Saturday, December 31, 2011

The Moral Act

Charles Pierce at Esquire:
It is a dead-level time for us as a people. There are now 146 million Americans who are ranked as "low-income" or "poor." Somebody really should do something about that. How we treat them in our politics is going to be the ultimate test of our moral credibility as a nation. Do we treat this situation as the national disgrace that it is, and commit ourselves as a nation to eliminating it? Or do we turn away from them, blame them for the malaise we feel in our lives, and drink deeply again from the supply-side, trickle-down snake oil? Do we look at the president — a Democratic president — and scream that this is no longer tolerable to us as a people? Or do we nod sagely and deplore the lack of civility and bipartisan cooperation in our government and hope that cooler heads will prevail, that the great national purpose of our age is to deprive ourselves further of what was supposed to be the promise of the country in the vague and futile hope that somehow, somewhere, things will get better down the line?  
The moral act is to scream.

The 47%

Much has been made of the 47% who, allegedly, don't pay taxes. As better articles will note, this excludes a lot of taxes, such as excise taxes, sales taxes, state income taxes and property taxes, as well as Social Security taxes. What the 53% crowd is trying to say is that 47% of Americans don't pay federal income tax. And why is that?

Kevin Drum did the math and reports that:
  • 23% pay nothing because they're poor. A couple making less than $19,000, for example, doesn't owe anything after their $11,600 standard deduction and two exemptions of $3,700 each reduce their taxable income to zero....
  • 10% are elderly and pay nothing because their Social Security benefits are [generally] exempt from federal income taxes. 
  • 7% pay nothing thanks to provisions in the tax code designed to benefit low-income families: the earned income tax credit, the child credit, and the childcare credit account.

All of which leaves us with about 7% who don't pay federal income tax because of deductions, tax-exempt income and the like.

But everyone who worked paid Social Security taxes.

So a reader asked how much Social Security revenues are attributable to these folks who, allegedly, don't pay taxes. An exact answer is impossible with the data we found, but we can come up with something close.

According to the Social Security Administration, a little over 48% of Americans made less $25,000 last year. Yet this group still managed to contribute $25 billion dollars to Social Security -- some 4.7% percent. That's actually more than the top 1% contributed ($23 billion or 4.3%). Now, sure there are a lot more people making less than $25,000 a year (72 million, give or take) than there are in the 1% (roughly 1.5 million), but that 1% does control 40% of the nation's wealth. So they've got that going for them.

But there is something a bit odd about that 48% -- namely, a full 100% of their earned income was subject to Social Security taxation. In fact, the same is true for the bottom 94% of working Americans. It's really not until the top 1% where you can see the benefit -- to the very well off -- of capping Social Security taxable income at $106,800. At that point, only 9.4% of their earned income is taxed by Social Security -- and none of their income derived from capital gains.

