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» VISIT US ONLINE @ DSNEWS.COM POLICY PERSPECTIVE (and oft-maligned) mortgage interest deduction as impending tax reform draws closer. Time may be running out for the age-old W presidential running mate means that fiscal issues will figure prominently in the political debate through the fall. Such discussions inevitably turn to eliminating "tax loopholes"— an idea voters support, until it affects them. One person's loophole is another's justifiable, necessary deduction, and that's what makes reform so hard. Closing the deficit will mean slaughtering some sacred cows, and there is no cow more sacred than the mortgage interest deduction (MID). It's worth an estimated $100 billion a year to taxpayers—a large sum, even in Washington terms. henever the government is running short on funds, policymakers begin reexamining the tax code. So now, with federal deficits running in the trillions of dollars, it's no surprise that tax reform is in the air. Mitt Romney's selection of GOP budget hawk Rep. Paul Ryan as his vice- wark of middle-class prosperity and mobility. Opponents call it inefficient and unfair. The strongest criticisms come from the political margins: on the left, because it dispropor- tionately benefits higher-income earners; on the libertarian right, because it's viewed as a needless government intrusion in the market. Politicians, whose fortunes rise and fall with public opinion, usually find it wise to ignore it. As the debate rages, it's worth considering Proponents describe it as an essential bul- why we have a mortgage interest deduction in the first place. Contrary to popular belief, it wasn't invented to encourage homeownership. Described by some as "the accidental deduc- tion," the MID was embedded in U.S. income tax law from the beginning. A Different Time The 16th Amendment provided the constitutional framework for a federal income tax, and a few months later the Revenue Act of 1913 codified its provisions. Originally it was a modest "class tax" affecting only the wealthy: The base rate of 1 percent applied to incomes above $3,000 ($4,000 for married couples) with an additional surtax up to 6 percent on incomes above $20,000. To understand that in today's terms, imagine paying no tax on income up to $65,000 ($85,000 for married couples), then 1 percent on income up to $500,000. On income above that, the top marginal rate would be 6 percent. allowed for the deduction of "all interest paid within the year by a taxable person on indebt- edness." No distinction was made between business and personal interest—a quirk that became more important in subsequent years. Soon the rates increased drastically to finance U.S. involvement in World War I, and fluctu- ated between relatively high levels thereafter. Developments around World War II Along with business expenses, the act to Treasury staff. That was the only limit that was placed on the process—that we would leave the mortgage interest deduction alone." The MID, which began as a minor concession to a tiny fraction of wealthy taxpayers, was now a "symbol of the American dream," in Reagan's description. But the Tax Reform Act of 1986 that emerged did make some major changes. Toder, now a fellow at the Urban Institute, and co-director of the Urban-Brookings Tax Policy Center, notes, "It eliminated all other personal interest deductions. So, you could no longer deduct credit card interest; you could no longer deduct interest on a car loan." The MID survived, though it was now limited to mortgage debt on first and second homes up to $1 million—with another $100,000 for home equity loans. The Debate Continues Twenty-six years later, the country faces a made the interest deduction more important than anyone could have foreseen: The income tax base was broadened to encompass a large swath of the middle class, while the New Deal had created a vast new apparatus for facilitat- ing long-term mortgage loans. And with the introduction of the Diners Club Card in 1950, a new age of consumer credit was dawning. For the first time it began to make sense for mil- lions of middle-class taxpayers to itemize their deductions—including interest payments. Tax reforms were enacted in 1969 and 1976, but the interest deduction was left untouched. By the 1980s a ballooning federal deficit put reform on the agenda again, and President Reagan directed the Treasury Department to formulate a proposal. Eric Toder was an official in the Treasury's budget crisis that makes those days seem quaint, and a growing chorus of voices is calling for the abolition of the MID. One voice on the other side is Lawrence Yun, chief economist and SVP of research for the National Association of Realtors. He's particularly concerned about any change in policy now. "The housing market," he says, "is just trying to get its footing, and trying to recover in a sustainable way. And any tweaking or changes to the mortgage interest deduction would be a sudden, negative shock to the housing market recovery process. So, it would be the worst possible timing." Yun acknowledges the MID drives home Office of Tax Analysis at the time and recalls: "He [Reagan] made a speech in the spring of 1984 in which he promised that he would not take away the mortgage interest deduction. And that was the only direction that was given prices up, but he points out this "capitalization effect" has created real wealth for millions of Americans and removing it could deflate prices by 10 to 20 percent, indiscriminately. "Home value declines mean wealth destruction for all homeowners, independent of whether they are utilizing the mortgage interest deduction," he notes. "So, someone who bought their home 30 years ago, 15 years ago, 10 years ago—is it fair to somehow destroy their housing wealth 81

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