Friday, November 18, 2011

Mortgage Deduction On the Chopping Block - Big Deal?

The headline reads as follows: Proposal to Limit or Eliminate Tax Deduction for Homes Is Unpopular, Could Raise Billions

There is no doubt that this headline is true on both counts: Unpopular and a Tax Loss for the government. On the opposite side, the mortgage interest tax deduction is Popular with homeowners but is it a big deal?

I set out to answer this for myself in detail using my records. I file separately as head of household with one dependent and I carry a large mortgage in its second year (in 2010), so the effect of a mortgage deduction elimination would be "as big as it gets" in my case.

In the process of estimating all taxes I paid in 2010 I discovered so many hidden charges such as tire disposal fees, and chemical and pollution fees. I do not travel a lot but taxes on hotels, car rentals and airlines are so heavy that they show up clearly.

Also, 2010 was an election year and I run a campaign. My dry clean bill was substantial and I discovered that the actual tax was 10.3% because of the chemical and pollution fees that government has added to the cleaners. The 10.3% includes Honolulu/Hawaii 4.67% general excise tax (GET). So a visit to the cleaners cleans both clothes and wallet!

Utility bills and car fees are vehicles for tax collection and the two of them combined are just as bad as Hawaii's GET which I went at length to calculate from a pile of receipts and statements.

Long story short, my aggregated breakdown of taxes in percentages is shown below, for the actual case with my mortgage and for an estimated case where my $36,000 deduction in mortgage interest was taken away.

It is quite clear that given my total income A, with mortgage deduction in 2101 I paid 0.311A in taxes. If I could no longer deduct mortgage interest then my total tax would have been 0.375A. The difference between the two is substantial and is roughly equal to my 3-year-old's annual day care cost. That's a big deal!

The bottom line is that being in Hawaii without a mortgage interest tax reduction would make me feel quite European. (EU is infamous about its high taxes due to the extensive socialist policies.) Nearly 40% of my middle class income would be lost to taxation.

While the elimination of this deduction may have a small impact in low cost residential markets, it's effects at regions with median housing prices over $300,000 would be significant to the housing and real estate markets, to the taxpayers of those areas and by extension to the general economies of those regions. It would be devastating for the handful of regions with median housing prices over $500,000, and Honolulu is one of them.

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