Thanks to our old trusty mortgage interest rate deduction, Californians saved deducted an average of almost $19,000 from their tax bills in 2008, the highest amount of any state. The national average was a little over $12,000. The Tax Foundation, which did an analysis of IRS data, is none too pleased.
"Sound tax policy dictates that interest payments be deductible only when they are incurred to produce taxable income, such as those resulting from a small business loan. Mortgage interest on a principal residence doesn't meet this requirement, but a special exception was carved out at the inception of the income tax in 1913, and the mortgage interest deduction has become one of the largest and most sacrosanct loopholes in the tax code."
Daniel Gross had a pretty good assessment of the giveaway in Slate several years ago, well before the housing bust.
The deduction plainly causes distortions. People are willing to pay more for houses and buy bigger houses than they otherwise would because they can deduct the interest from their taxes. "When Americans invest the bulk of their life savings in housing, that's a redistribution of capital from the productive business sector," said Martin Sullivan, a contributing editor of Tax Notes. What's more, the expansion of the deduction seems occasionally to have more to do with stimulating the financial-services industry than with allowing Americans to turn their homes into assets. Consider the growth of interest-only mortgages. With the deduction, the government is effectively subsidizing your monthly payment. But you're not building any equity, you're just paying rent. It's hard to say how an interest-only loan encourages home "ownership."
Lots of the interest-only nonsense has disappeared with the housing downturn. But as Conor Dougherty notes at Real Time Economics, the deduction "remains an untouchable tax break and a third rail of American politics." Here's the breakout of the big winners:
--California $18,876
--Hawaii $16,730
--Dist. of Columbia $16,720
--Nevada $15,502
--Washington $14,262
--Maryland $14,162
--Virginia $14,094
--Arizona $13,616
--Florida $13,375
--Colorado $13,300
--New Jersey $13,215
*As several readers pointed out, I goofed in describing the $19,000 as tax savings rather than a reduction in the amount of taxable income. Big difference. The amount of savings would depend on the income bracket.