By Walter Alarkon - 06/08/10 10:00 AM EDT
The popular tax break for mortgage interest, once considered untouchable, is falling under the scrutiny of policymakers and economic experts seeking ways to close huge deficits.
Although Congress last year rejected the White House’s proposed cut to the amount wealthier taxpayers can deduct for home mortgage interest payments, the administration included it again in its 2010 budget — saying it could save $208 billion over the next decade.
The new spotlight on the mortgage deduction and other tax expenditures comes as the Obama administration and Congress consider ways to reduce deficits the Congressional Budget Office (CBO) expects will average nearly $1 trillion over the next decade.
Policymakers seeking savings have tried to cap the mortgage interest deduction before — and failed. Five years ago, a bipartisan tax reform commission created by President George W. Bush proposed ending the mortgage tax break. But the commission’s plan stalled in Congress, partly because of popular support for the mortgage deduction.
Obama’s proposal, which would cut the deduction rate for itemized expenses for those making more than $250,000 to the rate paid by the middle class, was panned last year by members of both parties. They worried about its effect, during a recession, on charitable deductions and the housing market.
The White House says it was included in the president’s budget proposal again this year because it remains a good idea.
“The proposal will correct inequities in our tax code that allow millionaires to benefit from higher itemized tax deductions than middle-class families enjoy,” said Meg Reilly, spokeswoman for the Office of Management and Budget (OMB).
Although the backers of the mortgage interest tax break defend it as a key incentive for people to own rather than rent their homes, some say that’s not so. A Brookings-Urban Tax Policy Center study found that the mortgage interest tax break costs more than $100 billion annually but does little to encourage the middle class and less wealthy to buy homes.
“I’m not sure that we need to subsidize homeownership at all through the tax system,” said Eric Toder, the study’s lead author.
A bipartisan tax reform proposal this year by Sens. Judd Gregg (R-N.H.) and Ron Wyden (D-Ore.) would lower base tax rates and eliminate a host of tax expenditures, but not the mortgage deduction. Gregg and Wyden said they left it out because they wanted a “politically viable vehicle,” conceding that ending the mortgage break would mean less support for their plan from other lawmakers.
Toder maintains that federal budget and deficit projections have prompted a shift in the political environment, and in Congress’s willingness to take on what were once considered hallowed tax breaks.
“The kinds of things people are discussing in public are way beyond what they were talking about a couple years ago,” he said.
For instance, the costliest tax expenditure — the exemption on employer-based health benefits — was indirectly reduced as part of the Democrats’ health reform law. To pay for the expansion of health insurance and to nudge the health industry to keep down costs, Democrats enacted a new tax on high-cost healthcare plans.
The employer-based health benefits exemption will cost slightly more than $1 trillion over the next five years, according to OMB. The second most costly tax break was the mortgage deduction, which would cost $638 billion. Other big-ticket tax expenditures were the exemptions for 401(k) contributions, capital gains and corporate overseas earnings known as deferral.
Ending all of those permanent tax breaks would be one way of reining in debt, according to a report by former CBO Director Rudy Penner and other economists at the National Academy of Sciences. The other way to stop a rise in the real debt level without cutting Medicare, Social Security and Medicaid would be to increase all base tax rates and introduce a new value-added tax, which is levied on goods at each stage of production.
Penner testified about the cost of the large tax expenditures — and the difficulty of ending them — during an April meeting of Obama’s fiscal commission.
“The problem on the tax side is that you also have some really big sharks there, and I guess unlike most sharks, they’re very popular sharks,” Penner said.
One commission member, Senate Majority Whip Dick Durbin (D-Ill.), noted that the mortgage deduction was among those sharks.
Durbin and Rep. Jan Schakowsky (D-Ill.), also on the commission, have pressed their colleagues to look at tax expenditures along with government spending as they try to craft a fiscal reform plan.
“Durbin is asking tough questions, but hasn’t decided on the answers yet,” one of his aides said. “When we’re talking about a huge universe of revenue loss, he thinks that tax entitlements deserve the same scrutiny as discretionary spending.”
Republicans on the commission have also called for changes to the tax code, but they’ve talked more about reforming tax breaks for lower- and middle-income people, generally popular with Democrats.
“Any debate about true reform of the code would have to look at tax expenditures, such as the Earned Income Tax Credit and Making Work Pay credit on up,” said Sage Eastman, a spokesman for Rep. Dave Camp (R-Mich.).