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Eliminating the deductions for mortgage interest and real estate taxes would raise taxes disproportionately for middle-class households and make the tax system less progressive, according to new research from NAHB’s Economics and Housing Policy Group.
The study also concludes that the benefits of these deductions are collected primarily by middle-class taxpayers, with incomes between $50,000 and $200,000, and that greater benefits are earned by larger households and families, such as those with children.
“Contrary to the claims of some economists, the benefits of the mortgage interest and real estate tax deductions are collected primarily by the middle class,” according to study authors Robert Dietz and Natalia Siniavskaia. “Of the total, 68% of the benefits of the mortgage interest deduction, and 77% of the real estate tax benefits are claimed by those earning less than $200,000. These same taxpayers pay only 43% of all income taxes.”
The research estimates the tax benefit (or tax expenditure) collected by home owners from these deductions, while accounting for factors that would “claw back” the net benefits, such as the Alternative Minimum Tax and the standard deduction.
The only government source of who benefits from the housing deductions is the annual tax expenditure report from the nonpartisan Joint Committee on Taxation (JCT). However, the JCT uses a broader measure of income than gross income or adjusted gross income (AGI) — what it calls “economic income” — which includes tax-exempt interest (largely from bond income), employer-paid Social Security taxes, employer payments for health and life insurance and more. As a result, most taxpayers would find that the JCT places them in an income grouping higher than the AGI on their IRS 1040 return would suggest, perhaps by $10,000 or more.
To compensate for this, the authors of the study used IRS Statistics of Income data and estimated the distributions of the benefits of the tax deductions by AGI, as well as reporting the JCT information.
The NAHB economists found that the JCT tables indeed overstated the benefit of the deductions to those in the top income group. “In 2004, JCT found that 75% of the mortgage interest deduction benefit was collected by those earning less than $200,000 in economic income, while we estimate with the IRS data that 79% was collected by those with less than $200,000 in AGI.”
Using the JCT data, NAHB’s Dietz and Siniavskaia showed the tax liability and mortgage interest deduction and real estate tax deduction benefits for five income groups — under $50,000, $50,000 to under $75,000, $75,000 to under $100,000, $100,000 to under $200,000 and $200,000 and higher. The authors report that the shares of the total benefits of the two housing deductions exceeded the shares of taxes paid for every income class except the last one, those earning $200,000 or more.
These data “demonstrate that the mortgage interest and real estate tax deductions make the U.S. tax system more progressive, not less, as is often claimed.”
Another way of looking at the data, the report suggests: “Taxpayers with less than $200,000 in economic income paid $396 billion in taxes according to the JCT figures and earned tax savings of $58 billion from the mortgage interest deduction and $19.3 billion from the real estate tax deduction (19.5% tax savings as a share of final tax liability). For taxpayers with incomes of less than $100,000 in income, $142.1 billion in taxes was paid and tax savings of $27.1 billion due to mortgage interest and $7.3 billion due to real estate tax were earned (24% tax savings as a share of final tax liability — a larger benefit for this lower income grouping).
The report adds that “for taxpayers with less than $200,000 in AGI, the average tax benefit of the mortgage interest deduction is equal to 1.76% of AGI. For taxpayers with more than $200,000 in AGI, it is equal to 1.5%. This is clearly indicative of a progressive tax benefit.”
Larger Families in Larger Homes
The study also examines the relationship between housing tax benefits and household size and addresses the criticism that the mortgage interest deduction provides people with an incentive to purchase a larger, more expensive home.
“While the conflation of size and cost is not exact — particularly if you consider that a more expensive home may mean a more energy-efficient home that is ultimately more economically efficient and valuable — it may also be the case that the causality is in fact reversed for this claim. It is more likely the case that larger families demand larger homes, and the tax incentives help these families more to finance these homes with debt, particularly for first-time home buyers who may have less equity in housing," the study says.
Using the IRS SOI data from 2004 and looking at the number of exemptions taken by taxpayers, the research found that the average amount of the mortgage interest and real estate tax deductions generally increased with the total number of exemptions claimed. For example, the average benefit of the mortgage interest deduction rose from $1,304 for a single tax filer to $1,735 for a three-person household to $2,008 for a household with five or more.
“These results are consistent with intuition,” the study says. “Larger households and families require larger homes. And larger homes require additional mortgage debt to finance, particularly for younger home buyers, who are or may be in the process of having children. These greater home finance costs imply larger deductions for mortgage interest and real estate taxes, and similarly greater tax expenditure totals for the same.”
To read the entire report — “Who Benefits From the Housing Tax Deductions?” — click here.
For more information, e-mail Robert Dietz, or call him at 800-368-5242 x8285.