The Mortgage Interest and Property Tax Deductions: Brief Overview with Revenue Estimates

There has been increased concern over the size and sustainability of the United States' recent deficits, the country's long-run budget outlook, and most recently, the consequences of reaching the debt limit. This concern has brought the issues of the federal government's revenue needs and fundamental reform of the tax system to the forefront of congressional debates. One place Congress may turn to address these issues is the set of tax benefits for homeowners, particularly the mortgage interest deduction and the property tax deduction for homeowners. The Joint Committee on Taxation (JCT) has estimated that the mortgage interest deduction costs the federal government $96.8 billion annually and the property tax deduction $24.2 billion annually.¹ When these two deductions are combined they represent the largest tax expenditure, exceeding the exclusion for employer-provided health insurance.²

This report provides a brief overview of these two provisions, presents policy options with potential revenue effects, and briefly summarizes the economic effects of modifying the provisions. This report is a condensed version of CRS Report R41596, The Mortgage Interest and Property Tax Deductions: Analysis and Options, by [author name scrubbed]. Contained in that report is an in-depth summary of the mortgage interest and property tax deductions, distributional data, and reviews of the original intent of the provisions. Also included in that report is an analysis of the rationale for subsidizing homeownership, as well as an analysis of whether the mortgage interest and property tax deductions affect homeownership.

Mortgage Interest and Property Tax Deductions

The mortgage interest and property tax deductions are both itemized deductions.³ Of the approximately one-third of taxpayers who itemize (the remainder choose the standard deduction), approximately 80% claim the mortgage interest deduction and 86% claim the property tax deduction.⁴ Among homeowners, roughly 51% claim the mortgage interest deduction, while 55% claim the property tax deduction.⁵

Whereas the property tax deduction may be, generally, claimed without limit for all state and local property taxes paid on a home, the mortgage interest deduction may only be claimed for interest incurred on the first $1 million of mortgage debt and the first $100,000 of home equity debt ($1.1 million total). Mortgage debt is debt incurred in the purchase, construction, or substantial improvement of a first or second home.⁶ Home equity debt is a loan that uses the residence as collateral, and that can be used for personal expenditures (college education, vacations, etc.).

Potential Options and Revenue Estimates

There are a number of possible options for changing the mortgage interest and property tax deductions. This report focuses on options whose revenue effects have been estimated. These estimates are listed in Table 1 at the end of the report. The approximate annual revenue estimates provided are based upon available estimates of fully phased-in provisions converted to an annual basis. This was done in an attempt to place these estimates, done at different times and using different assumptions and methodologies, on a comparable basis. As such, these figures are intended to provide the reader with a relative estimate of the revenue-raising potential of the various proposals. For additional options, see CRS Report R41596, The Mortgage Interest and Property Tax Deductions: Analysis and Options, by [author name scrubbed].

Summary of Economic Effects

Housing Market and Economy

Changes to homeownership tax policy may effect the broader economy and the homeownership rate. How they effect the economy depends upon how large a change and how quickly it is implemented. Some have argued that a large sudden change in policy could cause home purchases to decrease, leading to a decline in home prices, and a negative shock to the broader economy in the short-run. To the extent that a policy change is smaller or more gradual, these concerns are lessened. In addition, the long-run performance of the economy could improve as federal tax revenues increase, implying less reliance on deficits, and as resources are allocated to more productive uses in the economy.

Assuming a gradual policy change, housing tax policy changes are expected to have minimal impact on the homeownership rate. In order to have an effect on the homeownership rate, tax incentives must address the most pressing barrier to households on the verge of homeownership—the down payment. The effects of the mortgage interest deduction and the property tax deduction on the homeownership rate are likely small because they are not well targeted toward lowering this barrier. The deductions' effects on homeownership are also limited because they are not well targeted toward the group of potential buyers most in need of assistance—lower-income households—which includes younger potential first-time buyers. A policy change could, however, have an effect on the size of homes purchased, as research suggests this is the primary margin the two deductions influence.

Distributional Impact on Taxpayers

The distributional impact of eliminating or limiting either deduction would tend to be concentrated among middle- and upper-income taxpayers. The current deductions provide a proportionally bigger benefit to higher-income taxpayers, since they are more likely to be homeowners, buy more expensive homes, and are subject to higher marginal tax rates. The requirement that homeowners itemize their tax returns to claim the deductions also limits who currently benefits to middle- and upper-income taxpayers.

Converting either deduction to a tax credit could provide a benefit to more homeowners since itemization would no longer be required. Without the need to itemize, the burden of tax preparation on homeowners would be lessened. Depending on the design of a credit it could create a more consistent rate of subsidization across homeowners. The value of a given dollar deduction for interest or taxes tends to increase as homeowner income increases. With a credit the subsidy can be fixed at a certain rate (e.g., 15%) across income levels. Progressivity in the tax code could also be increased by limiting the deductions or converting the deductions into credits.

Footnotes

1.	Based on CRS calculations using estimates reported in U.S. Congress, Joint Committee on Taxation, Estimates of Federal Tax For Fiscal Years 2010-2014, 111th Cong., 2nd sess., December 15, 2010, JCS-3-10 (Washington: GPO, 2010).
2.	The exclusion for employer-provided health insurance costs the government approximately $131.9 billion annually.
3.	A deduction reduces a taxpayer's taxable income. The value of a deduction to a taxpayer is equal to their highest marginal tax rate multiplied by the amount of the deduction. For example, the value of a dollar deduction for an individual in the 25% tax bracket is $0.25, while the value of the same dollar deduction for someone in the 35% bracket is $0.35. Thus, higher-income taxpayers typically benefit more than lower-income taxpayers from deductions.
4.	2008 IRS SOI Data, http://www.irs.gov/taxstats/indtaxstats/article/0,,id=96981,00.html, Tables 1.1 and 2.2.
5.	Author's estimates using 2008 American Community Survey and the 2008 IRS SOI Data, http://www.irs.gov/taxstats/indtaxstats/article/0,,id=96981,00.html.
6.	For purposes of the deduction a home includes a house, condominium, cooperative, mobile home, house trailer, boat, or similar property that has sleeping, cooking, and toilet facilities. See, Internal Revenue Service, Home Mortgage Interest Deduction, Publication 936, November 30, 2010, p. 2, http://www.irs.gov/pub/irs-pdf/p936.pdf.