A PDF of the Excel spreadsheet used to divine these numbers can be found here

Friday, December 30, 2011

Saving the Post Office through Financial Reform-ish

We wouldn't normally take the time to solve a problem which has largely been fixed, or that wasn’t that big of a problem in the first place, but the situation with the United States Postal Service is an opportunity to sneak in a little financial reform, and all in a historically appropriate manner.
In late 2011, much to do was made of the postal service’s financial condition. They were $8.5 billion dollars in the red, and Republicans were raising the usual cry for privatization (and further paring down union membership). The causes cited were generally high labor costs – some 80% of its budget – and the replacement of snail mail with e-mail.
We’re pretty sure no one got rich working at the post office, but it is undeniable that e-mail is proving to be a worthy substitute for regular mail in most cases.
But there is an additional reason for the postal service’s financial woes; namely, the Postal Accountability and Enhancement Act of 2006. Despite its non-threatening title, this law created a burden for the postal service which no other entity of the government -- or the private sector – faces. The postal service is now required to pre-fund 75 years of its employee benefits within a ten-year period.
We note in passing that Republicans, at that time, controlled the White House, the Senate and the House of Representatives. Coincidentally, there are more than a half million union members working at the post office – 47,000 with the National Postal Mail Handlers Union, 220,000 with the American Postal Workers Union, and 300,000 with the National Association of Letter Carriers.
The effect was drastic.
The USPS went from running a surplus in 2006 to running a $5 billion deficit in one year – despite seeing its revenue grow by $3.2 billion. The deficit is entirely due to the increase in expenses, which shot up $8.2 billion, or 11%.
So while we do need to junk this atrocious law, demand for the postal service’s, um, services, will continue to slacken, and adjustments must be made.
The USPS has done an admirable job at this, suggesting a slew of reasonable cut-backs, namely relaxing delivery times – right now, 40% of all first-class mail is delivered within one day – and eliminating Saturday deliveries; shuttering half of the 487 mail processing centers around the country and closing 3,700 of the nation’s 32,000 post offices; and eliminating about 100,000 of its 653,000 jobs.
We’re not happy at the loss of union jobs, and we’re concerned about how the closing of post offices will affect rural customers, who are not as well served by the internet as those in urban areas. To help the friendly folk at the post office, we’d like to propose that the United States Postal Service … get in the banking game.
Actually, the USPS is already in the banking game, as it sells money orders – $1.10 gets you a money order up to $500, and $1.55 gets you one up to $1000. And, until 1967, the USPS ran its own bank – the United States Postal Savings System. Citizens who were concerned about the financial health of banks (and their ethically dubious business practices) had an easy-to-use alternative. At its peak in 1947, the Postal Savings System held $3.4 billion in deposits, or $32.8 billion in 2010 dollars. This would have made them the 37th biggest bank in America.
By comparison, Citibank and Wells Fargo each have roughly $800 billion in deposits, and Bank of America and JPMorganChaseManhattanChemicalBankManufacturersHanoverBankOne have over a trillion dollars in deposits. The fifth biggest bank, U.S. Bank, has a mere $200 billion.
There are several great reasons why getting the Postal Savings System up and going again would be a good thing.
#1.  A lot of people can’t afford banks. A Pew Charitable Trust survey found that many households in the old Confederacy – figure that – don’t have checking accounts.
From the WashingtonPost

And both the FDIC and Pew suggest that about a third of all people who closed a bank account did so due to high account fees. 

#2.  Banks don’t want small customers. Felix Salmon at Reuters reports:
All four of the big banks have a standard checking account with a monthly fee which is waived once you keep a monthly balance of more than $1,500. At Wells Fargo, that fee is $5. At Citi, it’s $10. At Chase, it’s $12. And at BofA, it’s also $12, rising to $17 if you use your debit card.
Oddly, Felix is in a good position to judge these matters, as he was on the board of the Lower East Side Federal Credit Union. They, too, have a checking account fee – but it’s:
$3 a month, for people carrying a balance of less than $75 — essentially, a way to discourage people from keeping bank accounts open and unused with no money on deposit.
#3.  Banks are evil. The Pew study found that:
  • the median length of bank disclosures for key checking account policies and fee information was 111 pages;
  • overdraft fees will cost American consumers an estimated $38 billion in 2011—an all-time high; [and]
  • banks can maximize the number of times an account “goes negative” by reordering deposits and withdrawals to reduce the account balance as quickly as possible.

In addition, the Pew Charitable Trust reviewed how Wells Fargo treated one of its customers, Veronica Gutierrez, to extort more money from her.
Here are Gutierrez' charges in chronological order.
From the Pew Charitable Trusts

And here is how Wells Fargo maximized the penalties they could impose on her. 
From the Pew Charitable Trusts

