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Should we pay for the mistakes of others?

July 27, 2007 · 0 comments

Last night, while at a reception for BlogHer, I was asked whether I thought that the mortgage interest deduction for homeowners would be eliminated.

“Of course not,” I replied.

“Even with all of this sub-prime mortgage stuff?” the person pressed.

“It won’t be repealed,” I said, confidently.

But back in my room, I started thinking about it some more. The context of my discussion, before the mortgage deduction came up, was this issue of the government encouraging or discouraging certain behaviors through its tax policy. And clearly, the government wants to discourage this sub-prime mortgage lending fiasco – but would it really happen at the expense of all consumers?

Maybe I shouldn’t have been so quick to say no.

The sub-prime bailout is reportedly going to cost our government over $10 billion per year. This is money that you and I both know the government doesn’t really have to spend right now.

And raising taxes? Not so popular right now either.

But repealing existing tax policies? It just doesn’t sound as bad on paper.

Don’t get me wrong. I think that repealing the mortgage interest deduction would be wildly unpopular. But it would not be viewed as “raising taxes”, rather it would be spun as tax reform, cutting a “bad” policy.

And the numbers are on the side of the government. According to the Tax Foundation, the home mortgage interest deduction will cost the government about $90 billion next year. Not exactly chump change.

And this isn’t exactly a novel idea. In November 2005, the Advisory Panel on Tax Reform under President Bush recommended eliminating the mortgage interest deduction and replacing it with a significantly smaller mortgage interest credit. The Panel also recommended eliminating the deduction completely for second homes and home equity loans.

Of course, that didn’t happen in 2005 while the housing market was going all kinds of bonkers. Now that the housing market is slowing down, raising fears about inflation and the US economy, the idea of eliminating an incentive to buy a new home is not exactly garnering much interest (yeah, a bad pun). Additionally, many taxpayers bought more house than they could afford over the past couple of years largely in part to the idea that “at least the interest was deductible.” Eliminating that deduction could have crushing consequences.

But it’s still out there as a possibility. Cutting the deduction (probably over time) could be snuck into an existing bill without too much fuss. It would probably be spun as some kind of a relief package. Depending upon the amount of the credit available, it’s possible that a majority Democratic Congress could vote yes since it would make them look like they support the middle class (if the second home interest deduction was eliminated) at the expense of the wealthy. And those that are lobbied by the lenders who are bleeding money will have made their folks happy. So maybe my “ain’t gonna happen” was a little rash. I still think the chances of something like that passing are slight – but not impossible.

What do you think? Should taxpayers pay for the bad decisions of lenders and consumers? Or should people just live with the consequences of their own decisions? Is it the place of government to bail out lenders?

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{ 2 comments… read them below or add one }

1 Robert D Flach August 6, 2007 at 8:08 am

I posted a belated response to your question on my blog at http://wanderingtaxpro.blogspot.com/2007/08/so-what-do-i-think.html.

TWTP

2 Vic Bottomly August 7, 2007 at 12:29 pm

I actually think the mortgage interest deduction is bad policy. (Maybe because I don’t have a mortgage).

If the idea is to encourage home buying, why not go for the gusto: a home purchase deduction but not an interest deduction. I’d even trade that for the capital gains break we have now. That would encourage thrift and savings and discourage debt and using the home as an ATM. Thrift used to be considered a good thing.

Except it would cause problems for the consumer-based economy lead to a liquidity crisis, I guess. Not like what we have today.

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