage to announce the lucky grant recipients.

Here's what they might say: "We've decided to give 99 percent of the $120 billion to the top half of all households, and the remaining 1 percent to the bottom half. What's more, we believe one-third of this housing fund — $34 billion — should go to the top 3 percent of all households."

Wait a minute … is this Comedy Central? Aren't upper-income households best able to afford a home without any government subsidy?

Yes, they are. Yet the home mortgage interest deduction primarily helps people own a larger, more expensive home or two than they would own otherwise. And guess what? England, Canada and Australia have about the same homeownership rate as we do without any home mortgage interest deduction or comparable subsidy.

Moreover, HUD's entire budget to subsidize rents for low- and moderate-income households will be approximately equal to the tax savings for the top 3 percent of income earners from the home mortgage interest deduction. Were Congress to adopt an across-the-board cut for all discretionary outlays, surely the deduction should not be exempt while rent subsidies for our most vulnerable households are slashed.

Indeed, it is time at last for Congress to debate publicly which tax breaks, as well as which direct outlays, are fair and necessary as we enter an era when our nation can afford only those that satisfy the most rigorous standards.

John O. Fox, a visiting professor and tax-policy scholar at Mount Holyoke College and a former tax lawyer, is the author of "If Americans Really Understood the Income Tax." His e-mail is jofox@mtholyoke.edu.

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