Yup, the quadrupled their revenue.
#4.            Reducing balances held at the makes them less profitable. This is a feature, not a bug. The fewer deposits a bank has, the less it can lend out. And the less it can lend out, the less profit it makes. With less profit, the bank has less money to go to PAC and lobbyists. Maybe then we wouldn’t have a fiasco where the most qualified person to head up the Consumer Financial Regulatory Bureau – Elizabeth Warren – wasn’t even nominated, and the second choice – former Ohio attorney general Richard Cordray – couldn’t get an up-or-down vote.
#5.            It’s cheap funding for the federal government. Okay, $32.8 billion isn’t a lot of money when compared to a $3.83 trillion budget, but it’s something. But that number would explode if state and local governments were required to place their accounts there, instead of holding them at banks. See, also, #4.
#6.            It would be dirt cheap to do. Some of the biggest costs of banking are building and maintaining its branch offices, and payroll for tellers and the like. With the Postal Savings System, these costs would be … $0. The buildings are already in place, and the employees are already there. To be fair, some costs would be involved in things like setting up an on-line banking facility, but these would be minimal in comparison to the benefit of having 28,000 branch offices up and ready to go on Day One.
By comparison, Bank of America had 5,856 branches in 2010.
*                                   *                                   *
Now that we’ve come up with extra revenue for the postal service, we need to take some of it away.
Last year, there were 3.7 billion pounds of first-class mail – and an additional 9.3 billion pounds of standard mail (the kind mass-market advertisers use). We don’t know what percentage of that 9.3 billion is made up of catalogs, but we’d venture to say it’s substantial.
And wasteful. Our highly unscientific polling suggests that most catalogs get thrown away with barely a glance between their pages. At a minimum, there should be a Do Not Mail registry which operates like the Do Not Call registry, giving people the opportunity to opt out of receiving catalogs in the mail. This would result in lost revenue for the postal service, although some portion of that could be made up by increasing the rates applicable to standard mail.

Unfortunately, reducing the amount of junk mail will mean fewer mail carriers and processors. But maintaining those jobs just to drive around and deliver a billion (or two, or three) pounds of stuff no one wants just doesn't make sense.

Wednesday, December 28, 2011

Inequality in America -- 2011

Your fun facts on inequality for 2011.* 

Median income for 2010
Median income for 2007 (in 2010 dollars)
Percentage increase in median income from 2007 to 2010
Percentage increase in number of individuals making more than $1,000,000 from 2009 to 2010      
Percentage of the gain in wealth since 1983 which went to the top 1%
Percentage of the gain in wealth since 1983 which went to the top 5%
Percentage of the gain in wealth since 1983 which went to the bottom 60%

From the Economic Policy Institute

Median household net worth -- 2007
Median household net worth – 2009
Percentage increase in median household net worth from 2007 to 2009
Percentage increase in median household net worth for members of the House of Representatives, 1984 to 2009 (excluding housing)
Percentage increase in median household net worth for the rest of America, 1984 to 2009 (excluding housing)
Percentage of all households with no or negative net worth
Percentage of black households with no or negative net worth
Median household net worth for white families
Median household net worth for black families
Ratio of top 1% household net worth to median household net worth

From The State of WorkingAmerica's Wealth: 2011
by Sylvia Allegretto (Economic Policy Institute)

Home equity as a percentage of home value – Q1, 2006
Home equity as a percentage of home value – Q4, 2009
Number of years in which the home equity percentage was less than 50%

From The State of WorkingAmerica's Wealth: 2011
by Sylvia Allegretto (Economic Policy Institute)

Percentage of the nation’s wealth held by the top 5%
Percentage of American households in 2007 which owned no stocks at all (either directly, or through mutual funds or 401(k) plans)
Percentage of American households in 2007 with direct ownership of stocks
Average earned income for the top 1% in 2010
Total aggregate earned income for the top 1% in 2010
Percentage of the total aggregate earned income for the top 1% which was not subject to Social Security taxes


Hoping next year is better for all of us. Even the 1%.

* Links are to reports from the Federal Reserve, the Social Security Administration, the Economic Policy Institute and a Washington Post article. In addition, we performed some basic math to come up with some of the numbers, such as the percentage decrease in median income from 2007 to 2010, and aggregate earned income figures.

