Paul L. Caron

Monday, January 24, 2011

Sullivan: The Mortgage Deduction Heavily Favors Blue States

Tax Analysts Martin A. Sullivan (Tax Analysts) has published Mortgage Deduction Heavily Favors Blue States, 130 Tax Notes 364 (Jan. 24, 2011):

The benefits of the mortgage interest deduction are not evenly distributed among the states. ... [T]he per capita tax benefit from the mortgage interest deduction for Californians is more than two and a half times that for Texans. Marylanders get nearly five times the benefit of citizens in neighboring West Virginia.

We always knew the mortgage interest deduction was unfair -- favoring those in high tax brackets with big houses over renters and low-income homeowners. But until we did the calculations -- as far as we know, the first of their kind -- we did not suspect the geographic dispersion of tax benefits would be so large. ...

In addition to the wide disparity in benefits, the other striking feature about the mortgage interest deduction is how well the subsidy correlates with Democratic strength. ... [The fourteen] states with the highest per capita benefit were states captured by Obama in the 2008 election [Maryland, District of Columbia, California, Connecticut, Virginia, New Jersey, Massachusetts, Colorado, Washington, Nevada, Hawaii, New Hampshire, Minnesota, Delaware]. In the six states with the lowest per capita benefits [West Virginia, Mississippi, North Dakota, South Dakota, Arkansas, Oklahoma], Republican challenger John McCain won the vote. ... Obama won the popular vote in 22 out of the top 26 jurisdictions, compared with 8 out of the 25 states with the lowest per capita benefits.

Unfairness of Federal Mortgage Interest Deduction:
Per Capita Benefits, Top and Bottom States, 2008

These new estimates give a glimpse into the future politics of tax reform and deficit reduction. As tax reform moves forward, we can expect Democratic senators to be the most lukewarm to proposals for limiting the mortgage interest deduction to less expensive homes. And if it is a choice between cutting the mortgage interest deduction and cutting tax subsidies for energy companies, that will be an easy decision for the senators from Oklahoma.

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Tracked on Jan 26, 2011 4:31:11 PM


Personally, I would like to see the tax code simplified. It is outrageous that the system is as complex as it is.

Posted by: High Point | Jan 26, 2011 9:33:28 AM

It is funny to listen to Red State conservatives start talking like liberals when it comes to an issue like this. When is giving back money to a taxpayer an entitlement? By not taking more of my money you are not giving me anything, you are just failing to take something that is mine. Every few days it seems some wonk is talking about Mortgage Interest deduction and how it needs to go away. Republicans own houses too and they like writing off their interest the same as Democrats and the fact that there are more poor people in Red states should be another discussion, not trying to pin the idea that it is liberals who want to keep the itemized deductions. The tax code is ripe with preferences for the rich. Not just this one.

Posted by: George W | Jan 25, 2011 7:53:22 AM

The second home deduction allows a family to maintain a home near a remote long-term job site.

Posted by: AMTbuff | Jan 24, 2011 8:00:38 PM

Maybe someone could explain to me why there's a mortgage interest deduction allowed on a second home? Why should a middle-class taxpayer subsidize a second home that he cannot afford to purchase on his own behalf?

Posted by: ColoComment | Jan 24, 2011 6:43:26 PM

It amazes me how often people on all sides of the political spectrum are so bent on making changes in tax laws on a quantum level. Deduction today, gone tomorrow. Income free today, hand it over sucka tomorrow.

It would be far better if every change in the tax laws had to be phased in gradually over a minimum of time. Amongst other things the Law of Unintended Consequences would not show up unexpectedly with a harsh judgment to follow. Stupid policies would be shown to be such before they killed their victims.

But I guess thats too much to ask.

Posted by: Tcobb | Jan 24, 2011 3:03:40 PM

Re:Posted by: Foobarista | Jan 24, 2011 1:49:37 PM

Simple solution is to reign in or lower the current $1mil cap on loan interest deductions. I don't know any middle class people living in $1mil homes. Current tax code still allows the tax deduction of the first $1mil if interest debt on homes with debt in excess of $1mil. Why? They can also phase in the new provisions much like they seemed to have done in 1987 if you read the current tax rules that exempt the $1mil cap for loans originated before 1987:

Posted by: Bryan | Jan 24, 2011 2:33:15 PM

Bob, it wouldn't be that much. That family of four already has a $10.5K personal exemption (assuming married, filing jointly). To properly figure the actual tax savings from a mortgage, you have to go by the following math:

total mortgage interest in a year - ($10.5K - schedule A deductions other than mortgage interest).

