Considering it’s been less than a decade since the real estate crash that plunged the world into economic calamity, you might think Republicans in Congress would be a little wary of legislation that risked infuriating voters by pushing down house prices.
Apparently not! As part of the massive tax-cut push they've cued up for this year, GOP leaders are quietly contemplating a proposal that would indirectly curtail the mortgage interest deduction, long considered a sacred cow of American tax policy. The move would almost certainly lead some home values to fall, though it's hard predict by how much.
Currently, homeowners who itemize their taxes can deduct the value of their interest payments on up to $1 million of mortgage debt. That wouldn't change under the House GOP's latest tax blueprint, which Speaker Paul Ryan rolled out during the summer campaign season and is set to serve as a launching-off point as Ways and Means Committee Chairman Kevin Brady crafts his reform legislation. However, the plan would render the mortgage break useless for millions of families by roughly doubling the standard deduction available to all taxpayers, from $12,600 to $24,000 for a married couple.
How so? Itemizing only makes sense for taxpayers if it will save them more than the standard deduction. Since most homeowners don't pay $24,000 a year in mortgage interest, and Republicans want to eliminate most other major deductions, including the break for state and local taxes, it will be extremely difficult for most households to hit the threshold at which itemizing becomes reasonable. The Tax Policy Center estimates that “38 million (84 percent) of the 45 million filers who would otherwise itemize in 2017 would opt for the standard deduction” instead. To be clear, these people should receive a tax cut—they would only pick the standard deduction in order to save money. The entire point of expanding it is to give working households a break while reducing their paperwork. But as a side effect, the tax advantage of owning a home would disappear, which should hurt real estate prices.
And what if you still itemize? Owning your home will net you less in tax savings than before, which should make it a less valuable asset. After all, the bigger the standard deduction, the smaller the edge from itemizing.
The House GOP half-acknowledges all this. Their proposal notes that “far fewer taxpayers will choose to itemize deductions, with the vast majority of taxpayers finding they are better off by taking advantage of the larger, simpler standard deduction instead.” But instead of honestly addressing how that might affect housing—the major source of middle-class saving in this country and one of the biggest drivers of the economy—they point to the magic asterisk of tax-cut fueled economic growth: “By improving the overall economy, this Blueprint promotes a thriving housing market.” This does not inspire confidence.
The House will almost certainly have an ally on this in Donald Trump. The president-elect's tax plan—which he may or may not have actually read—calls for expanding the standard deduction for joint filers to $30,000.
Again, it's tricky to say precisely how far home prices might fall as a result of this tax change. We certainly aren't talking about a 2007-style 30 percent bust. Federal Reserve Board economist David Rappoport recently estimated that killing the mortgage interest deduction entirely would bring down home values about 6.9 percent on average, nationwide.* Partially euthanizing it might have a smaller effect, but I haven't seen anybody model it out yet.
Still, it is unsurprising that the housing lobby is getting ready to fight this change tooth and nail.
Now, time for a disclosure: I bought an apartment last year. Had I known this tax change was coming down the pike, I might have kept renting. I certainly would have purchased a somewhat less expensive apartment. I am conflicted out the wazoo on this issue. But then again, so are millions of Americans.
It also must be said that the mortgage interest deduction is an objectively horrible piece of public policy that should be reformed. Currently, it's an estimated $80 billion-plus subsidy that disproportionately helps upper-middle-class and wealthy households—according to the Tax Policy Center, 72 percent of its benefits go to the highest-earning 20 percent of taxpayers. This is to be expected, since wealthier people can buy larger houses and take out bigger mortgages. It also explains much of its political invulnerability; people who earn low- to mid-six-figures vote and very much treasure their slice of the welfare state that's submerged in our tax code. But as a result, the deduction mostly encourages people who could have afforded homes anyway to buy bigger. Research has shown it does little if anything to expand homeownership overall, and may actually discourage it among younger American by driving up prices.
“The subsidy very well might help upper middle-income taxpayers in high-rate brackets to afford larger mortgages and thereby purchase more expensive homes,” the Urban Institute's Eric Toder wrote some time back. “It is unclear, however, why federal taxpayers should subsidize relatively well-off people’s acquisition of more expensive homes.” If we were starting from scratch, we'd never introduce this tax break to begin with.
There are also plenty of good ideas floating around about how to fix it. Both Democrats and Republicans have suggested turning the deduction into a standard tax credit available even to those who don't itemize, in order to target the benefits at the middle class. You could also try to follow the U.K. model and simply phase out the benefit over decades. That allowed them to ditch the subsidies without cratering the housing market.
But the House GOP is proposing to do precisely the opposite on both fronts. It would change the tax code overnight. And it would only save the deduction for wealthier households, leaving it for the rich to preserve the political fiction that the deduction hadn't been eliminated. In order to rack up $24,000 in annual interest payments at today's rates, a homeowner would need a roughly $550,000 mortgage (and after a couple of years they'd be back under the threshold). The median new home sold in the U.S. only cost $305,000 in November. Well-off New Yorkers buying two-bedroom apartments on the Upper West Side would still get a nice housing subsidy. Ohioans buying three-bedrooms in Cleveland? Not so much.
The perverse upshot of all this is that Republicans have engineered a way to mostly eliminate the mortgage interest deduction, hurting home values for the middle- and upper-middle-class, while leaving the luxury market comparatively unscathed. Welcome to the Trump years.
*Correction, Jan. 5, 2017: This post originally misspelled economist David Rappoport’s last name.