Monday, December 26, 2011

Housing and/or Bankruptcy Reform

So far, we’ve fixed Social Security and reformed personal income taxes to make them both more equitable and reduce the deficit. We’ve also solved the problem of corporate personhood, as well as finally acknowledging the equal status of women. And we’ve established the need for another stimulus package, shown that it can be done on the cheap, and proposed one targeted at providing aid to states, addressing dramatic infrastructure needs and helping out the little guy a bit.
On to housing. Or bankruptcy reform.
Let’s do both.
Right now, housing is a mess. At least 22% of all mortgages are under water, and maybe as many as 29%. That's 10.7 million homes at a minimum, and 14.1 million homes as the max. One out of every twelve mortgages is delinquent, and one in every twenty-five mortgages is in foreclosure. All told, one in eight mortgages is either delinquent or in foreclosure -- some 6.4 million homes. And, with the size of the average American household being 2.6 people, that means that 16.6 million people are at risk of losing their homes. That's bigger than the population of fourteen states plus the District of Columbia!

And for those homes in foreclosure, they tend to be massively delinquent. Seventy-two per cent haven’t made any payments in at least a year, and almost 40% haven’t made a payment in two. In July of this year, the average delinquency for loans in foreclosure was 599 days
Foreclosure obviously sucks – hard – for the borrower. But it also sucks for the lender. Foreclosure processes are costly, take a long time, and then the lender has to sell the home into a depressed market. In 2010, loss severity – the percentage of the principal lost – was 44% for prime loans. For Alt-A loans, loss severity was 59%, and sub-prime loss severity was 75%. And Fitch (the lesser known of the three major rating agencies, after Standard & Poor’s and Moodyz) predicted that things would get a couple notches worse in 2011, with sub-prime loss severity going to 80 -85%.
And it gets worse. The lender is responsible for the foreclosed home until it’s able to resell it. On a banal note, that means the lender is on the hook for property taxes, further reducing its net take. But the lender is also responsible for the upkeep of the home, though few take this seriously. As a result, many foreclosed homes are now turning into mold factories, as many as 50% in some states.
Black mold in a Los Angeles home.
Foreclosure, in the best of times, is a brutal and ugly process. Foreclosures during a massive recession are a nightmare.
So what’s the way out of this mess? A couple of years ago, it looked like HAMP (Home Affordable Modification Program) and HARP (Home Affordable Refinancing Program) might do the trick. HAMP was designed to help homeowners at risk of foreclosure, and HARP was a more general refinancing program. Both have been disasters. 
HAMP actually resulted in increases in principal – not reductions – for some 80% of participants. Perhaps not coincidentally, the default rate for modified loans runs as high as 40% within one year of the modificationHARP was supposed to help three to four millions homeowners, but so far only about 900,000 folk have participated.
Oddly, if the mortgage were pretty much any other kind of debt , the borrower could seek refuge in bankruptcy. Bankruptcy judges have the power to “cramdown.” What this means is that the judge can disregard the original contract and ostensibly fashion a new one, with a reduced principal amount, a lower interest rate or a longer term – or a combination of all three and more. The bankruptcy judge then crams this new contract down the throat of the lender.
(For a more technically accurate but still eminently readable explanation of how this works, see this CreditSlips post. And, by the way, it didn't always work this way. Cramdowns on mortgages were permitted until 1993. )
While the lender isn’t happy – lenders in bankruptcy never are – they often should be. The simple idea behind this practice is that liquidation – foreclosing on the home and distributing the proceeds – often doesn’t maximize returns to the lenders. It seems weird to forgive a borrower his debt – this idea is known as moral hazard – but it’s often the most economically sound thing to do. It’s making the best of a crappy situation.
So one solution would be to treat mortgage debt like every other debt. And that’s what Congress tried to do in 2009, before the Senate killed the bill. But there’s actually a better solution -- Chapter M bankruptcy -- proposed by Adam Levitin, a professor of law at Georgetown. 
In a Chapter M, all foreclosure actions would be automatically removed from state court to federal bankruptcy court. If the lender prevailed in the foreclosure action, then the homeowner would be offered a standardized pre-packaged bankruptcy plan. The plan could be based on HAMP modification guidelines (interest rate reduction to achieve 31% DTI goal, but without federal funding) plus cramdown to address negative equity. 
If the homeowner were willing and able to pay under the plan, the homeowner would keep the house. Otherwise, the foreclosure sale would be completed on an expedited, standardized basis (say 45 days to sale) through a bankruptcy trustee’s sale, which gives good title to the purchaser. The homeowner’s non-mortgage debts would “ride-thru” unaffected. If the homeowner redefaulted, the same expedited foreclosure process would apply. 
A Chapter M process would address negative equity (including second liens), as well as affordability. It would also remove mortgage servicers from the modification process, thereby eliminating servicer capacity and incentive issues. 
A Chapter M might be more attractive to mortgage lenders than traditional Chapter 13 cramdown option because it offers a fast-tracked, standardized foreclosure process, quick foreclosure upon redefault, court-ordered protection of property against homeowner destruction during foreclosure, and the ability to provide clean title. 
Chapter M would have no affect on non-mortgage lenders. Like Chapter 13 modification, Chapter M would have no cost to the federal government and would be immediately available, using existing courts and Chapter 7 panel trustees for sales. Unlike Chapter 13, Chapter M would avoid the adverse selection problem, as all homeowners in foreclosure choose between paying per standardized terms or losing the house quickly.
One of the chief advantages to both the traditional cramdown and Chapter M ideas is that they don’t actually need to be used to be effective. Knowing that this option exists for homeowners should act as an incentive for lenders to agree to loan modifications and refinancing before turning to more drastic --and expensive -- alternatives.
This solution is actually a win-win situation. People get to stay in their homes, and lenders end up with more in their pockets than they would have had by foreclosing.
We can do this.

