Fannie, Freddie, and the Mortgage Interest Deduction

By :: February 10th, 2011

Tomorrow, the White House will release its ideas for overhauling mortgage giants Fannie Mae and Freddie Mac.  While there is little agreement in Washington over just what to do, there is broad bipartisan support for big changes. In large part that’s because when the implicit government guaranty behind Fan and Fred turned explicit in the wake of the 2008 housing collapse, taxpayers were socked with a bill of $130 billion.

Pols are shocked that we’d add $130 billion to the nation’s burgeoning debt to subsidize owner-occupied housing this way. Except we spend far more than that each year buying down the cost of home ownership through the tax code. The one-time $130 billion cost to taxpayers of the failure of Fan and Fred is a fraction of the $210 billion annual cost of the mortgage interest deduction, the deduction for state and local property taxes, and the exclusion of capital gains taxes on owner occupied housing. Over a decade, those tax subsidies will cost more than $2 trillion.

The single biggest housing subsidy is the mortgage deduction, which will add $130 billion to the deficit in the coming year alone. But even worse, at a time when both Democrats and Republicans claim to worry about the long-term deficit, the MID is a case of government acting as a reverse Robin Hood—the biggest  subsidies go to those who need it least.  The Tax Policy Center estimates that more than 70 percent of the benefit of the mortgage and property tax deductions go to the highest-earning 20 percent of households—those making $104,000 or more.  

This happens mostly because the tax break on home loans is structured as a deduction.  Imagine, for instance, that you and I both pay $1,000-a-month in mortgage interest. If you are in the 10 percent bracket (a married couple with adjusted gross income of $36,000 or less), your after-tax interest  cost  is $900. If my wife and I are in the 35 percent bracket (with taxable income of $379,000 or more), our after-tax cost is just $650. And that’s after federal taxes. The benefit is even more dramatic when you figure state income tax breaks.    

This upside down subsidy also encourages the purchase of more expensive houses. I understand that some communities have very high housing costs. I live in one. But the average sales price in the U.S. last year was just $270,000.

Fan and Fred can guaranty loans up to $729,750 and there seems to be general agreement to allow that cap to fall back to the pre-recession level of $625,500. Yet the mortgage deduction is available for loans up to $1 million (and can even be used for vacation homes). And hardly any politicians are talking about cutting that. 

Oh, and keep in mind that while we are spreading $200 billion-plus in tax largess among the those lucky duckies in their mini-mansions , the feds spend less than one-quarter as much for direct housing assistance (aimed mostly at low and moderate income households). And that spending will almost certainly be frozen or even cut as a part of coming broad reductions in domestic spending.

The chairs of Obama’s fiscal commission proposed addressing the upside down tax subsidy by reducing the limit on deductible mortgages to $500,000, barring the subsidy for second homes,  and turning the deduction into a 12.05 percent credit. With a credit instead of a deduction, homeowners with a $1,000 monthly interest payment would lower their tax bill by $1205, no matter what bracket they were in.    

About these ideas, Obama has said…nothing.   

In a rational world, the president and Congress would sit down and figure out how government should assist home buyers in an era of severe fiscal constraint. I’m no housing expert so just how to do that is far beyond me. But providing the biggest subsidies to the highest income buyers in the biggest homes isn’t where I’d start.

54Comments

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  2. Dave K  ::  8:37 am on February 11th, 2011:

    That’s all well and good….but one should consider the impact of a change in the deduction to the pricing of residential property. I am not an economist, but when I purchased my current home (and former home for that matter), I figured out what I could afford on a monthly basis after tax and then worked back into the loan amount. Therefore, if we going to cut the tax benefit, that would increase my after-tax monthly cost, thereby lowering the loan amount. By lowering the loan amount, it decreases what I can afford. Therefore, the amount of purchasing power I have has been reduced. When my thought process is multiplied across all homebuyers, it amounts to a decrease in purchasing power and therefore reduces the demand for housing. The decrease in demand will cause prices to fall to reflex the new after-tax paradigm. As a current homeowner, not only is my after-tax cost of current ownership going to increase, I face a potential fall in the value of my house due to purchasing power erosion.

  3. Mike M,  ::  10:01 am on February 11th, 2011:

    It would need to be based by region though. The average price for a one bedroom Apartment (a one bedroom!) in Manhattan is $1 million and while prices in some, but not all, borrough neighborhoods are lower than that, they are no half a million bucks. This plan really unfairly penalizes New Yorkers and other people who prefer to live in or near the major cities.

