The Mortgage Interest Deduction

I'm no expert on the history of taxation, just someone who fumbles through his own form every April. But it is my understanding that prior to 1986, an interest payment on ANY personal loan was deductible.

That year there was a desire to raise revenues, in a way that wouldn't raise the marginal tax RATE, because supply-sider doctrine focuses on whether the tax rate is going up or down rather than on the question of whether a given taxpayer owes more to the IRS this year than he did last. So in 1986 Congress passed and Reagan signed a bill that removed the interest deduction from any loan. With the important exception of home mortages.

That exception was preserved on the theory that encouraging home ownership is a good thing. Apparently a non-controversial bipartisan notion in the US.

Obama's new budget limits the range of households that can take such a deduction, cutting it off at $250,000.

There is a lot that might be said about this subject. I saw a very interesting letter in the Wall Street Journal in late February. Richard P. Urfer, a fellow from Morristown NJ, wrote that the elimination of interest deductibility for everything except mortgages encouraged the misllocation of capital into housing. He also writes about a tax change [also in 1986?] that allowed tax free profits up to $500,000 on the sale of a primary residence (every two years).

These changes, says Urfer, transformed the home market into "a municipal bond-type investment vehicle." And everybody crowded in, although other sparks were necessary to turn this dry wood into the present conflagration.

Does Urfer's analysis sound plausible to you, dear readers?

At any rate, leaving my own anarchistic views out of account and thinking "within the box" of the current US political system in its broad outlines, I'll say this: there may be a case for abolishing the mortgage interest deduction altogether, completing the work that was begun in 1986. But there is no good case for creating a cut-off line at $250,000.

This is especially obvious if we agree that Urfer is right. If the exception made for mortgage interest in 1986 helped direct speculation into houses, then preserving taht exception but narrowing its scope with an arbitrary income limit won't do anything to prevent another go-round of this sort of boom and bust. All it means is that McMansions won't be part of the next go-round.

It may just mean that the next time there is a housing bubble it will be more intensely focused on middle and lower income housing than the last time. That's an improvement?

What if I were allowed to deduct the interest on payments I made to credit card companies if and only if I had incurred my debts to those companies in order to raise cash to gamble in a casino? The "gaming" industry would love this idea were it politically palatable at all. Would it be a wise policy?

If somehow we found ourselves in that situation and wanted to reform our way out of it, would it make sennse to keep the deduction, but put a household-income ceiling on it?