If the latter amount is less than zero, the whole interest is deductible.

But if it isn't, not all the interest is deductible. In fact, the point here is if the family lives in, say, Texas (with no state income tax), much of the mortgage interest may end up effectively not being deductible. (BTW, in your example, the family has about $7.5K of interest in the first year, decreasingly every year afterward, assuming a $150K 30 year standard-amortization fixed mortgage @ 5%.)

And for someone making only $50K with 4 kids, they are unlikely to have $10.5K of additional deductions - unless they live in a high-tax blue state (or give a bunch to charity, have really big medical expenses, etc).

Posted by: Foobarista | Jan 24, 2011 1:59:23 PM

Bill has made a very interesting point regarding the deductibility of state and local taxes. As it stands states with no income taxes, mostly red states, are subsidizing those with with income taxes.

Totally. CA and NY both have state income taxes in the 9% range.

Repeal that deduction. Why should the rest of the country subsidize these states?

Posted by: Eagle | Jan 24, 2011 1:56:02 PM

There is some incorrect information in the comments. First, the mortgage interest deduction is allowable for the AMT, so it definitely does not increase AMT liability. (The deduction for state and local taxes does increase AMT liability.) Second, the mortgage interest deduction is not phased out or disallowed at high incomes. It's capped at a $1M mortgage amount, but your income can be $5 billion and you still get the deduction.

The biggest problem with repealing the mortgage interest deduction is the penalty it would create for younger taxpayers with high mortgage payments as compared to older taxpayers who have paid off their homes. The latter have more disposable income, and under the current system they pay higher income taxes.

Posted by: AMTbuff | Jan 24, 2011 1:22:12 PM

We need some kind of consumption tax. No deductions and loopholes are fair. They should all be eliminated. Every. Single. One.

Posted by: Stephen | Jan 24, 2011 1:08:36 PM

I regularly hear from liberals that blue states are net tax donors and red ones net tax recipients. My reply to that is that the red states will happily do without blue state revenue if the blue states agree to do without the red states' food.

Posted by: West | Jan 24, 2011 12:14:31 PM

"The really interesting question is why blue states are such ardent supporters of a system that works so hard against them."

Ah, because it isn't about us against them. It benefits the individual, not the state or any other aggregate. People get a greater "benefit" solely because they pay more interest on a mortgage.

My wife and I get our interest deduction, and we could care less what other peoples deductions are.

Posted by: Keith_Indy | Jan 24, 2011 12:02:15 PM

Another factor affecting high borrowing for homes is the influence that environmentalists have on land use laws and regulations. This usually limits the development of new areas and drives up price for existing homes, especially in blue state metropolises, e.g. San Diego, LA, SF, Portland, OR and Seattle. Thomas Sowell has written on this subject.

Posted by: Paddy | Jan 24, 2011 11:58:03 AM

I constantly hear residents of CA complaining that they are a donor state, that pays more in taxes to the fed gov than they get in benefits. But I wonder if this morgage tax deduction disparity is factored into the calculation, so they are less of a donor state than they think?

Posted by: richard40 | Jan 24, 2011 11:51:03 AM

There is no red state subsidy to blue states. According to the Tax Foundation:

"Thanks to a steeply progressive federal income tax, states with a high average cost of living and commensurately higher incomes pay vastly higher federal taxes, payments that are unlikely ever to be matched by federal spending directed to those states. Ironically, most of these high-cost, high-paying states are the so-called blue states that have consistently supported a more steeply progressive tax system."

Moreover, blue states tend to get less back in Federal dollars than red states. My own state, NJ, which now has the highest local tax burden in the nation, is normally dead-last in terms of how much Federal money we get back. Nor does the income tax system take into account differences in cost of living.

The really interesting question is why blue states are such ardent supporters of a system that works so hard against them.

Posted by: Burke | Jan 24, 2011 11:25:43 AM

This is absolutely no surprise to me. We have a median-priced house in Texas and the only way we get any benefit from the mortgage interest we pay on taxes is by double paying property tax every odd year and itemizing only in that year.

