Monday, November 15, 2010

The Mortgage Interest Deduction Brouhaha

On November 10, 2010, Erskine Bowles and Alan Simpson, chairmen of President Obama’s deficit reduction commission, presented suggestions for spending cuts and tax increases to the 18 member group.

Several personal income tax changes were included in the package.  One proposed eliminating all current deductions in exchange for sharply lower rates.  The two biggest are the home mortgage deduction (the subject of this post) and employer provided health insurance.

The IRS has released its preliminary report on personal income tax returns for 2008.  About 140 million individual tax returns were filed in 2008.  (All numbers are rounded off for ease of reading.)  Of these, 92 million (66%) took the standard deduction, totaling $699 billion.  The remaining 38.5 million (34%) took MID of $462.5 billion.

Tax filers with adjusted gross income (AGI) over $200,000 constituted 9.7% of all returns, yet took 46.6% of all MID.  The size of the average deduction increased with each higher income bracket.  Filers with AGI of $100,000-200,000 took an average MID of $13,900.  Those with AGI of $1-1.5 million took an average of $32,000.  Those between $5-10 million AGI took an average of $37,000.

The benefit of the MID depends on the filer’s tax rate. Those in the $100,000-200,000 bracket pay a marginal rate of 25-28%, which means that each MID dollars saves 25-28 cents in taxes..  Those over $374,000 pay a marginal rate of 35%, saving 35 cents on each dollar.  For the 18 million filers with AGI under $75,000, most save 15 cents of each MID dollar because their tax marginal tax rate is 15%.

Back of the envelope calculations of tax savings (MID times tax rate) indicate that the top 10% of filers received about 60% of MID tax benefits.

As previously blogged, the home ownership rate in the U.S. is below that in many Western countries without a MID.  Eliminating the mortgage interest deduction (MID) in exchange for lower [a flat] tax rates makes sense.

Another interesting post on this subject can be read here.

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