$100 billion mortgage interest deduction may be in play.

A battle of epic proportions is brewing as part of the federal budget process. Pressures to reverse the rapid growth of the federal budget deficit have implications for both spending programs that affect housing as well as current tax laws. A recent congressional report from the Congressional Research Service, a research arm of Congress, has broken down the value of major tax breaks, which total more than $1 trillion a year. This is about the size of the annual federal budget deficit. Current tax breaks benefit almost all segments of the population, including homeowners.

At almost $100 billion a year, the mortgage interest deduction accounts for 8.1% of all federal tax deductions, behind employer-provided health insurance, $164.2 billion a year and the exclusion for employer-provided pensions, second largest at $162.7 billion. Exclusions for Medicare and Social Security benefits rank fourth at $76 billion annually and 6.1%.

A number of leading economists and advisory groups are recommending that the mortgage interest deduction be restructured, but that the net tax incentives remain at $100 million a year. Latest to join the call to modify the deduction into a tax credit is Yale Economist Dr. Robert Schiller, who is widely recognized for his work on the history of stocks as well as housing prices. As part of a comprehensive package that would lead to substantial deficit reduction, both President Obama’s Simpson-Bowles Deficit Commission and the Debt Reduction Task Force of the Bipartisan Policy Center have recommended the replacement of the current mortgage interest deduction with a flat mortgage interest tax credit.

All three have recognized that the current mortgage interest deduction has become very inefficient. It offers little or no incentive to most first time buyers, who end up paying the same amount of tax whether they take the standard deduction or itemize the mortgage interest and taxes.

First time buyers are key to restoring liquidity to the housing market. Low mortgage interest rates haven’t been sufficient to persuade them to risk losing money by purchasing a home that may be worth thousands of dollars less next year. The home ownership tax incentive for potential moderate income first time home buyers has largely evaporated over time.

A couple who currently rents typically takes the “standard” federal income tax deduction ($11,600 in 2011) because it is much greater that the amounts they could deduct if they itemized their deductions instead. That’s about the same as the mortgage interest and real estate tax payments on a $130,000 mortgage, which they could itemize if they buy a home. Most renters have relatively small amounts of other itemizable deductions. Most of them are also in a low income tax bracket, so the relatively small total increase in itemized deductions they might get from buying a home isn’t worth much after taxes.

Our research suggests that the net tax savings for many potential first time home buyers under the current mortgage interest deduction formula is only worth $25-$50 a month. Obviously a potential tax savings of $300 - $600 a year doesn’t provide much incentive to risk buying a home that could drop $3,000 - $5,000 in value over the next year.

This is not to suggest that the mortgage interest deduction formula does not provide a significant tax incentive for home ownership for most people. A high income taxpayer with a million dollar mortgage can save tens of thousands of dollars in taxes every year because of the mortgage interest deduction. In the current market he may have trouble selling that home because the person that might by his home is stranded for lack of a buyer of his own home. This liquidity challenge problem extends down the home ownership food chain to the first time buyer, who usually liberates 2-3 upstream transactions.

One way to increase the number of first time buyers would be to make the home ownership tax incentive equally beneficial to them as it is to wealthy home buyers who have large mortgages.  A flat mortgage interest tax credit that was the same rate for all homeowners regardless of their tax bracket or the size of their mortgage, would give first time and returning buyers a substantial tax incentive to buy a home. Tax credits are subtracted from tax liability after deductions are taken on your federal income tax forms, so first time or returning buyers could still take the standard deduction. As a result they would realize all the home ownership tax benefits of a tax credit. A flat mortgage interest tax credit would be proportionate to the size of the mortgage, so it would be much more fair that the current formula. The tax benefits on the mortgage interest paid on a $1 million dollar mortgage would be ten times the tax benefits on the mortgage interest paid on a $100,000 mortgage.  

