It isn't being celebrated, except perhaps by the IRS, H&R Block and Turbo-Tax, but 2013 is the centennial year of the 16th Amendment--the amendment which made an income tax constitutional. That means that 2013 is the centennial of the mortgage interest deduction. It isn't being celebrated either. Ever since December 2010, when the Simpson-Bowles Commission raised the possibility of replacing the deduction with a tax credit, or repealing it outright, it has been attacked by many across the political spectrum.
The most common criticism is that the deduction is unfair--that most of the benefit goes to people who are rich. Low-income families can't use it because they don't own a home or they don't itemize their deductions. But it's a bum rap. The criticism of the mortgage interest deduction is not accurate and not especially relevant. It really applies to the other major deductions.
The last year for which we have detailed income tax statistics is 2010. Millionaires received 10 percent of the dollar value of the mortgage interest deduction. But millionaires received over 20 percent of the value of the tax deductions for charitable contributions, and for state and local income taxes. These are the deductions that matter for them. Counting taxpayers with incomes between $250,000 and $1 million as "rich," as they were called in last year's political debates, doesn't change this picture. The mortgage interest deduction was less valuable than either of the others to this group. Altogether there were less than three million rich households; they received over 40 percent of the total deductions for state and local taxes, and over 35 percent of the deductions for charity.
Some 13 million taxpayers in the lower half of the income distribution - with incomes less than $50,000--received between 15 percent and 20 percent of all deductions for mortgage interest. That's more than their share of the deductions for charity (12 percent) and for state and local income taxes (less than 5 percent). In addition, there were 8 million lower-income families who didn't pay any federal income tax in 2010 because their mortgage interest deduction was more than their tax liability. In a weak economy, the deduction was probably a big help to many of them.
What about the objection that so few income taxpayers can claim the deduction? There were 112 million households in 2010. Some 46 million claimed the mortgage interest deduction. That's about 41 percent of all households. So more than half of homeowners did not claim the deduction. Is that a reason to repeal it?
If it is, it's a better reason for eliminating the deduction for state and local income taxes. In California that year, there were 14.4 million state income taxpayers. Only 4.7 million were able to claim a federal tax deduction for their state taxes--less than a third--and California has one of the nation's highest state tax burdens.
Other states are similar. In Illinois, with a moderate tax burden, less than one-third of taxpayers itemize their state income tax. In Arizona, with one of the lowest burdens, it's about one-quarter. Because so few taxpayers in these states are able to itemize their state income tax payments on their federal return, should we eliminate the state and local income tax deduction because it's "unfair" to the two-thirds or three quarters of state taxpayers who cannot claim it?
There are good reasons why fewer than half of all households claim the mortgage interest deduction. Many are young and haven't saved enough to buy a home. Many are elderly and have paid off their mortgage. When they were younger, they benefited from the deduction. Fewer than half of us can claim the mortgage interest deduction now; but for some part of our lives, more than half of us did or will claim it.
Our ability to claim the deduction makes a difference in our lives. As we pay down on our mortgages, we build wealth. The equity in our homes is about one-quarter of the total wealth of families. That's about as much as our stocks are worth, including our IRAs and 401(k)s, and more than the value of all small and unincorporated businesses. These are the three major categories of our wealth. But there's a difference between our homes and other assets. About two-thirds of us own our homes. Financial assets and small business ownership is much more concentrated among the well-to-do.
Even after the Great Recession, widespread homeownership is the most important factor helping to reduce wealth inequality in the U.S. The distribution of wealth is more equal than it would be if most families were not homeowners. We are rightly concerned about inequality in America. Repealing the mortgage interest deduction will push us in the wrong direction.