Sir Isaac Newton’s third law of motion states that, “For every action there is an equal and opposite reaction.” I contend this law is not limited to the world of physics, but also the financial realm.
As the U.S. government continues to run up massive deficits, no doubt all parties will continue to search for spending cuts that help shrink the revenue versus spending abyss. Frequently discussed is eliminating the mortgage interest deduction (MID). As discussed in a previous blog, http://blog.stewart.com/stewart/2012/12/18/home-mortgage-interest-deduction-on-the-chopping-block/, the MID costs the U.S. Government $100+ billion per year in lost income tax collections. At the same time, no doubt, the MID has incented more households to be homeowners, and that, some of the tax savings have been capitalized into home values today. Under current rules, the interest expense on an individual’s primary and secondary home for loans totaling up to $1 million can be deducted from an individual’s taxable income as long as the loan(s) were used to acquire or improve the property.
So what would happen if the MID was eliminated besides a decline in home values and perhaps fewer homeowners? Studies referenced in the previous blog post in December 2012 proffered a reduction in home values from 6.9 to 15 percent. But are there other ramifications outside of just the impact on home values?
The answer is yes, based on a recent study completed by the Tax Foundation, a non-profit located in Washington, D.C. The Tax Foundation viewed the impact of eliminating the MID on the overall economy and concluded:
- The U.S. government would collect $101 billion of income taxes that the MID eliminates
- GDP, however, would shrink $254 billion due to spending cuts by consumers (since they will pay more taxes, they would spend less)
- 659,000 full-time-equivalent jobs would be eliminated due to the decline in GDP
- Overall hourly wages would decline 1.1 percent
- To counteract the decline in GDP (and achieve the same level of spending), an across-the-board 6.8 percent tax cut would be required
According to the Tax Foundation’s analyses, the act of collecting these taxes would increase the taxes paid by these homeowners, and at the same time reduce their spending. That reduction in spending would eliminate 659,000 jobs and reduce hourly wages 1.1 percent. Hence the use of Newton’s Third Law of Motion.
To read the entire Tax Foundation analyses, click http://taxfoundation.org/article/case-study-1-mortgage-interest-deduction-owner-occupied-housing. This is one section of an 11 part series by the Tax Foundation examining the impacts on revenues, employment and wages for altering taxes and deductions as known today.
To quote Sir Isaac, “For every action there is an equal and opposite reaction.” And that includes the home mortgage interest deduction.