Editor’s note: This story has been corrected to reflect that the top tax bracket in 2011 and 2012 under the extension of the Bush era tax cuts will continue to be 35 percent.
The Obama administration’s proposed 2012 budget would trim the value of itemized deductions for high-income taxpayers by nearly one-third, reducing the tax benefit some homeowners with mortgages receive if they itemize the interest portion of their loan payments on their tax returns.
The administration proposed such a measure as part of last year’s budget negotiations, but Congress did not approve it.
In this year’s budget message, President Obama pitched a cut in itemized deductions for the wealthy as a means for paying for the cost of protecting middle-class taxpayers from having to pay the Alternative Minimum Tax, or AMT.
For too long, "we have tolerated a tax system that’s a complex, inefficient and loophole-riddled mess," the president said in his budget message. Year after year, he said, "we go deeper into deficit and debt to pay to prevent the AMT from hurting many middle-class families."
An across-the-board 30 percent reduction in itemized deductions for high-income taxpayers would represent the most significant tightening of a tax break since a major overhaul of the tax system in 1986, the administration said.
Obama also said he continues to oppose the permanent extension of the 2001 and 2003 tax cuts for families making more than $250,000 a year.
"While I had to accept these measures for two more years as a part of a compromise that prevented a large tax increase on middle-class families and secured crucial job-creating support for our economy, these policies were unfair and unaffordable when enacted and remain so today," he said.
Only about one-third of taxpayers claim itemized deductions, but the mortgage interest deduction alone cost $86 billion in lost revenue in fiscal year 2009, the National Low Income Housing Coalition said in testimony before a bipartisan deficit reduction commission.
In a report published in December, the commission proposed that the mortgage interest deduction be changed to a 12 percent nonrefundable tax credit. Only interest paid on debt of up to $500,000 on a principal residence would be eligible. The report was not adopted by the needed "super majority" of members needed to make official recommendations to Congress.
As it’s structured now, the tax code allows homeowners to claim as deductions the interest paid on total mortgage debt of up to $1 million on both their principal and second homes.
Individuals with incomes above $200,000 and families with incomes above $250,000 can lower their taxes by an amount equal to as much as 35 percent of their itemized deductions.
Because most of the monthly payments on a new loan go to interest, rather than principal, interest payments in the first year of a $500,000 mortgage carrying a 5.5 percent interest rate total about $24,800.
Under the current tax code, the mortgage interest deduction could save a family in the 35 percent tax bracket with a brand new $500,000 mortgage as much as $8,680 in the first year of the loan.
If the cap was lowered to 28 percent, as proposed, the mortgage interest deduction would be worth no more than $6,900 to the same hypothetical family with a new $500,000 mortgage.
That’s not as dramatic a reduction as the one proposed by the deficit commission, but industry groups were able to shoot down the proposal for a 28 percent cap last year.
The National Association of Realtors and other industry groups have mounted advertising and lobbying campaigns arguing that the mortgage interest deduction also benefits the middle class.
NAR’s "Home Ownership Matters" public relations and lobbying campaign promotes homeownership as a tool for building wealth, and the group has even created an iPhone app that allows homeowners to estimate the tax savings they could realize by claiming the mortgage interest deduction.
NAR was critical of the deficit commission’s proposal to revamp the mortgage interest deduction, claiming an adjustment could hurt home prices by up to 15 percent. NAR promised to "remain vigilant in opposing any plan that modifies or excludes the detectability of mortgage interest."
Other highlights of the proposed 2012 budget include a net $1.1 billion reduction in the Department of Housing and Urban Development’s budget, to $42 billion. Cuts include a 7.5 percent ($300 million) reduction in funding for Community Development Blog Grants, and $172 million less for new housing construction for seniors and the disabled.
The budget requests $19.2 billion for the Housing Choice Voucher program, which provides rental assistance to more than 2 million extremely low- to low-income families, and $9.4 billion for Project-Based Rental Assistance to preserve approximately 1.3 million affordable units.
The administration’s budget would also reduce the Department of Agriculture’s single-family housing direct loan program by 81 percent, to $211 million. The USDA program would be more effective if it was refocused on providing loan guarantees, the administration said, proposing up to $24 billion in USDA loan guarantees on as many as 170,000 mortgages.
The budget also included a new estimate of the cost of the government’s bailout of Fannie Mae and Freddie Mac, saying that with dividend payments to the government, total net cost to the taxpayer through 2021 could total $73 billion, 45 percent lower than the net costs to date.