August 30, 2011
Taxation and Government Finance Committee
Legislative Committee
The following is for study only and has NOT been approved by the Taxation and Government Finance Committee, Legislative or Executive Committees or the Board of Directors.
Issue:
Should C.A.R. maintain its opposition to any changes to the MID?
Action:
Optional.
Options:
1. Maintain C.A.R.'s current position of opposition to any changes to the MID.
2. Direct C.A.R.'s Economics Department to prepare a report analyzing the effect on the economy of proposed changes to the MID.
3. Other.
4. Nothing.
Status/Summary:
Due to the nation's and California's continuing budget deficits, the MID is again being threatened with at least some type of modification. The state Legislature's non-partisan Legislative Analyst's Office (LAO) has concluded that most of benefits of the MID accrue to taxpayers who would own a home even if the MID didn’t exist. As a result, the LAO has outlined a number of options for modifying the MID. Similarly, the deficit-reduction commission established by President Obama proposed replacing the deduction with a 12% tax credit, limiting eligible mortgages to those of $500,000 or less, and eliminating the tax break for second homes and home equity loans. The LAO estimated that in fiscal year 2008-2009 the MID tax expenditure cost California $5.7 billion in lost tax revenues. As such, it is easy to see the appeal to elected officials of somehow limiting the MID. However, an analysis of 2008 Internal Revenue Service data showed that Californians claiming the MID saved $18,876 on average on their tax bill. As such, it is difficult to imagine the MID ever being completely eliminated. However, it is likely proposals to modify the MID will continue to be advanced. Does it make sense for C.A.R. to be prepared when these proposals are advanced by studying the economic impacts of the various modification proposals?
Discussion
Due to the nation's and California's continuing budget deficits, the MID is again being threatened with at least some type of modification. The MID allows homeowners to deduct interest payments on mortgages of up to $1 million for joint filers and $500,000 for single filers. Also, the MID can be used for first and second homes. Finally, the MID can be used on home equity loans of up to $100,000 for joint filers and $50,000 for single filers.
In November 2007 the LAO released a report that concluded:
[The MID] is poorly designed … for achieving the policy goal of increasing the rate of homeownership. The structure of the MID directs most of its benefits to taxpayers who would own a home even if the MID did not exist, rather than to those whose rent-or-own decision may be influenced by the presence of the MID.
The LAO reiterated this same point two years later in a presentation before the bi-partisan Commission on the 21st Century Economy established by Governor Schwarzenegger and legislative leaders.
The LAO’s report arrives at its conclusion by reviewing income tax data which reveals that most of the benefit derived from use of the MID accrues to high-income taxpayers. The top 20 percent of taxpayers by income constituted over half of the number of taxpayers who used the MID and these taxpayers received over three-fourths the dollar value of the deduction. The LAO believes that these taxpayers would own a home regardless of the MID because they have the financial resources with which to purchase a home. The LAO speculates that the MID allows these homeowners to purchase a larger home or to purchase other items such as vehicles, furniture, etc. High-income taxpayers benefit from the MID largely because (1) they generally itemize, and (2) as the income tax rates increase with income so, too, does the value of any deduction.
As a result of these findings, the LAO outlined a number of options for modifying the MID. These include:
- Allow the MID only for principal residences - as opposed to also allowing it for second homes.
- Eliminate the MID for home equity loans.
- Reduce the MID loan cap (currently, $1 million for joint filers).
- Means test the MID - in other words, limit use of the MID to those who financially need assistance to buy a home.
- Restrict the MID to first-time homebuyers.
- Limit the number of years the MID can be claimed.
- Make the deduction "above the line" meaning that even taxpayers who claimed the standard deduction – instead of itemizing – would benefit.
In the alternative, the LAO also suggests that the Legislature could replace the MID with a mortgage tax credit. Such a credit would be a specified percentage of the amount of mortgage interest paid. By virtue of the tax assistance being a credit instead of a deduction, all homeowners would benefit and, moreover, the value of the credit would not be tied to the tax rate of the taxpayer.
A tax credit is also what the deficit-reduction commission established by President Obama recommended which proposed replacing the deduction with a 12% tax credit and limiting eligible mortgages to those of $500,000 or less, as well as eliminating the tax break for second homes and home equity loans. President Obama’s 2012 budget would limit the deduction for homeowners in the top tax breaks as was also proposed for 2010 and 2011; put simply, individuals making $250,000 or more would be limited to the 28% rate as opposed to 33% or 35% rates. The Obama commission’s recommendation is similar to the recommendation of a bipartisan task force headed by Pete Domenici, former Republican chairman of the Senate Budget Committee, and Alice Rivlin, director of the Office of Management and Budget during the Clinton administration, which proposed replacing the MID with a 15% tax credit.
The LAO estimates that in fiscal year 2008-2009 the MID tax expenditure cost California $5.7 billion. Given recent state budget deficits in the neighborhood of $15 billion, it is easy to see the appeal to elected officials of somehow limiting the MID. However, an analysis by the Tax Foundation think tank of 2008 Internal Revenue Service data showed that Californians claiming the MID saved $18,876 on average on their tax bill. As such, it is difficult to imagine the MID ever being completely eliminated. However, it is likely proposals to modify the MID will continue to be advanced. Does it make sense for C.A.R. to be prepared when these proposals are advanced by studying the economic impacts of the various modification proposals?
