Key Issues in Tax Reform: The Mortgage Interest Deduction
Updated November 14, 2017
Key Issues in Tax Reform: The Mortgage Interest Deduction
Tax reform proposals are generally structured around
Based on 2014 IRS data (the most recent year available),
lowering tax rates while broadening the taxable base. The
44% of all homeowners claimed the mortgage interest
base-broadening component of tax reform could be most
deduction. Among the 56% of homeowners who did not
directly accomplished by eliminating special provisions in
take advantage of the deduction, 36% had no mortgage, and
the tax code known as tax expenditures. One of the largest
hence no interest to deduct. The remaining 20% of non-
tax expenditures is the mortgage interest deduction (MID).
claimants had mortgages, but likely either (1) were toward
On the one hand, modifying or eliminating the mortgage
the end of their mortgage payments so that the deduction
interest deduction could raise significant revenue. On the
was not worth much, (2) lived in a state with low state and
other hand, any change could affect individual homeowners
local taxes and thus claimed the standard deduction, or (3)
and the overall economy.
lived in a low-cost area and therefore had a relatively small
mortgage. In 2014, the deduction was claimed on about
Brief Summary of Current Law
22% of all federal income tax returns and 74% of itemized
Currently, a homeowner may deduct the interest paid on a
returns.
mortgage that finances a primary or secondary residence as
long as the homeowner itemizes their tax deductions. The
Proposals to Reform the MID
amount of interest that may be deducted is limited to the
The Tax Cuts and Jobs Act (H.R. 1), introduced on
interest incurred on the first $1 million of combined
November 2, 2017, proposes reducing the maximum
mortgage debt and the first $100,000 of home equity debt
mortgage amount eligible for the deduction from $1 million
($1.1 million total). If a taxpayer has a mortgage exceeding
to $500,000 for new mortgages. The bill would also
$1 million, they may still claim the deduction, but they
eliminate the deduction for interest paid on mortgages on
must allocate their interest payments appropriately to
second homes and home equity loans. The Senate Finance
ensure that only the interest associated with $1 million of
Chairman’s mark of H.R. 1 proposes only eliminating the
debt is deducted.
deduction for interest on home equity loans.
Although many contend that the purpose of the mortgage
The Congressional Budget Office (CBO), in its December
interest deduction is to promote homeownership, this was
8, 2016, Options for Reducing the Deficit report, presented
not the deduction’s original purpose. When laying the
the option of converting the mortgage interest deduction to
framework for the modern federal income tax code in 1913,
a 15% nonrefundable tax credit and limiting the eligible
Congress recognized the importance of allowing for the
mortgage amount to $500,000. The ability to deduct interest
deduction of expenses incurred in the generation of income,
associated with second homes or home equity debt would
which is consistent with traditional economic theories of
be eliminated. The conversion would take place gradually
income taxation. As a result, all interest payments were
over six years.
made deductible with no distinction made for business,
personal, living, or family expenses. It is likely that no
The Unified Framework for Fixing Our Broken Tax Code,
distinction was made because most interest payments were
issued by the Office of the Speaker on September 27, 2017,
business related at the time and, compared to today,
states that it would retain the mortgage interest deduction.
households generally had little debt on which interest
The House Republican Conference’s “A Better Way” tax
payments were required—credit cards had not yet come
reform blueprint plan calls for the Committee on Ways and
into existence and the mortgage finance industry was in its
Means to evaluate potential options to increase the
infancy. Among those who did hold a mortgage, the
deduction’s effectiveness and efficiency. Regardless of the
majority were farmers.
committee’s findings, the plan states that the deduction will
not be altered for those who continue to itemize, even if the
For more than 70 years there was no limit on the amount of
homeowner refinances. The tax reform blueprint does not
home mortgage interest that could be deducted. The Tax
suggest options for altering the deduction.
Reform Act of 1986 (TRA86; P.L. 99-514) eventually
restricted the amount of mortgage interest that could be
Former House Ways and Means Committee Chairman
deducted and limited the number of homes for which the
Dave Camp’s Tax Reform Act of 2014 (H.R. 1) proposed
deduction could be claimed to two. Mortgage interest
preserving the deduction but reducing the eligible mortgage
deductibility was limited to the purchase price of the home,
amount to $500,000 over a four-year period. To lessen the
plus any improvements, and on debt secured by the home
impact on the housing market, the new limitations would
but used for qualified medical and educational expenses.
only apply to new mortgage debt. Furthermore, the proposal
Subsequently, the Omnibus Budget Reconciliation Act of
included a grandfather provision for refinanced debt if the
1987 (P.L. 100-203) made a number of additional changes
original mortgage debt was incurred prior to the mortgage
that resulted in the basic deduction limits that exist today.
limits being reduced.