  4. Sid F.  ::  11:52 am on February 11th, 2011:

    I think both of these comments are very good and illustrative of the problem of going from theoretical tax reform to actual tax reform.

    Everyone is in favor of a fairer, less complicated tax system, but no one has been able to come with an actual structure that accomplishes this without substantial costs to certain sub-groups and with the necessary political support to carry it through. Major revenue neutral tax reform and a peace settlement in the mideast both have huge support, and both will come about the same time.

  5. Tom Cusack  ::  3:26 pm on February 11th, 2011:

    In total agreement that amount and allocation by income of tax expenditures for home ownership are excessive. This isn’t just a federal tax problem, it carries through to the STATE level also.

    A recent blog post on my Oregon Housing Blog shows Oregon home ownership STATE tax expenditures in next 2 years will total $2.2 billion, while Oregon rental tax expenditures are projected at $114 million. [Post is HERE: http://oregonhousing.blogspot.com/2011/02/super-sunday-post-23-billion-in-state.html

    Pruning, phasing down home ownership tax expenditures at STATE level could help balance severely stressed state budgets.

  6. Marik7  ::  5:16 pm on February 11th, 2011:

    Of course, we should remember that the mortgage interest deduction discriminates against a large minority of Americans as well–renters.

  7. Tony ML  ::  5:37 pm on February 11th, 2011:

    The Uk abolished this subsidy years ago and it didn’t kill the ownership market – this is more a matter of personal preference and sentiment. In fact, rental (properly regulated and managed) is the most economically efficient way for most low to middle income families to live and adds flexibility to the jobs market whereas home ownership has a massive drag effect on employment.

  8. Michael Bindner  ::  9:28 am on February 12th, 2011:

    On Freddie and Fannie, they should be sold to the Federal Reserve, who is forcing servicers to mark loans to market. It can then set up a Freddie and Fannie in each Fed region to make back its losses.

    The home mortgage deduction and the property tax deductions should both be done away with – not to balance the budget but to shift the subsidy to a larger child tax credit. Along with a consolidation of credits and exemptions – this credit would be $500 per month per child. Since the largest cost of adding children is additional housing (as health insurance is the same no matter how many kids you have), this shift won’t hurt the housing sector, although it may change the mix of housing offered and will also help renters. Indeed, if the rich will buy that vacation condo at the beach anyway, housing as a whole will increase. If removing the subsidy lowers the cost of beach houses, this might be a good thing, especially for weekend renters like myself.

  9. Sid F.  ::  7:02 pm on February 12th, 2011:

    A child tax credit of $500.00 per month would mean that a married couple with two children and a gross income of up to $90,000 to $100,000 would have no income tax liability.

  10. » A chink in the mortgage interest deduction armor?  ::  6:16 am on February 13th, 2011:

    […] the proposals and reaction to them in the New York Times, the paper's DealBook blog, Reuters, TaxVox, Business Insider,  GPB News, the Washington Post and […]

  11. TaxVox » Blog Archive » Fannie, Freddie, and the Mortgage Interest … | Mortgage info  ::  7:51 pm on February 13th, 2011:

    […] feedback@thetakeaway.org (Public Radio International and WNYC Radio) wrote an interesting post today. Here’s a quick excerptTomorrow, the White House will release its ideas for overhauling mortgage giants Fannie Mae and Freddie Mac. While there is little agreement in Washington over just what to do, there is broad bipartisan support for big changes. … Read the rest of this great post here Related Posts:Possible end in sight for mortgage giants Fannie and FreddieWho are Fannie Mae and Freddie Mac? : : Mortgage lendersWall Street, Not Fannie and Freddie, Led Mortgage Meltdown – The …Fannie Mae, Freddie Mac to consider new fee structure for mortgage …Fannie Mae, Freddie Mac Blame Mortgage Servicers For Foreclosure … This entry was posted on Monday, February 14th, 2011 at 12:51 am. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site. […]

  12. Michael Bindner  ::  2:20 pm on February 14th, 2011:

    It would also mean that a married couple with two kids and an income of $50,000 would get a nice raise and may add that third child.

  13. Michael Bindner  ::  2:21 pm on February 14th, 2011:

    It also depends on what other tax provisions are allowed to expire, like mortgage interest. Remember, my plan also ends individual filing.

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