The fiscal-cliff compromise on New Year's Day made substantial changes to existing tax law and permanently implemented a number of decade-old tax breaks for the vast majority of taxpayers. Yet even though some lawmakers have argued that the tax increases they agreed to marked the full extent to which they were willing to concede for the sake of higher government revenue, many believe that further revenue-generating measures may come in future battles over sequestration, the debt ceiling, and the passage of a federal budget.
One place that many policymakers have looked to as a potential source of revenue is to eliminate the mortgage interest deduction. With the housing market having suffered so greatly in the past five to seven years, fears that taking away the deduction would lengthen housing's decline deterred lawmakers from seriously considering cutbacks on mortgage interest. But if there were ever an ideal time to get rid of the deduction, it's now, because a number of factors are lining up perfectly to make its disappearance as painless as it's ever going to be.
What the deduction means In simple terms, the mortgage-interest deduction allows taxpayers to write off the mortgage interest they pay as an itemized deduction. Interest on up to $1 million in mortgage debt is generally deductible, with the deduction available either for a principal residence or a second home.
The mortgage-interest deduction is a relic from pre-1986 tax law. Before then, all interest on personal loans was deductible, but the Tax Reform Act of 1986 took away deductions on interest on credit cards and most other personal debt, leaving mortgage loans as a concession to encourage home ownership.
Why now's the right time to kill the deduction Proponents of the deduction argue that it's a key component to keeping home prices up. Especially in high-cost areas, the amount of interest has historically been quite significant, and the deduction can cut interest costs for high-income taxpayers by more than a third. Given what many perceive as the fragile state of the housing recovery, eliminating a tax deduction on mortgage interest could throw housing back into a dive.
Yet when you look at some of the factors that have driven the housing recovery, it's far less clear what impact getting rid of the mortgage-interest deduction would have. Consider the following: