How to Reform the Mortgage Interest Deduction

No matter how motivated some politicians might be to cut the deficit, some programs and tax credits are simply untouchable. For example, Social Security can never be eliminated. Also in this category is the mortgage interest deduction. Despite all of its problems and its incredible expense to the government, homeowners and banks will never allow its elimination. Still, the deficit commission has it on the table, according to Damian Paletta of the Wall Street Journal. But since it will never be killed altogether, it could be reformed instead.

One method for creating reasonable reform is to question the very foundation of a rule or program. Although the mortgage interest deduction was not created to encourage homeownership, that end has become its aim over the past several decades. But some individuals don't need any extra assistance from the government to buy a home. So it should be targeted at middle- and lower-class Americans. This would lower its cost to the government, but still accomplish its goal.

Lower the Maximum Balance

Right now, the mortgage interest deduction can be claimed by anyone whose mortgage balance is less than $ 1 million. Does someone who can afford a mortgage of $900,000 really need help from the government? Probably not. And there's an awful lot of interest that can be deducted with a mortgage of that size. So one way cut the cost of the mortgage interest deduction would be to limit the size of the balance on which it can be claimed.

One reasonable limit might be a $500,000 threshold. Most middle class Americans aren't buying homes that will result in a mortgage balance of much more than that. The precise balance that should qualify can be debated, but it's pretty obvious that $1 million is far too high.

Create a Maximum Income Threshold

While lowering the maximum balance that qualifies for the credit would help, it wouldn't be a perfect solution. What if Bill Gates had a home worth many millions of dollars, but his mortgage balance had declined to $500,000? He could then deduct his mortgage interest, even under the revised limit above.

Clearly, someone who is making millions of dollars per year doesn't need the government's help to pay for a mortgage. Consequently, an income limit to claim the deduction would be a good idea. Defining that limit is also something that could be debated, but the $250,000 per year threshold might be a popular option. High earners can afford to pay for their mortgage interest in full, so why is their homeownership being subsidized?

When it comes to budget busting, there will be few tax credits or programs that can be completely eliminated. But reform is possible through compromises like this. It won't have as much impact as getting rid of entire expenditures, but it's a start.

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Daniel Indiviglio was an associate editor at The Atlantic from 2009 through 2011. He is now the Washington, D.C.-based columnist for Reuters Breakingviews. He is also a 2011 Robert Novak Journalism Fellow through the Phillips Foundation. More

Indiviglio has also written for Forbes. Prior to becoming a journalist, he spent several years working as an investment banker and a consultant.

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