Addressing Tax Reform by Curbing the Home Mortgage Interest Deduction

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Tax Policy

A cap on the home mortgage interest deduction may be considered as part of federal tax reform to help pay for tax cuts. In this article, the Tax Foundation's Amir El-Sibaie discusses what states benefit the most from the current deduction, how limiting the deduction could broaden the tax base, and what impact a change could have.

Amir El-Sibaie

By Amir El-Sibaie

Amir El-Sibaie is an analyst with the Center for Federal Tax Policy at the Tax Foundation.

Recent reports suggest that the Trump administration is looking to limit the home mortgage interest deduction as another means to pay for lower tax rates as part of tax reform.

Under current law, individuals who itemize their deductions can deduct mortgage interest paid on loans up to $1 million of home mortgage debt principal. This effectively creates a limit on the amount of mortgage interest a taxpayer can deduct.

Lawmakers could broaden the individual income tax base by further limiting the home mortgage interest deduction on loans up to $500,000 worth of principal. This would reduce the amount of mortgage interest individuals could deduct against their taxable income. Using Tax Foundation's Taxes and Growth model, we estimated that this proposal could raise as much as $95 billion to $300 billion over the next decade, depending on how the cap is structured.

Top 1 Percent

The largest tax increase would fall on taxpayers in the top 1 percent. Assuming the lower cap was fully implemented in 2017, they would see their after-tax income fall by 0.62 percent on a static basis. A small number of taxpayers in the middle quintiles would see a tax increase, but it would average less than one-tenth of 1 percent. Reducing the cap would mainly affect high-income taxpayers who tend to have larger houses, more mortgage debt, and live in areas with more expensive homes. Middle- and lower-income taxpayers would be much less likely to face a tax increase.

Changes to the home mortgage interest deduction would also impact certain parts of the country differently. On a state-by-state basis, the average home mortgage interest deduction received per tax return filed varies greatly. The states that benefited the most from the home mortgage interest deductions were Maryland ($3,175), California ($2,960), and Virginia ($2,931). The states that benefited the least were Mississippi ($964), South Dakota ($867), and West Virginia ($856).

There are two primary factors that account for the regional variance in the use of the home mortgage interest deduction: housing prices and income levels.

Regional Housing Prices

Regional housing prices directly impact mortgage interest payments. In areas where land is scarce, such as Hawaii, the low levels of supply will push prices up and increase the amount of interest paid on mortgages. The opposite is also true. In states such as North and South Dakota where land is plentiful, low land prices will directly reduce the number of individuals claiming the home interest mortgage deduction and the amount of the deduction.

Income levels also impact the amount a state claims in mortgage interest. As stated, higher-income taxpayers are more likely to purchase larger homes and have more mortgage debt. In addition, they are more likely to itemize because they pay more in state and local taxes and make more charitable contributions—the two other major itemized deductions available to taxpayers.

The Trump administration has made cutting tax rates a priority, and lawmakers must figure a way to pay for that with numerous base broadeners. Lowering the cap on the home mortgage interest deduction would offer a substantial amount of revenue and generally only target high-income earners.

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