November 22, 2017
The NYT had a good piece discussing the potential impact of capping the mortgage interest deduction and property taxes on the housing market; however, the piece missed an important way in which the Republican tax bills would reduce the benefits of the mortgage interest deduction. The piece notes that doubling the standard deduction will reduce the number of people who itemize and therefore benefit from the mortgage interest deduction.
But both bills also end the deduction for state and local income taxes. Without this deduction, most homeowners will have few other deductions apart from their mortgage interest and whatever is allowed for property taxes. These deductions will be less for almost everyone than their standard deduction ($24,000 for a couple). This means that they would just take the standard deduction and the mortgage interest deduction would be of no value to them. (The Tax Policy Center projects that just over 5 percent of tax filers would still itemize their deductions if these changes in the tax code are put into effect.)
In fact, even if they still chose to itemize the mortgage interest deduction will be far less valuable under this new code. Suppose that they had $10,000 in property taxes that are deductible and pay $15,000 a year in mortgage interest and have no other deductions. Since the combined total of $25,000 exceeds the $24,000 standard deduction, it would pay for this couple to itemize; however, the benefit is much smaller.
Their benefit from itemizing is just the difference between their itemized deductions and the standard deduction. In this case, this difference reduces their taxable income by $1,000, saving them $250 on their taxes if they are in the 25 percent bracket. If we still had a $12,000 standard deduction, their itemized deductions would be reducing their taxable income by $13,000, saving them $3,250 on their taxes.
In short, by raising the standard deduction and reducing the number of itemized deductions that are available, the Republican tax proposals will be hugely reducing the value of the mortgage interest deduction even if they follow the Senate bill and don’t reduce the cap on deductible interest.
Addendum
Thanks to Robert Salzberg for calling my attention to the Tax Policy Center projection.
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