Many first time or returning buyers would find they could save $100 - $200 per month on their federal taxes with a mortgage interest tax credit versus only $25-$50 a month under the current mortgage interest deduction formula. As a result home ownership would then become substantially less expensive than renting for many potential first time or returning buyers. While this approach would be somewhat less generous than the current formula to homeowners in higher tax brackets with large mortgages, the home ownership tax incentives for wealthier homeowners would still remain very substantial. For the average homeowner the net effect would be the same as today. If the tax credit is set at a level that is neutral with respect to federal tax revenues (i.e. the same impact as the current mortgage interest deduction) home ownership tax benefits over a typical homeowner’s lifetime would remain the same as they are today. The benefits would simply become more front loaded with this approach,  making home ownership far more attractive to first time and returning home buyers.

These are the folks we need to attract to home ownership if we are to restore health to the housing sector. We also need to help the many homeowners who are currently threatened with foreclosure. Many of them are in lower tax brackets due to job losses or cutbacks in working hours. For them the current mortgage interest deduction formula produces little tax savings. Many would be able to get by if their cash flow increased by another $100 - $200 per month and a flat mortgage interest tax credit would improve their cash flow by that amount.

There are additional reasons to restructure the mortgage interest incentive as well. Homeowners enter retirement with more savings than renters at the same income levels, mainly due to their accumulated home equity. Homeowners are thus less likely to become dependent on needs-based federal programs such as Medicaid later in life, and their accumulating equity is also a buffer against financial challenges throughout their career. Policymakers recognize that we need to reduce the costs of many federal social programs as part of our deficit reduction efforts. One way to do that is to encourage more renters to become homeowners, and to do so earlier in their careers, by replacing the mortgage interest deduction with a mortgage interest tax credit.

The housing sector remains weak, so there’s little chance that Congress will cut back on the current $100 billion in annual home ownership incentives. There’s also little chance that the amount will be increased given current budget realities. However the housing recovery will receive a significant boost if Congress simply replaces the current deduction with a tax credit that has the same overall tax impact.

Because of widespread support the other top four tax incentives (employer-provided health insurance, the exclusion for employer-provided pensions, and exclusions for Medicare and Social Security benefits are relatively unlikely to see substantial modification as part of the budget process. This will make it difficult for House Republicans to include them as part of an unspecified array of tax breaks to be eliminated in order to offset the costs of lowering top tax rates for both corporations and individuals to 25%, from the current 35%, as they proposed in a budget unveiled in late March.

There is far less public support for maintaining the current preferential rate for capital gains, which ranks fifth in terms of annual revenue losses at $71 billion and 5.8% of federal tax deductions. After that things get harder. Other tax deductions further down the list account for smaller amounts of tax savings, and many are very popular (the earned-income and child credits, deductions for state and local taxes, and charitable deductions).

The Congressional Research Service report, noted that "it may prove difficult to gain more than $100 billion to $150 billion in additional tax revenues" by eliminating tax breaks. Even that amount seems optimistic, so it is difficult to imagine where the necessary revenues to fund the Republican corporate and personal rate cuts would come from.

In late March a bipartisan group of U.S. Representatives offered a resolution that called for Congress to use the Simpson-Bowles Deficit Commission /Debt Reduction Task Force’s recommendations as the models for a Congressional budget that would reduce the deficit by $4 trillion. Since its December 2010 release, the Simpson-Bowles plan has become recognized by many independent budget analysts as the best hope for reducing the deficit and restoring the nation’s economic health.

Unfortunately both conservative republicans and liberal democrats voted against the measure, which was supported by the dwindling number of moderates in the House of Representatives. Instead, the House adopted a conservative Republican budget proposal that has no chance of passing in the U.S. Senate. If the Senate and House eventually compromise and approve a package that reduces the deficit, it will likely look much like the Simpson-Bowles Deficit Commission /Debt Reduction Task Force’s recommendations. In that scenario the aforementioned changes in mortgage interest incentives for home ownership could become law. Unfortunately it is even more likely that conservative republicans and liberal democrats will be unwilling to compromise in this election year, and that Congress will approve only another stopgap measure that only pushes the resolution of this serious threat to our economy into 2013.

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Congressional disapproval ratings are at all time highs.

Retiring Congressman Dennis Cardoza recently authored the following analysis of the challenges faced by Congress today. We share his thoughts with you because we believe that they help explain the astounding disapproval rating (nearly 90%) that voters express about Congress today.

