MIT Professor Discusses Mortgage Deduction Reform

Robert Siegel talks with William Wheaton, a professor of economics at Massachusetts Institute of Technology, about the home mortgage interest deduction. It's one of the tax breaks being considered for reform under a budget plan proposed by a bipartisan group of senators known as the "Gang of Six."

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ROBERT SIEGEL, host:

One provision of the Gang of Six proposal is reform, not eliminate, tax expenditures for health, charitable giving, homeownership and retirement.

Now, the phrase tax expenditures is a creative piece of semantics. Since the government forgoes tax revenues for those deductions, they are called tax expenditures. And that means that closing a tax loophole can be described as cutting a government expenditure, in this case, a tax expenditure.

We thought we'd take a look at one of those tax breaks that's named as a candidate for reform, the home mortgage interest deduction. And we'll start with this definition from the Internal Revenue Service. I'm quoting:

"Generally, home mortgage interest is any interest you pay on a loan secured by your home - main home or a second home. The loan may be a mortgage to buy your home, a second mortgage, a line of credit or a home equity loan."

Well, MIT economist William Wheaton has made a specialty of real estate and housing, and he joins us now from Cambridge.

Welcome back to the program.

Professor WILLIAM WHEATON (Economist, MIT): Thank you very much.

SIEGEL: And tell us what kind of proposal is most likely to be a reform, not elimination, of the home mortgage interest deduction.

Prof. WHEATON: Well, I suspect that the proposal most likely to emerge out of the Senate committee is one where the interest on second homes is eliminated, one where the total amount of mortgage debt will be capped at a lower level than the $1 million that it's currently capped at, and, rather than having an interest deduction where the deduction ranges from 15 percent all the way up to 38 percent for very wealthy Americans, will be a constant 10, 12 or 15 percent in the form of a tax credit.

SIEGEL: Now, let's explain that. You're saying the reason that the benefit of this deduction ranges from a low to a high rate is it depends on how big your income is and what rate you pay your taxes at.

Prof. WHEATON: Oh, absolutely. And every American who earns more than $150,000 or $200,000 is subject to 35 or 38 percent tax rates. So they're deducting it at that rate, meaning they're only paying 62 percent of every dollar of mortgage interest they actually pay. Uncle Sam is basically picking up the other 38 percent.

But if you're a first-time homebuyer and you're down there in a 30, $40,000 income range and your marginal tax rate is 20 percent or 15 percent, then you're only deducting that fraction, and it's nowhere near as - of much consequence.

SIEGEL: So you're saying the deduction as it presently exists compounds the advantage of income here or at least the size of the home that you're (unintelligible).

Prof. WHEATON: Absolutely. And it's a - any time you make mortgage credit cheap, you encourage people to sort of spend more on housing.

SIEGEL: Now, what do you say to people who are in the real estate industry who would say, look, it's depressed right now, the housing market is in terrible shape, it doesn't seem to be picking up, to do anything that would harm it, it's the wrong time to do that?

Prof. WHEATON: I would say it really depends on what you do. The housing market's current straits is really due completely to the foreclosure crisis. And that just keeps dumping houses on the market. And the problem is there's not enough first-time buyers left in the current situation to absorb those houses once they get in the market.

And I'm not sure that the interest deductibility of mortgages will have much of an effect on that because a lot of that's entry-level buyers, and they're the ones who are not really very much affected by this proposal.

SIEGEL: But when people do polls and ask Americans whether they support it, a large majority say they support it, far larger than the number of people who actually use it.

Prof. WHEATON: That's a very, very good point. And I think it's due to the fact that everybody has in their mind a dream of owning a home and owning a big home. So if you say to them, even people who currently don't own homes, we're going to eliminate this deduction, and it will make owning a home more difficult. People are thinking: Oh, that's part of my life plan. I don't want that.

SIEGEL: Professor Wheaton, thank you very much for talking with us.

Prof. WHEATON: Been my pleasure.

SIEGEL: That's William Wheaton, professor of economics at MIT.

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