Friday, December 23, 2011

Burying the Lede

We're going to take a small break from saving America to address a minor point in a recent post by Felix Salmon about a Jeffrey Goldberg post about a Sylvia Allegretto post on the Waltons of Wal-Mart.

Goldberg discussed the new Crystal Bridges art museum in Bentonville, Arkansas, built with the largesse of Alice Walton.
Model of Crystal Bridges; not to be confused with the country singer. Or the r&b one.

All that is nice, argued Goldberg, but the charitable efforts of the Waltons might be better focussed on, say, their employees who work at minimum wage and/or without health insurance. In his piece, he noted that Allegretto had argued that the six Walton heirs have a collective net worth greater than the bottom 30% of the entire country.

This garnered some press.

Salmon responded to defend Walton, and wrote:

[T]ake this seemingly damning statistic from Goldberg’s column: 
In 2007, according to the labor economist Sylvia Allegretto, the six Walton family members on the Forbes 400 had a net worth equal to the bottom 30 percent of all Americans. The Waltons are now collectively worth about $93 billion, according to Forbes.
This sounds outrageous, until you stop for a second and take note of the fact that Jeffrey Goldberg, individually, has a net worth greater than the bottom 25% of all Americans. 
According to the latest data we have, 24.8% of American households had zero or negative net worth — add them all together, and you get zero. Jeffrey Goldberg’s net worth, it’s safe to say, is greater than zero. 
Holy mother of oh my god are you shitting me?

One of out of every four Americans isn't worth anything? 75 million people have no net assets?

I'm sure it's a very nice museum, and if I ever get out to Bentonville, I'll be sure to take a tour, but the fact that one in four Americans has ... nothing (or worse!) was the lede in this story.

From Wikipedia:  Walton has been involved in at least three automobile accidents. In an April 1989 incident, she struck and killed 50-year-old Oleta Hardin. No charges were filed. In a 1998 incident, she is reported to have hit a gas meter while driving under the influence and told the responding police officer, "I'm Alice Walton, bitch!" She paid a fine and served no jail time.

