If there is one part of the tax code that is almost universally excoriated by economists, it is the mortgage-interest deduction. Emerging from a 1913 provision that allowed business owners like farmers to deduct any interest they paid on business expenses, the mortgage-interest deduction now lets people who buy homes deduct part of the cost of their mortgage on their taxes. According to the Joint Committee on Taxation, it saved Americans $77 billion last year—$77 billion that would otherwise have gone to the government. Liberal groups have long targeted the deduction, arguing that it disproportionately benefits white and wealthy homeowners while leaving out people who don’t own homes, or who don’t itemize their taxes, and who thus can’t take the deduction.
So it seemed initially surprising when the tax bill released by Republicans on Thursday proposed capping the mortgage-interest deduction, which has long been off-limits in American politics. The plan would cap the portion of a mortgage on which people can deduct their interest at $500,000, down from the current level of $1 million. (Existing mortgages will be grandfathered in and those homeowners will be able to continue to receive the current deduction.) “This sounds like it would be at least a small gesture in the right direction,” Alan Mallach, a senior fellow at the nonprofit Center for Community Progress who has advocated for phasing out the mortgage-interest deduction, told me.
Yet though the idea of capping the mortgage-interest deduction excited a lot of progressives on Thursday, they were not pleased by the predictable slew of conservative tax moves it was paired with: cutting the corporate tax rate, getting rid of the estate tax, and creating a “pass-through” bracket that would lower taxes on small businesses. The issue is that a cap on the mortgage-interest deduction—a change that would add billions and billions of dollars to annual government revenues—is in this case being used to finance a tax plan whose primary benefits accrue to the wealthy. In order for the bill to pass, President Trump and congressional Republicans need to ensure that it wouldn’t add more than $1.5 trillion to the deficit in the next 10 years; capping the mortgage-interest deduction would help offset some of the government revenues that would be lost as a result of the plan’s proposed tax cuts.
Progressives, then, were torn between supporting a move long thought impossible and pushing back against the rest of the bill. “It’s certainly historic to see a Republican bill make reforms to the mortgage-interest deduction,” Diane Yentel, the president of the National Low-Income Housing Coalition, which had previously proposed such a cap, told me. “The problem is that the bill would then use those savings to pay for lowering the corporate tax rates, which for us is a nonstarter.”
Progressives don’t like the deduction because it is regressive: The richer people are, the more it helps them, because they spend more money on houses and because their marginal tax rate is higher, meaning the deduction shaves off a greater share of their tax bill. The Congressional Budget Office has found that 75 percent of the benefits of the mortgage-interest deduction go to the top 20 percent of earners. In fact, according to Todd Sinai, a real-estate professor at Wharton, the deduction doesn’t even appear to encourage homeownership, which it was ostensibly designed to do; Sinai said it predominantly benefits people who would have bought a home anyway. What’s more, lower and middle-income people who own homes often don’t use the mortgage-interest deduction because they don’t itemize their taxes, something that only half of all homeowners do.
There may be another, more selfish, reason liberals dislike the idea of capping the mortgage-interest deduction: It will most heavily affect people in blue states like New York and California, where the majority of people taking the mortgage-interest deduction live. D.C., Hawaii, and California have the highest shares of mortgages that are larger than $500,000, at 27.3 percent, 24 percent, and 16.8 percent, respectively. There are 24 states with fewer than 1 percent of homes with mortgages over $500,000, and almost all of them are majority-GOP states.
The proposed change to the mortgage-interest deduction cap, which currently stands at $1 million, would only apply to new mortgages. This may also deter current homeowners in expensive markets from moving, because they would have to trade a mortgage that they can deduct on their taxes from one that they cannot. But even some current homeowners in blue states expressed consternation about the reform. “I need this deduction. Without this deduction, our tax bracket is too high,” Drew Kanevsky, a New Jersey resident who benefits from the mortgage-interest deduction, told me. Kanevsky, 38, owns two homes, one in Delaware and one in New Jersey, but told me that his family has worked hard to get where they are today. He thinks the proposed reforms target blue states like his; Kanevsky, however, says he’s a political moderate, and that with this proposal, the Republicans are “chasing us moderates away.”
Not surprisingly, real-estate and construction industry groups were vocal in their opposition to the proposal. The National Association of Realtors “cannot support a bill that takes homeownership off the table for millions of middle-class families,” said William E. Brown, the group’s president, in a statement. The National Association of Homebuilders also released a statement opposing the proposal, saying it “abandons middle-class taxpayers.” The GOP proposal itself, attempting to satiate those critics, has been portrayed in talking points as “preserving” the mortgage-interest deduction, rather than taking steps to eliminate it.
But Sinai, of Wharton, says fears of the proposed cap are overblown. The share of households with mortgages over $500,000 is very small, at about 6 percent, and even households that have mortgages over that amount can still deduct the first $500,000 of their mortgage when calculating their taxes. “It’s about as innocuous a limitation as you can do,” Sinai told me. “It only affects a couple percent of households, and they are the households that can buy expensive houses.”
It would take a lot of changes for a proposal like this to please progressives. Most groups who had called for reform, like the National Low-Income Housing Coalition, had proposed that the savings from reforming the mortgage-interest deduction be invested back into housing for low and moderate-income people. That’s not where the savings from the cap would go in this proposal. “If this were just a plan that capped the mortgage-interest deduction, I think we’d support that,” Hunter Blair, a budget analyst with the left-leaning Economic Policy Institute, told me. “But it’s a small piece of an otherwise huge tax cut for the rich and corporations.”
Housing advocates say that they have a better solution to encourage homeownership for among a broader group of Americans, though their proposal would likely not be feasible in today’s political climate. They want to eliminate the mortgage-interest deduction entirely and replace it with a 15 percent nonrefundable tax credit for all people with a mortgage. A tax credit would allow people who don’t itemize their taxes to get a tax break for spending money on a mortgage. It would make the tax benefits of having a mortgage available to lower-income homeowners, Yentel told me. The Tax Policy Center estimates that phasing out the mortgage-interest deduction and levying a 15 percent credit would raise $191 billion in government revenue between 2017 and 2026. Support for such a proposal, however, would depend heavily on where those savings were spent—on more tax cuts for businesses, or on programs that help the middle-class and poor.