Wednesday, January 2, 2008

TAX | Deductible Interest Valuable to NYC

Jan. 2, 2008–City Limits Magazine includes a proposal (#7) to end the deductibility of interest paid on mortgages. The idea is the deduction encourages people to live outside of cities. (More people rent in the cities.)

But simply eliminating deductibility of mortgage interest without substituting a tax credit would exacerbate weakness in housing prices. It would especially affect New York City area homeowners:
1. NYC area homes cost more than the national average, so average mortgages are higher.
2. NYC area average incomes are higher than in the nation as a whole, so average tax rates are higher and more taxpayers are itemizing interest deductions.
3. Most NYC area taxpayers are subject to state and local income taxes, so the value of interest deductibility is higher than elsewhere.

President Bush's tax reform panel proposed ending the mortgage-interest deduction for homeowners that has been in the income tax code since it was created in 1913. The deduction benefits about 125 million U.S. homes but is under attack because Washington needs revenue and many economists believe there are better ways to structure tax incentives. The panel favors replacing the deduction with a 15 percent tax credit for mortgage interest up to a regional home-price limit. This would be a big change.

One feature of the panel's proposal that would be a minor change and would benefit New Yorkers is the panel's proposal for regional variation in the cap on tax-favored mortgage debt. The existing cap limits interest deductibility to a flat $1 million in mortgage debt. The cap does not allow for regional variation in housing prices and was instituted in 1987. Inflation has been steadily reducing the value of the deduction and the loss to the U.S. Treasury (and to NY State and NY City revenues).