On October 7, 2011, her 62nd birthday, she was again arrested for driving while intoxicated in Weatherford, Texas, after a dinner with friends in Fort Worth. Walton's attorney released a statement acknowledging the incident and expressing regret.

Taxes -- The Semi-Concise Summary

So ... how to fix America's personal income tax problems?

  1. Expand the number of brackets to what they were during the early Reagan years, and bring the top marginal rate back to the 50% it was back then. It was good enough for St. Ronnie; it's good enough for today. 
  2. Get rid of the capital gains tax. Treat all income as ordinary income. 
  3. Junk the mortgage interest deduction. OK, just phase it out then.
  4. Set the trigger for the alternative minimum tax at $250,000 (for a household) and adjust it automatically for inflation.
The result will be a much simpler tax code that raises considerably more money, with nearly all of that additional revenue coming from the top 1% or so. And, with a little luck, we should be able to offer some mild tax relief for the poor and middle class. 

One last thing. One of the more pernicious lies bandied about this past year was that 47% of American didn't pay federal taxes. In fact, everyone who gets paid to work paid federal taxes in the form of FICA -- Social Security and Medicaid taxes. But because these taxes are tallied separately from income taxes, they get forgotten. 

And this really doesn't make sense, because Social Security and Medicaid is what a lot of what the federal government does.

2010 Federal Budget -- Outlay by Category

In 2010, Social Security and Medicaid accounted for about 28% of the federal budget -- and everyone helped pay for it. 

(If you add in Medicare and defense spending, you end up accounting for about two-thirds of the budget -- which is why government is sometimes called "an insurance company with an army.")

It's time for the lie to die. So from now on, FICA taxes are rolled into general personal income taxes. Nothing under the hood will change -- FICA taxes will still be deducted from paychecks as they have been. Technically, your marginal rates will go up, but the FICA taxes you already paid will offset them entirely. You'll net out, but it will be now be clear how much you're actually paying to keep the government going.

T's for Taxes; T's for Tennessee -- Part V (Alternative Minimum Tax)

Like the mortgage interest deduction, the alternative minimum tax (or AMT) seemed like a good idea at the time, but has grown into something perverse. 

Its origins lie in the discovery in 1969 that 155 of the wealthiest Americans had succeeded in avoiding paying any taxes. Congress enacted the Tax Reform Act of 1969, part of which instituted an add-on tax targeted at making the wealthy pay … something. Congress then changed its mind with the Tax Equity and Fiscal Responsibility Act of 1982, which changed the AMT to its current state as a parallel tax system. 

And it's not a very simple system. Some things (such as state and local taxes) no longer qualify as deductions, and some other things which weren’t taxed as income now are (e.g.,interest from revenue bonds (like a state or municipal bond to build an airport, and whose payments come from the income it generates) – but not general obligation bonds (a state or municipal bond paid back out of taxes). Certain caps are raised, some depreciations take longer ... it's a mess.

And that’s the first problem with the tax. If your income is above a certain relatively modest level (currently, $74,500 for a household), you have to calculate your taxes twice, and that's a pain.

The second problem is that Congress failed to index the AMT to inflation. So an idea which was originally targeted at the wealthiest couple of hundred Americans ends up hitting more and more of the middle class. (Congress will, from time to time, apply "patches" to the AMT to correct for this, but it hasn't come up with a permanent solution.)

Finally, the third problem with the AMT is that is has grown quite a bit in terms of how much personal income tax it generates. While it only produced about $122 million in 1970 (about $671 million in 2009 dollars), it now produces about $39 billion. For the sake of comparison, the AMT was responsible for a minuscule 0.15% of the $86 billion raised in 1971, and was responsible for about 4% of the $900 billion raised last year -- or about 25 times as much.

