Interest deductions would be broadened under new proposals

WASHINGTON — With signs of recession growing daily, new tax proposals are emerging here that could touch millions of American homeowners.

Last week, the most influential trade group representing home-mortgage lenders, the Mortgage Bankers Association of America, unveiled a housing-oriented economic-stimulus plan that includes broadened deductibility for interest payments on home loans.

The association called for an amendment to the federal tax code that would allow all homeowners with mortgages — not just those who itemize — to write off their annual home-mortgage interest.

Under the current tax code, homeowners who opt for the standard deduction on their income-tax filings are not permitted to write off mortgage interest as a separate item. The mortgage bankers say that prohibition is inequitable and hurts the economy because it takes money out of millions of Americans' pockets.

Deductions by itemizers — estimated to number about 33 million out of the nation's 70 million tax-filing homeowners — represent a huge financial benefit. This year alone, according to federal budget projections, homeowners will write off and pocket a record $65.7 billion in mortgage-interest payments. The savings are uncollected federal taxes on the regular income that they'd otherwise have to pay if they didn't have a home mortgage.

The mortgage bankers offered no estimates of how much larger the total write-offs would be if non-itemizers were allowed to claim the mortgage-interest deduction. But a real-estate economist estimated about 11.1 million additional taxpaying households would receive financial benefits — a new federal rebate, in effect — if they could take the deduction.

Who are the people who'd end up with net new money in their wallets? Federal estimates suggest they are predominantly moderate to lower-income families, as well as borrowers whose loans are relatively small, or are nearing the end of their amortization periods, when the interest components of monthly payments are low.

According to a congressional tax study this year, current savings from mortgage-interest deductions are gobbled up by the most-affluent homeowners — those with annual incomes of $100,000 and higher. Though they represent 32.2 percent of the total number of homeowning taxpayers who itemize, they pocket nearly 60 percent of the deductions.

Households with $30,000 to $40,000 annual incomes, by contrast, account for just 6.7 percent of those who itemize and deduct mortgage interest, and they receive less than 2 percent of the total revenue benefits. The mortgage bankers' proposal would presumably encourage most households now opting for the standard deduction to ask for a piece of the write-off pie — swelling the total cost of the mortgage-interest subsidy far beyond $65.7 billion a year.

Though the proposal came with no operational details, a source at the trade group confirmed that a "likely" approach would allow non-itemizing homeowners to attach a copy of their annual, lender-provided mortgage-interest reporting statements to their income-tax filing and to claim the interest deduction at their marginal tax rate.

Many of those write-offs, the source said, would be at the 15 percent bracket, but others would be at substantially higher tax brackets.

A second, radically different, tax proposal also has surfaced on Capitol Hill. Sponsored by U.S. Rep. Maxine Waters, D-Calif., and joined by 55 co-sponsors, the Home Equity Loss Prevention and Economic Recovery Act of 2001 (H.R. 2969) would allow taxpayers to deduct the interest on up to $10,000 worth of consumer debts.

The purpose, according to Waters, would be to "avoid the need to borrow against home equity," and thereby "to encourage economic recovery." The bill would amount to a partial rollback of provisions in the Tax Reform Act of 1986 that banned interest deductions on consumer and personal debts, but permitted them on home-mortgage and home-equity loan borrowings.

Since that time, millions of homeowners have shifted billions of dollars worth of credit-card, auto-loan and other consumer debts onto their homes to qualify for interest deductibility. That, in turn, has brought total home-equity debt loads to near-record heights this year, raising the possibility of sharply higher foreclosure rates in a recessionary economy with higher unemployment.

By allowing limited deductibility of consumer interest, Waters' bill would take some of the pressure off families to lump all their debts on their homes. Unlike credit-card and personal debts, mortgages and home-equity loans are "secured" — that is, the creditor can seize the underlying asset for nonpayment.

Both the mortgage bankers' and Waters' plans are new, and are unlikely to get attention this session in a Congress preoccupied with fighting a foreign war and domestic bioterrorism. But next year, they could be the focus of some energetic housing debate.