Posted by: Blue | Jan 24, 2011 11:19:16 AM

Well, this should do a pretty good job of reducing the cost of housing by 2/3ds, just as a similar move did the same thing for commercial real estate in the 90's. Of course the elimination of the commercial mortgage interest deduction caused the Savings & Loan collapse. But we won't have the same problems here, and trillions of dollars of wealth won't be wiped out here because... um... well, we'll be able to do lots of neat things with the increased taxes we collect for one year before we've gotten rid of those pesky blue state homeowners.

Seriously - you're going to cavalierly kick the legs out from under the one investment market that >70% of the U.S. participates in? This is going to benefit Republicans how?

Posted by: Joe Blow | Jan 24, 2011 11:12:01 AM

These deduction issues are eloquent arguments for going to a flat tax. Some years back, when a number of flat-tax proposals were floating around (basic idea: a circa $11,000 deduction for each exemption with no other deductions, with the balance taxed at flat rate of circa 19%) I compared what I paid in my, then, latest return with what I would pay under the various flat-tax proposals. In some cases the tax would have been a little higher, in others, a little lower. I didn't care, it was all so much simpler -- and I'm writing as some one living in NYC. I recall a Sunday morning ABC news/talk, from that time, with Brinkley, Roberts and Donaldson. The guest was a flat-tax advocate -- perhaps Dick Armey -- who explained how it would work. In the "panel chat" during the closing minutes of the show, Brinkley said he was surprised how the tax would work, since he was under the impression that the flat tax rate applied from the the first dollar of income on -- and the fellow panelists of "informed" inside-the-beltway types, shared that mistaken impression.

Posted by: triplesec | Jan 24, 2011 10:59:32 AM

It never ceases to amaze me the lack of fiscal judgment some people have. Republican/Democrate I really dont care who you are, repealing the mortgage tax deduction would have a catastrophic affect on not only our nations economy (the repurcussions lasting for many lifetimes), but would devastate the middle class family and destroy the housing market here in the U.S..

Think about it this way, a person with a family of 4 with a $50,000 income would see their monthly disposable income go down by as much as $100 based on a 170k mortgage. Its pretty small but may be huge to a family of 4 at this level (no soccer for their kids or their kids can't go on the fieldtrip, etc. Also considering a family at this level has little to no disposable income anyways, this would mostl likely be a crushing blow).

Now consider a middle class family the backbone of our economy (which we all know is the single most important driver to economic stability). Assume a family of 4 with 100,000 income. These people would see their monthly income drop by $300 (triple) on a $270,000 mortgage. Considering this amount can be anywhere from 20%-50% of the middle class families disposable income, you should be able to discern what the affect this huge of a reduction in disposable income would mean with regards to spending in the U.S.. Remember, consumer spending accounts for 2/3rds of the economic activity and a majority of that spending is done by the middle class.

So the moral of the story is, if you repeal the mortgage tax deduction (which is already phased out for high income earners over $250k), you will destroy home prices (once again), decrease demand for homes (prices decline even more), people won't be able to sell their homes and will lose their life savings as a result when they go bankrupt (once again), Jobs will go away, more people will be unemployed as a result and we would have ghost towns pop up overnight (empty neighborhoods, etc.). The impact would not just be on housing but would also be on rental properties since housing and rental prices are inversely tied to each other. As a consequence, home price declines would result in rental price increases as the demand for rental units increases relative to the decreased demand in housing. So basically not only did you kill the economy, you killed the american dream and we now all will live in overly priced rental units with no yards, parks, etc. and at the whim of our landlords (think slums).

Anyways your choice but it is really very short sighted.


A Republican.

P.S. your Democratic take makes no sense, Republicans spend less and tax less, while democrats do the opposite. So since repealing the mortgage deduction is like increasing taxes (which everyone agrees is a bad idea) it is a very Democratic type move to repeal the deduction which is contra to your observation in that Democrats would fight the hardest to keep the deduction.

Posted by: Bob | Jan 24, 2011 10:53:03 AM

The irony is that the houses are more expensive in part due to the tax deduction itself, which could amount to a six-figure government subsidy over the course of a 30 year mortgage in a high-cost area. After all, the tax deduction means you can "afford" a higher mortgage payment, so you're inclined to buy more house (or a house in a more expensive neighborhood, etc).

