In the spirit of this thread, I'll contribute an article that I found some moons ago.
Enjoy,
-IR2
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full article, by Roger Lowenstein: <strong><a href="http://www.nytimes.com/2006/03/05/magazine/305deduction.1.html?pagewanted=2&_r=2&adxnnlx=1232694079-ZxzaMu9Y3VCQR8qhAmaAYw">A Brief History of the Mortgage-Interest Deduction</a></strong>.
Who Needs the Mortgage-Interest Deduction?
By ROGER LOWENSTEIN
Published: March 5, 2006
One of the first financial lessons I learned from my father was that when you buy a house, you get a tax break from deducting the interest on your mortgage. Therefore, he would explain as if it were as natural as pivoting at second base on a throw from shortstop, a person could afford to pay more for a house that he owned than he would on a residence that he was only renting and on which he didn't get the tax break.
I didn't know why the government had chosen to influence my decision in this manner, and even less did I consider how it might affect the people on the other side ? the people who might be selling me a house, or lending me the money, or, for that matter, the guy who might have liked to have rented me an apartment if the Internal Revenue Code hadn't been tilted against him.
But it was a lesson I took to heart. When I was considering buying my very first dwelling, a 1BR w/EIK on West 79th Street with, for those who were sufficiently agile, a faint glimpse of the Hudson River, I vaguely remember that I scratched out the monthly cost of the mortgage payment, after which Dad made some quick calculations to demonstrate that the "after-tax cost" of the mortgage actually was within my budget.
From then on, deducting the interest became an indispensable tactic (in fact, it was the only tactic I had) in my forays into real estate. The houses got steadily bigger, and so did the mortgages. Last year, when my new wife and I bought a modern colonial in suburban Boston that was intended to accommodate a majority of the children we had accumulated from our first marriages, not to mention a plurality of our itinerant relatives, I took out an "interest only" mortgage, a big attraction of which was that the payments (all interest, no principal) were entirely deductible.
By then, I did know something about what the government was up to. Or at least I thought I did. Some fellow in the Treasury Department had long ago decided it would be a good thing for families like ours not to suffer through our lives as tenants. In fact, he (whoever he was) decided it would be good for our neighbors and for society in general if we could be owners and not just dwellers. In early America, only those who owned property were eligible to vote, and the notion that tenants were only provisional citizens, or at least had a lesser stake in things, has somehow endured. According to studies, people who own their homes take better care of them; they fix the roof more often and plant more lilacs. They join more clubs and community groups; they vote more often; they move around less often; and their kids do better in school. The government is subsidizing my house so I will do more gardening. Or something like that.
But when exactly did the interest deduction begin? I had often heard my father rhapsodize about the G.I. Bill of Rights, which was enacted in 1944, when he was serving in the Pacific, and which a few years later was paying his tuition at law school; the mortgage-interest deduction came to be joined in my mind as an adjunct piece of social policy. One got you an education and the other got you a house: together, they bought entree to the middle class.
Since the great migration to the suburbs also occurred after World War II, I assumed that the interest deduction was of a similar postwar vintage. Over the years, it has become an American folk legend: the government invented the mortgage-interest deduction to help people buy their own homes, and the level of homeownership has risen ever since.
<strong>What part of the legend is true? Basically, none of it.</strong>
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The first modern federal income tax was created in 1894. Interest - all forms of interest - was deductible; the Supreme Court, however, quickly ruled that the tax was unconstitutional. In 1913, the Constitution was amended and a new income tax was enacted. Once again, interest was deductible.
There is no evidence, however, that Congress thought much about this provision. It certainly wasn't thinking of the interest deduction as a stepping-stone to middle-class homeownership, because the tax excluded the first $3,000 (or for married couples, $4,000) of income; less than 1 percent of the population earned more than that. The people paying taxes - Andrew Carnegie and such - did not need the deduction to afford their homes or their yachts.
There is another reason Congress could not have had homeownership in mind. The great majority of people who owned a home did not have a mortgage. The exceptions were farmers. But most folks bought their homes with cash; they had no mortgage interest to deduct.
When Congress made interest deductible, it was probably thinking of business interest. Just as today, the aim was to tax a business's profits after expenses had been netted out, and interest was an expense like any other. In a nation of small proprietors, basically all interest looked like business interest. Whether it was interest on a farm mortgage, or interest on a loan to purchase a tractor, or interest charged to a general store that purchased its inventory on credit, it all would have looked like a business expense. Credit cards did not exist. So Congress just said, "Deduct it."
It was not until the 1920's and the spread of the automobile that home mortgages outnumbered farm mortgages. In the 1930's, the mortgage industry got a huge assist from the feds - not from the tax deduction, but from agencies like the Federal Housing Administration, which insured 30-year loans, and, over time, the newly created Federal National Mortgage Association, or Fannie Mae. Before then, the corner bank would issue a mortgage and wait for the homeowner to pay them back; now savings and loans could replenish their capital by selling their mortgages to Fannie Mae - meaning they could turn around and issue a new mortgage to someone else.
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In any case, the growth of credit cards in the 70's began to turn the interest deduction into a serious loophole. People were becoming plastic junkies; if you paid for a washing machine on credit, the I.R.S. would give you a subsidy. By the 1980's, this threatened the entire system of revenue collection. There was some talk that the Treasury was looking at eliminating deductions, including, possibly, the interest deduction. Economists thought it was a good idea. "Tax economists tend to be skeptical about preferences in the tax," says Joseph Thorndike, the director of the Tax History Project at the nonpartisan Tax Analysts. "Are they targeted to the right people? We give tax breaks for college; do we send more kids to college or help middle-class kids who are going to college anyway?" Fine and well, but was an elected official really going to risk fooling with the mortgage deduction?
President Reagan was not. Addressing the National Association of Realtors in 1984, he said, "I want you to know that we will preserve the part of the American dream which the home-mortgage-interest deduction symbolizes." He didn't mention that it also symbolized the American love affair with debt; after all, it encourages people to pay for their homes with a mortgage instead of with equity. Two years later, in the tax-reform act of 1986, Congress ended the deductibility of interest on credit-card and other consumer loans; it left the mortgage deduction in place.
But Congress did set a cap. Today, a taxpayer can deduct the interest on mortgages worth up to a total of $1 million on his or her first or second homes. Also, you can deduct up to $100,000 on a home-equity loan. (And what prevents you from using a home-equity line to buy a flat-screen TV and then deducting the interest? Absolutely nothing; go for it.)
At the beginning of 2005, flush from his election victory, President Bush envisioned another major tax reform, somewhat similar to that of 1986. Simplifying the tax code was a major goal, as was winnowing out the tax breaks that were again eating a hole through the Treasury. Bush appointed a nine-member, bipartisan panel to drum up a proposal. The president ordered the panel to "recognize the importance of homeownership." People figured the interest deduction was off limits.
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One reason is that homeownership in the U.S. is about the same as it is in Canada, Australia and England, where interest isn't deductible. Another reason is just common sense. If you want to increase homeownership, you have to do something so that renters become owners. But just over two-thirds of all taxpayers, including most renters, don't itemize their deductions, generally because they don't earn enough; they simply take the "standard deduction." The mortgage deduction doesn't help them.
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<strong>You can think of the mortgage deduction as a distortion that has helped potential home sellers ? not buyers or owners ? and this is why the housing industry is so agitated.</strong> Research suggests that without the deduction, people would still buy the houses they do now; they would just cost a little less. In effect, the market would adjust downward to reflect some of the decrease in buyers' purchasing power.