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Key Issues in Tax Reform: The Mortgage Interest Deduction
President Obama’s National Commission on Fiscal
The inability to establish causality, however, does not mean
Responsibility and Reform (Fiscal Commission)
that homeownership does not result in positive externalities
recommended replacing the mortgage interest deduction
that justify housing subsidies. But one could argue that
with a nonrefundable credit equal to 12% of the interest
determining whether to provide subsidies for
paid on mortgages of $500,000 or less. The credit would be
homeownership depends on establishing cause and effect. If
restricted to a taxpayer’s primary residence, and no credit
homeownership does not generate the positive effects some
would be allowed for interest associated with home equity
believe it does, then the economic justification for
loans.
subsidization is diminished. In this case, the overall
performance of the economy could be enhanced by
President George W. Bush’s Advisory Panel on Federal
eliminating the deduction, and allowing resources to be
Tax Reform (Tax Reform Panel) also proposed replacing
reallocated to more productive uses in other sectors.
the mortgage interest deduction with a credit. Specifically,
Eliminating the deduction could, however, have an effect
the Tax Reform Panel proposed a tax credit equal to 15% of
on the size of homes purchased and home prices, as
mortgage interest paid. Under the proposal, the credit would
research suggests these are the primary margins that the
be restricted to a taxpayer’s primary residence. The size of
mortgage interest deduction influences.
the mortgage eligible for claiming the interest credit would
be limited to the average home price in the taxpayer’s
An alternative to eliminating the mortgage interest
region.
deduction would be limiting its availability to better target
it toward those needing assistance to purchase a home. This
The mortgage interest deduction could also be eliminated.
could be accomplished by lowering the eligible mortgage
The key to such a step is the choice of time period over
amount to more closely resemble that of a first-time
which it would be phased out. Completing the phase-out
homebuyer, limiting the amount of deductible interest,
within the budget window would generate the most revenue
restricting the deduction to primary residences, instituting
for scoring purposes, but could be too abrupt for the
income restrictions, or capping the tax rate at which the
housing market and economy. Alternatively, the deduction
deduction could be claimed. If Congress is concerned about
could be eliminated over 15, 20, or 30 years, with a fixed
the distributional objectives of tax reform, a more-limited
date after which the deduction would no longer be
deduction would also promote progressivity in the tax code.
available. For example, if January 1, 2047, were chosen as
the cut-off date, taxpayers who buy a home in 2017 could
The objective of homeownership promotion might also be
claim the deductions for 30 years, buyers in 2018 could
better achieved by converting the deduction to a tax credit.
claim the deduction for 29 years, and so on.
A credit could better target potential first-time homeowners,
since itemization would no longer be required. Without the
Budgetary and Economic Issues
need to itemize, the burden of tax preparation on
Limiting or eliminating the mortgage interest deduction
homeowners would also be lessened. Depending on the
could increase federal tax revenues. The Joint Committee
design of the credit, it could create a more consistent rate of
on Taxation (JCT) estimates that the deduction will cost
subsidization across homeowners. The value of a dollar
$84 billion per year, on average, between FY2015 and
deduction for interest tends to increase as homeowner
FY2019. Thus, modifying the deduction could be used to
income increases. With a credit the subsidy can be fixed at
finance a reduction in deficits and the debt, lower tax rates,
a certain rate (e.g., 15%) across income levels which would
or provide for alternative tax incentives or direct spending
increase progressivity in the tax code relative to current
programs.
policy.
While the mortgage interest deduction is commonly
The short-run economic effects from modifying or
believed to promote homeownership, the economic
eliminating the mortgage interest deduction would depend
literature tends to suggest that this effect may be rather
upon how large the change was relative to current policy
small. This is because the deduction is not well targeted to
and how quickly it was implemented. Some have argued
the largest barriers to homeownership—down payment and
that a large, sudden change in policy could cause home
closing costs. The deduction’s effect on homeownership is
purchases to decrease, leading to a decline in home prices,
also likely limited, because it is not well targeted toward the
and a negative shock to the broader economy in the short-
group of potential buyers most in need of assistance—
run. To the extent that a policy change would be smaller or
lower-income households—which includes younger
more gradual, these concerns are lessened. In addition, the
potential first-time buyers.
long-run performance of the economy could improve as
federal tax revenues increase, implying less reliance on
Homeownership promotion is often thought to be desirable,
deficits, and as resources are allocated to more productive
because it may produce social spillover benefits. For
uses in the economy.
example, homeownership may lead to safer neighborhoods,
greater civic participation, higher overall property values,
This In Focus is part of a series of short CRS products on
and greater income and wealth equality. The economic
tax reform. For more information, visit the “Taxes, Budget,
literature, however, has not been able to support those
& the Economy” Issue Area Page at http://www.crs.gov.
claims. Does homeownership lead to higher income and
wealth, or is the relationship reversed, and higher income
Mark P. Keightley, Specialist in Economics
and wealthier households are more inclined to become
homeowners?
IF10584
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Key Issues in Tax Reform: The Mortgage Interest Deduction
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