RealEstateEconomyWatch.com

First, there were hints during the campaign.  Senator Obama’s stump speech called for a more equitable tax system, which begins with a tax cut for most Americans-those making $75,000 to $100,000.  Then it’s paid for by possible increases for those making $200,000 to $250,000 or more.  And the tax increases would include “closing loopholes.”

 Not too many people paid attention until February 26, when President Obama released his budget for fiscal year 2010-which starts in October.  It included a phased reduction n the value of the mortgage interest deduction and other deductions for the nation’s highest earners.

 The lobbyists and trade associations started raising the alarm last spring but, with record foreclosures and sinking property values, it took some time for their message to get through to the grass roots.  Now the Wall Street Journal, Washington Post and other major media outlets have weighed in with major stories and finally the real estate agent blogs are bubbling with posts about the unheard of, inconceivable possibility that the cherished mortgage interest deduction, the MID, as it’s fondly known, may soon cease to exist for a huge chunk of the upper tier of the real estate market. 

Interest paid by taxpayers on their mortgages has been deductible since the birth of the modern income tax in 1894, along with interest on all other loans.  As other forms of interest lost their deductible status, mortgage interest remained sacrosanct throughout the 20^th Century, even as the mortgage finance industry developed and grew to make financing available to more buyers.  Along with the housing GSEs (Fannie, Freddie and the Federal Home Loan Banks) and programs like the Federal Housing Administration, VA housing loans and USDA rural housing loans.

 In 2006, the mortgage interest deduction cost the Federal government and saved 40.5 million taxpayers $443 billion.  Some $66.5 billion in deductions went to taxpayers making more than $200,000.   That’s about 15 percent of the total revenues lost to the deduction.

The Administration proposed limiting the value of the MID for upper income taxpayers by, in effect, converting the deduction to a 28% tax credit for those individuals who are currently in the 33% or 35% tax brackets. For the 2009 tax year, the 33% tax bracket starts with couples with taxable earnings of $208,850, when adjusted for personal exemptions and various deductible expenses. A taxpayer in the top bracket paying $1,000 of mortgage interest, for example, would see a tax break worth $350 reduced to $28.

 Households paying income taxes at the 33% and 35% rates can currently claim deductions at those rates. Under the Obama proposal, they could deduct only 28% of the value of those payments.

With the Democrats controlling Congress, immense pressure from the stimulus programs to reduce the deficit, and public support for the ideal of homeownership waning according to some polls, the MID may be facing its greatest challenge in more than a century.

 The short term odds against the Obama proposal, however, are huge.  Such far-ranging policy is not set in budget resolutions.  Amending the MID would require legislation that would undergo a lengthy process in both the House Ways and Means and Senate Finance Committees as well as the floors of the House and Senate.  Few laws have as much enthusiastic support of 40 million taxpayers-perhaps 60 million voters. 

 The Administration’s strategy is clearly not to fight for a change this year but to open the debate on what has in the past been one of the hottest of hot political hot potatoes in Washington. 

 Is time on their side?  Consider:

•  Homeownership is down significantly during the housing depression, off 1.7 percentage points since its 69.1 percent peak in 2005. (see The Housing Downturn and Homeownership)
• Respected scholars like Thomas J. Sugrue writig in the Wall Street Joutnal that the American Dream is the creation of Federal subsidies that in the end have brought ruin to people who probably should never have owned a home.
•  Many characterized the Obama administration’s plans to pump $4.25 billion of economic stimulus money into creating tens of thousands of federally subsidized rental units in American cities as a major shift on housing policy and an abandoning of George W. Bush’s vision of creating an “ownership society,” according to the Boston Globe.

 The impact on the housing markets should the limitations on taxpayers earning over $200,000 ever be enactive are horrendous, much greater than simply removing $66 billion from the pockets of middle and upper income homeowners.  NAR did a comprehensive job of estimating the wreckage it would cause to all levels of levels of house, not just upper tier, in this white paper.  But numbers may not be enough.

“This is so scary that it makes any Halloween slasher movie look tame.  The implications of this mess are huge and growing by the minute,” wrote Patt Fenn of Cindy Jones RE/Max Allegiance agency in Springfield, Virginia on the popular Active Rain blog. 

 Stay tuned.  The mortgage interest deduction is in play until further notice.