Mortgage-interest write-offs top list of tax-reform untouchables

Homeowner subsidies run up the U.S. deficit but continue to be a political hot potato.
By Kenneth R. Harney | Washington Post Writers Group
Posted February 6, 2005

It's federal tax-reform season at the White House, with a new presidential commission drafting a potentially radical streamlining of the Internal Revenue Code by midyear.

But President Bush already has pulled some of the biggest tax-system goodies off the reform table. Tops on the list of untouchables: The massive benefits that American homeowners receive annually in deductions from their federal income-tax filings.

How big are those benefits? Very. Congress' bipartisan Joint Committee on Taxation recently toted them up and found that in 2005 alone, homeowners will receive more than $116 billion in direct-tax subsidies. Although homeowners may not feel subsidized, Congress has rewarded them for years -- but not renters -- with tax preferences as a matter of public policy. And with the homeownership rate approaching a record 70 percent, that policy has been highly effective.

Now to the costs of stimulating all that home buying. According to the joint tax committee, American homeowners this year are expected to receive:

• $72.6 billion in tax deductions for their mortgage-interest expenses. The tax code allows homeowners to write off interest on first and second mortgages -- including equity lines and loans -- up to an aggregate $1.1 million worth of their mortgage debt. That, in turn, has encouraged millions of Americans to convert billions of dollars of nondeductible credit-card debt and auto loans into tax-subsidized home-equity debt. At the same time, interest deductibility on primary mortgages has helped buyers afford ever-larger loans on ever-pricier houses. Renters receive no such subsidies.
  

• $22.9 billion in tax benefits through exclusions of capital gains on sales of principal residences. This category has ballooned since 1997, when Congress first sanctioned tax-free treatment of up to $250,000 (for single filers) or $500,000 (for married joint filers) on the profits from home sales.
  

  The $250,000 to $500,000 exclusions are available on homes owned for just 24 months and can be used without limit every 24 months. Even homeowners who sell within less than 24 months can pocket profits tax-free, provided their early sale was caused by employment or health changes, or by "unforeseen circumstances."
  

• $19.6 billion in write-offs for local property taxes paid on owner-occupied residences.
  

• About $1 billion for interest subsidies on local and state bond programs that provide low-cost mortgage money for moderate-income home buyers.
  

Tax preferences for homeownership represent a chunk of the federal deficit, but they are so ingrained into home prices, mortgage affordability, construction and local revenues that virtually no politician on Capitol Hill -- or in the White House -- suggests publicly that they need to be pared or ended.

Who pockets the tax code's generous subsidies to homeowners? When the joint tax panel examined distribution of mortgage-interest preferences in 2004, it found that people in the highest-income bracket, with $200,000 in annual incomes and above, represented less than one-half of 1 percent of all homeowners who took mortgage-interest deductions. But they got 22 percent of the $70.2 billion in mortgage-interest tax write-offs that year.

That shouldn't be shocking. After all, those homeowners tend to pay the biggest mortgage bills, and are in the highest tax brackets, where deductions provide heftier savings. But the distribution pattern changes as you descend the income ladder:

Homeowners with incomes between $75,000 and $100,000 comprised 19.3 percent of those taking write-offs, but pocketed 18.2 percent of the deductions. In the next bracket down, homeowners with incomes between $50,000 and $75,000 were the biggest single group to take deductions -- 26.4 percent -- but got 16.1 percent of the $70.2 billion total. Owners with incomes of $30,000 to $40,000 represented nearly 10 percent of all owners claiming mortgage-interest write-offs, but got just 3.1 percent of the total tax-savings pie.

The same distribution curve holds for other homeowner-tax subsidies as well. Top-income households were 3.8 percent of all homeowners claiming property-tax write-offs in 2004, but received 15 percent of the total. At the other end of the spectrum, homeowners with incomes between $30,000 and $40,000 were 9.4 percent of all those taking property-tax write-offs, but ended up with 3.7 percent of the benefits.

Whatever your philosophical take on numbers such as these, remember: Absent some political revolution on Capitol Hill, homeowner-tax subsidies are here to stay. You might hear about proposals to rein them in later this year -- putting a lid on mortgage-interest deductions or scaling back capital-gains exclusions. But even before you hear about them, they will be stone dead politically.