Posted by: Foobarista | Jan 24, 2011 10:49:37 AM

What's missing here is the behavior that leads to the tax deduction: the payment of mortgage interest. The states cited as benefitting the most from the deductability of mortgage interest are generally the ones with the highest housing costs and, therefore, the highest mortgages. I only get a deduction because I paid the mortgage interest. In that sense, it's not an entitlement.

As a California homeowner, I don't feel particularly blessed with this deduction. It certainly makes my house more affordable, though. I know I'm in the minority because I'm one of the few who are still paying their mortgage.

Posted by: Joe | Jan 24, 2011 10:38:46 AM

To be fair, the states that receive the most benefit from the mortgage interest deduction also have higher living costs. These costs lead to higher salaries which induce higher income tax (including pay-roll taxes) and possibly even the alternative minimum tax. The people who are getting the short end of the stick are renters in the blue states.

Posted by: Simmer | Jan 24, 2011 10:30:57 AM

and everyone of those blue states is more prone to paying AMT rate taxes, with those deductions for interest AND state income tax tipping you into AMT land.

Posted by: bob | Jan 24, 2011 10:20:57 AM

The state of California does have a state tax deduction for eligible renters and is structurally geared to support a great deal of low-income homeowners/no-income (Democrat) voters.
California tax/ownership bias doesn't seem to have helped stem the rising tide of relocation as non-vested people flee the tax-hostile state.
Meanwhile long-term homeowners are held in place by the regulatory-capture effected by the benefits of CA-specific Prop-13, whereby low-cost residential property-taxes make it simply un-affordable to move elsewhere. I'd like to move because of the hostile regulatory/tax/freedom environment, but I can't afford to since my property taxes will skyrocket beyond recognition.

Posted by: DirtCrashr | Jan 24, 2011 10:20:48 AM

I think the converse of this is blue states are generally higher income and therefore contribute more in income tax.

Posted by: st louie mo | Jan 24, 2011 10:20:14 AM

Wait till they look at the disparate impact of deducting State and local income taxes from Federal income taxes. There's a fat subsidy to Blue States too.

Posted by: Frightened | Jan 24, 2011 10:18:42 AM

Wrong. The Republicans will defend this mortgage interest deduction tooth and nail, whatever the demographic-political breakdown may look like. (Good work on that front, by the way.) Their solution to the exemption of Federal taxes for employer-provided health insurance, which is arguably the original sin of our entire government-distorted health insurance market with its lush tropical jungle of mandates and restrictions and tort opportunities and third-party payment schemes, is to expand the exemptions even further.

They will do the same on this one, even though there is good reason to believe that the exemption is a big reason why our housing market was in such worse shape than that of, say, Canada, which lacks such tax exemptions.

Posted by: voltaire in '08 | Jan 24, 2011 10:02:09 AM

One more item that also has been overlooked is the tax exempt status of state and municipal bonds. I amy be wrong but it appears that the blue states have a disproportionate amount of the bonds issued and are more apt to run much higher deficits proportionally than the red states. If mortgage deductibility goes so should state and local tax deductions and eliminate the tax excempt status of state and municipal bonds.

Posted by: cubanbob | Jan 24, 2011 10:00:39 AM

Mortgage interest, state and local taxes, AMT; all have huge constituencies in the deep blue states wanting to keep their entitlements...uh, deductions.

Posted by: CR | Jan 24, 2011 10:00:21 AM

Bill has made a very interesting point regarding the deductibility of state and local taxes. As it stands states with no income taxes, mostly red states, are subsidizing those with with income taxes. Also the blue states where the market housing is so much more expensive is in part due to land use restrictions and zoning and rent control. Again subsidized by the red states if the deductibility logic is taken to it's conclusion.

Posted by: cubanbob | Jan 24, 2011 9:55:08 AM

This should come as no surprise to anyone. The top states are all expensive housing markets and coastal states where, with the exception of the southern coast, we find blue states congregated. The Blue States also bear a disproportionate share of the AMT. They are higher income states with higher property taxes and mortgage interest payments.

Back in 1986 when there was an attempt to repeal the deduction for all state and local taxes, it was the same states that fougfht hardest to retain it.

Posted by: Bill | Jan 24, 2011 7:56:03 AM