Did you notice that the green slice is almost as big as the blue slice? The green slice is what Republicans would like you to forget about when they say that 47% of Americans don't pay federal taxes. In fact, the green slice represents a flat tax of 13.3% (4.2% Social Security tax on employees, 6.2% Social Security tax on employers, and 2.9% Medicaid tax split evenly between employees and employers) which is capped at $106,800 of earned income. Every dollar of earned income above $106,800 -- and every single dollar from capital gains -- is excluded from this tax. And it's still as big as all the revenue generated from personal income taxes. 

Unfortuntely, there doesn’t seem to be a quick fix to this problem – or at least one we can see. So let’s prioritize and see what we can get done relatively quickly.

The biggest problem with the AMT is that its scope has grown to be far more expansive than what was originally intended – all due to the failure to automatically adjust the AMT for inflation. So let's get that out of the way first. Whatever we end up doing, we'll allow for inflation so that we don't have to re-visit this issue every few years.

The second biggest problem is that it hits too much of the middle class. With the AMT trigger set at $74,500, roughly a third of American households would at least have to prepare their taxes twice. If, however, you set the trigger at the oft-discussed $250,000 level, you'd only affect about 2 - 3%

And at that income level, the chances that a professional tax-preparer is involved is pretty good -- meaning that even these households wouldn't be inconvenienced by doing their taxes twice!

Setting the AMT at $250,000 may be the best idea at the moment. It maintains the AMT for those Americans who are earning the most, while allowing the vast, vast majority of Americans to go their merry ways. It should continue to generate some revenue, though certainly not as much as in the past. Fortunately, however, the changes we're making to the tax code -- namely, taxing capital gains as earned income -- should more than make up for that.

Thursday, December 8, 2011

T's for Taxes; T's for Tennessee -- Part IV (The Mortgage Interest Deduction)

Of all the reasonably well-intentioned but ultimately misguided deductions which deliver the vast bulk of their benefit to the well-off (and very well-off), the king is the mortgage interest deduction (or MID). It’s got to go.

According to noted pinko rag The Economist:  

The MID is almost impossible to defend on distributional grounds. It only goes to people whose income is high enough to merit itemising deductions, and its value rises with their tax bracket.

A study for the Urban Institute and Tax Policy Center by Eric Toder, Margery Austin Turner, Katherine Lim and Liza Getsinger estimates that its elimination would cost the average household an average of $559 more per year in tax. But the impact is highly progressive: for bottom quintile the average increase would be just $2 or 0.01% of after tax income; for the middle quintile, $215 or 0.49% of income; and for those in the top quintile minus the very richest 1%, it would average $1,723 to $4,234, or 1.59% to 1.63%. Only for the richest 1% does its relative importance decline.

The study notes that the MID has not been found to increase home ownership, which makes intuitive sense: the families that benefit are precisely those most able and likely to buy a home regardless of the tax treatment. It only encourages them to buy larger homes, and to do so with more debt; anyone who pays off their mortgage gets no benefit.

So how did we end up with an expensive program – about $100 billion a year -- that does pretty much nothing to boost home ownership rates, but offers yet another way for the well-off to save more money.

From the testimony of Alex Pollack before the Senate Committee on Banking,  Housing and Urban Affairs

According to Roger Lowenstein* of the New YorkTimesthe idea of a mortgage for a home is a relatively new idea. Until the 1920s, homes were typically paid for in cash, although farms would be purchased with the help of a mortgage. As such, it made sense to allow a deduction for mortgage interest, as the farm was the family’s business.

In fact, no one paid much attention to personal interest deductions at all until 1986. By then, credit cards had become a staple of modern life, people were accruing more and more debt, and they were deducting the interest on that debt from their taxes. The Tax Reform Act changed that, but did preserve a deduction for mortgage interest – the first time such a distinction had been made. (This legislation also taxed capital gains as ordinary income, a point we discussed here.)

So why doesn’t the mortgage interest deduction help home ownership?

Imagine a world with no mortgage interest deductions (by the way, this place exists – most other countries don’t offer this deduction) where you’re looking to buy a home and you’ve got a budget of $225,000. Fortunately, there is a nice house available at that price point. But there’s a really nice home available for $250,000, but that’s just too far over budget for you.