By Rep. Dennis A. Cardoza (D-Calif.)

Favorability ratings don’t lie. In politics, when your approval rating is below 50 percent, you’re on shaky ground. When you’re between 4 and 13 percent -- as this Congress consistently is -- you’re in revolution territory! Congress is officially broken due to extreme partisanship on both sides. The real question, however, is who is left to step up and fix it?
 
Over 40 percent of the voters in the nation identify themselves as “moderates.”  However, less than 10 percent of the current members of Congress would self-identify the same way. Congress was designed to represent a cross section of America. This is no longer the case. 

Lately, the media has made much of the fact that centrists are leaving the Senate in droves, with the departures of Senators Olympia Snowe (R-Maine), Kay Bailey Hutchison (R-Tex.), Joe Lieberman (I-Conn.), Kent Conrad (D-N.D.), Ben Nelson (D-Neb.), and Jim Webb (D-Va.) at the end of this year.

There is rarely any mention that this exodus already happened in the House in 2010 – albeit mostly involuntary – and the resulting gridlock should serve as a warning. Scores of Blue Dogs and moderate Republicans either resigned or lost their elections when the Tea Party took power. This extremism has absolutely devastated the day-to-day operations of the House. With a great many more moderate retirements already announced in 2012, I don’t see any improvement on the horizon.

The situation is made worse by the “seniority system.” The most senior members with the safest (most partisan) districts stay the longest, gain the most clout, and become chairmen and leaders. The result is that the partisan skew is magnified. As Congress continues down this ever-increasing path of hyper-partisanship, the pressure on and frustration among sitting moderate members steadily increases until we choose to retire.
 
There are serious “real world” consequences for the lack of moderates in government, too. Businesses are getting caught up in a vicious tug of war between regulation-happy liberals and live-free-or-die conservatives. The other day I spoke briefly to a group of CEO’s from across the country. One of their biggest complaints was that it takes too long to get anything done these days. I could not agree more. Trivial regulation is clogging America’s economic arteries, stymieing our “can-do” spirit that made this country great. During World War II, a time of great crisis, the Pentagon was built in 18 months. Today, the environmental permits for the parking lots alone would take 10 years.
 
But that doesn’t mean our government should scrap every safeguard and always say "yes." Our leaders have a duty to protect the public interest, and not every project or program should get approval. In those cases, a swift NO is much more desirable for all concerned than death by a thousand paper cuts or, more correctly, being crushed by reams of environmental documents. Sensible moderates are needed to balance competing interests, so the pendulum of regulation doesn’t swing too far in either direction.
 
We need a change of heart in how legislating is done.  Leaders – and the voters who elect them – need to recognize that “compromise” isn’t a four-letter word. The purpose of legislating isn’t to grandstand – it is to work out differences and find commonality that is in the best interest of our country.
 
Members of Congress from both parties must take responsibility for getting things done, or our representative democracy will fail. 

The American Homeowners Grassroots Alliance believes that Rep. Cardoza is absolutely correct. The solution lies in the hands of the 40 percent+ of the voters who are “moderates.” Too often moderates fall for the post-primary pitches of far right or far left candidates who attempt to reposition themselves as more moderate than they actually are during the general election campaign. Moderates all too often simply vote for whichever one they perceive as the lesser of the two evils. 

Moderates need to become more militant. The solution for moderates to vote for neither, and don't contribute to their campaigns of either. Don't contribute to the national committees of either party because both are presently controlled by the far right and far left. Instead support and vote for moderate candidates only. In some cases you'll have to go down the ticket to the level of the local dog catcher before you find a moderate you can vote for. That's ok, because if the dogcatcher gets 50% more votes than the successful right or left wing local mayoral candidate, it will both send a message and help advance the dogcatcher's political career.

Congress will continue to become increasingly dysfunctional until moderate voters recognize the cause of the problem and take matters in their own hands. They need to get involved as volunteers in the campaigns of moderate candidates, whatever their party affiliation, and do everything they can to help spread the word.

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