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The mortgage interest deduction should be repealed in its entirety. Since its repeal will upend taxpayer reliance and decrease home prices, the repeal should be gradual. However, full repeal, without the grandfathering of existing mortgages, is appropriate. The mortgage interest deduction is an over hundred billion dollar annual tax expenditure that does not meaningfully advance its goal of promoting homeownership and instead contributes to instability in the housing market. It should not be sustained.

In 2005, a bipartisan Advisory Panel on Federal Tax Reform recommended changes to the mortgage interest deduction that provide a helpful starting point for plans to phase out the deduction. These recommendations, with some key modifications, offer an appropriate plan for its gradual phase out.

In 2005, the Panel recommended converting the mortgage interest deduction into a 15 percent tax credit available to all taxpayers regardless of their marginal tax rates. This tax credit would not function like a first-time homebuyer tax credit available in the year of purchase. Rather, like the mortgage interest deduction, it would be payable over the term of the mortgage and its value would be based on the mortgage interest paid in any given year. However, instead of multiplying the amount of mortgage interest paid in any given year by the taxpayer’s marginal tax rate (currently up to 35 percent), the amount of mortgage interest paid in any given year would be multiplied by 15 percent. Since a fixed percent would be multiplied by the amount of mortgage interest paid, rather than the taxpayer’s marginal tax rate, this incentive was referred to as a mortgage interest credit (rather than a mortgage interest deduction). The Panel also recommended limiting the credit to interest only on mortgages on primary residences and gradually reducing the mortgage cap from $1.1 million to a number reflecting the average regional price of housing (ranging from about $227,000 to $412,000 depending on the location of the home).166 _{The proposal was to be}

phased in over five years for existing mortgages.167

The Panel’s recommendations are a helpful starting point for plans to gradually eliminate the mortgage interest deduction partially because these recommendations were evaluated in 2005 for their potential impact on the economy. Despite the significant reduction in mortgage caps proposed by the Panel, studies showed that nationally only about 13 percent of mortgage originations would have been negatively affected by the new caps. Only 832,925 mortgage originations of 6.29 million mortgage originations total in one study were for amounts above the proposed caps.168 _{The small percentage of homeowners potentially}

affected by the reduced mortgage caps proposed by the Panel indicates that mortgage caps could be reduced without destabilizing the real estate market.

Studies also showed that, despite the small percentage of homeowners potentially affected by the reduced caps, the proposal would have increased tax revenues significantly. The Congressional

166. 2005 PRESIDENT’S ADVISORY PANEL,supra note 26, at 61.

167. Id. at 238.

Budget Office estimated the potential increased revenue available if such a proposal took effect in 2013.169 _{It estimated that $12.7 billion}

more revenue would be collected in 2013, that $51.6 billion more revenue would be collected in 2014 and that a whopping $387.6 billion more revenue would be collected between the years 2013-2019.170 _These

revenue increases were available by reducing the mortgage caps to regional averages over a five-year-phase-down period, by converting the deduction to a credit worth 15 percent of the mortgage interest paid by all taxpayers regardless of their marginal tax rates and by limiting the deduction to primary residences.

While the proposal by the 2005 Panel is a helpful starting point to plan for a gradual reduction of the mortgage interest deduction, the data above indicate that several changes would make the phase out more effective and avoid the continued harm caused by mortgage tax incentives.

First, during the phase-down period, the mortgage interest deduction should be capped at a 15 percent rate, not converted to a 15 percent credit for all taxpayers as the Panel had recommended. The Panel proposed that all homeowners paying mortgage interest should receive a credit for 15 percent of the interest they pay regardless of their marginal rates. Since that 15 percent mortgage interest credit would not have been an itemized deduction, it would have been available to all taxpayers, even if they took the standard deduction. Further, since the credit was offered at 15 percent for all taxpayers, it would have increased the tax incentive for taxpayers in the 10 percent bracket. These features of the Panel’s proposal likely were efforts to make the mortgage interest incentive more progressive and to increase the rate of homeownership. However, since mortgage interest incentives, including the 15 percent credit proposed by the Panel, are difficult to predict, poorly-timed, insensitive to market conditions, resistant to change and cause price capitalization, they should not be increased for any category of taxpayer, even in the interest of progressivity. Extending the benefits of mortgage interest incentives to new categories of taxpayers (including those taking the standard deduction) serves only to increase taxpayer reliance on a faulty incentive. Instead of offering mortgage interest

169. CBOPUB.NO.3191,supra note 26, at 187.

incentives to taxpayers who do not currently receive them, targeted first- time homebuyer tax credits and direct expenditure programs should be used to increase rates of homeownership by low- and middle-income taxpayers.

Second, mortgage caps should be gradually reduced to zero— eliminating the mortgage interest deduction—not simply reduced to regional averages as the Panel had recommended. While the Panel’s recommendation of reducing the mortgage cap over five years from the current cap of $1,100,000 to various caps based on regional averages is prudent and properly avoids disproportionate disruption to areas with higher home prices, the cap should be further reduced over the following five years until the mortgage interest deduction is fully eliminated. The mortgage interest deduction fails to achieve its goal of promoting homeownership, results in a huge loss of potential revenue and exaggerates dangerous boom/bust cycles in the housing market. Tax incentives for mortgage borrowing should not continue. Instead, they should be entirely eliminated and replaced with incentives that are fully paid at the time of a home purchase. Home purchase tax incentives can more effectively respond to market conditions and are easier to change if they fail to achieve desired outcomes.

Finally, a plan to phase down and then eliminate the mortgage interest deduction should coincide with extended homebuyer tax credits used to stabilize the real estate economy during the transition period for reasons described in more detail below.