You wake up the next day to find that the mortgage interest is now deductible, so you re-calculate your housing budget and learn that $250,000 is now doable. You call up your broker to place a bid, but he tells you that $250,000 will no longer do it – the asking price is up to $285,000. But he does have a nice home available for $250,000 – it’s just the same one that cost $225,000 the day before.

This is because when Congress made mortgage interest deductible, they made it deductible for everyone. So everyone at a given budget point X got an identically sized gift Y to spend on a house. You're still  competing with everyone else with an X budget, you're just competing with more money -- (X + Y).

So who wins in this situation?

Well, firstly, the realtors win. Realtors work off commissions, so anything which increases the prices of homes is good news to them. Secondly, the banks win, and for the same reason. When a home’s value increases, that means the bank can write a bigger mortgage on that property, and collect more interest. And the well-off win, for several different reasons.

Melissa Labant, technical manager at the American Institute of Certified Public Accountants, calculated two situations for middle- and upper-income homeowners in more expensive states.

In the first situation, consider a couple who earn $137,300 a year and are in the 25 percent tax bracket. If they owned a $350,000 house paying 5 percent interest on their mortgage, they would save $4,375 a year on interest of about $17,500.

For the wealthiest homeowners the deduction is far better. People with $1 million homes with the same 5 percent rate would be paying $50,000 a year in interest. As they would most likely be in the top 35 percent tax bracket, they would save $17,500 a year in federal taxes through the deduction.

As the well off have bigger mortgages, they’re able to deduct more interest. But the well-off may well have more than one mortgage – and the mortgage interest deduction applies there, too. So we end up subsidizing not only home ownership, but vacation home ownership as well – which seems a bit much. In fact, all mortgage interest is deductible up to $1 milliona year.  Who the hell has $1 million a year in interest payments?

Finally, not only is mortgage interest deductible, but so are the interest payments on home equity loans. As home equity loans actually require you to already own a home, they do little to increase home ownership.

(One of the tricks in the securities industry was to take the proceeds from a low-interest home equity loan and use it to fund a securities trading account. If a margin account were used instead, the interest payments would be higher, and they wouldn’t be tax deductible.)

Unfortunately, the mortgage interest deduction is often viewed as one of the several third rails of politics. But recent polling suggests that Americans may be ready for a change.

Now, according to a recent Bloomberg Poll, a growing number of Americans may be willing to end the mortgage tax deduction -- as long as they get something in return. Forty-eight percent of respondents said they were willing to give up all tax deductions, including the home mortgage deduction, in return for lower tax rates for every tax bracket. Forty-five percent were opposed in the survey of 997 adults.

So now that we’re all on board for killing the MID, how do we do it? Unfortunately, we can’t just do it all at once. Many people purchased homes with the expectation that their mortgage interest would be deducted, and they may not be able to afford those homes without it. But we can take care of the most egregious parts.  We can eliminate the tax deduction as it applies to new home equity loans, which shouldn’t be much of a problem; banks aren’t making many of these loans anyways. And we can similarly eliminate the tax deduction for anything but primary residences – gone are the subsidies for beach houses (unless you actually live on a beach).

And we can address the primary deduction gradually. As noted earlier, the maximum allowable interest is $1 million a year. If we reduced the cap by $200,000 a year, we wouldn’t affect anyone but the screamingly well off for four years. And as for the fifth year, we would be fine if we cut the tax rates for the poor and middle class, so as to compensate for the (minimal) effects of ditching the mortgage interest deduction. 

And without the mortgage interest deduction, we've actually made preparing your taxes easier. Now even more people will take advantage of the standard deduction. You're welcome!

* Roger Lowenstein – who penned the best article on Social Security we know of – also wrote the best article on the mortgage interest deduction, which has been added to the Reading List sidebar. If you want to know more than your neighbors, that’s the place to go, and that’s where most of the following information came from.