As we think about the "fiscal cliff" and the "debt crisis" it is important to remember that about 1/3 of our current government deficit is due to a lack-luster economy. Thus, each proposal to increase revenues or reduce the deficit should be evaluated with regard to its impact on jobs and other economic factors, and the extent to which these factors stimulate or depress the economy.
As I explain below, the mortgage interest tax deduction stimulates the economy and increases the demand for private ownership of homes and condominiums, thus raising the prices on these assets and stimulating the construction industry. Eliminating this deduction would have a very depressing effect on the economy, thus increasing deficits while raising taxes on many middle income people who have made long-term investment decisions based on the deductibility of their mortgage interest.
Business interest is deductible.
It is seldom mentioned in debates of the home mortgage tax deduction that when a small business takes out any kind of loan, all of the interest is deductible as a business expense. For people who own investment properties, it should still remain possible to retain the deductibility of interest on a mortgage if it is taken out on their investment property. Some of these people currently make sure to have a large home mortgage before they start to borrow against their investment properties for two reasons. First, interest rates for home mortgages are slightly less than for investment properties, and second, it makes it much easier to increase the amount of equity in one's investment properties, thus also lowering the interest rates that you may pay on mortgages on the investment properties. In this case, the home mortgage is playing a very important role in raising capital for your personal business interests for businesses that are so small they may not even file income tax as a business, but simply operate with the "Supplemental Income and Loss" form in the federal income tax.
For most homeowners who do not have any investment properties, however, we see that when their mortgage interest is tax deductible, then as they think each month about whether to pay off part of their home mortgage or buy something else that they want, they note that this investment locks up the money very strongly, and only pays interest at the rate of their mortgage. This is typically more than they can get on a CD, but, given the mortgage tax deduction, they must still pay income tax on reductions in the amount of interest they have to pay on their mortgage, so the mortgage interest saved is taxed as if it were income. If we were to eliminate the mortgage interest deduction, then this investment would be a "tax-free" investment, and the economic incentive to pay off your home mortgage would much higher than it is today. The economic impact of this would be to depress the economy by adding to the low demand for products and services that we are currently seeing from the middle class.
If we look at people who can just barely afford to buy a house, and how the mortgage tax deduction affects them, we see that the amount of money by which their yearly mortgage interest reduces their taxes is money they can afford to pay on a mortgage with either a higher interest rate or a larger principal amount. Thus, such people will be priced out of the market and will not be able to buy their first home until their income is higher, unless the prices of homes drop. Thus, it is likely that we will see the prices of single family homes and condominiums drop in response to the reduced demand from first-time home owners, and even reduced demand from people looking to buy a larger home than their first home purchase. This could have a serious impact on the construction industry and on the banks, since it would also increase the number of mortgage holders whose mortgages are under water. In addition, it would wipe out significant amounts of wealth for those in the middle class who have built up equity in their homes.
The financial justification for the mortgage tax deduction is that it allows first-time home owners to have the tax advantages of buying a house as an investment property, and being able to deduct the interest from their investment revenue before determining their amount of profit. Those opposed to this deduction point out that it also makes it possible for people to borrow money against their homes simply in order to consume more. This is not a business investment, and so the interest should not be tax deductible. In fact, there have been many complexities in the tax law that tried to prevent use of home mortgage money from being used for consumption purposes, but recent tax law changes and limited funding of the IRS have made such complexities either obsolete or at least hard to enforce.
I have been very surprised that people who think that Democrats "do not know how things work" have been advocating eliminating the home mortgage tax deduction. It makes me think that many people who are smug about how rich they are think this is proof that they do understand "how things work" even if they did not personally make their own wealth. We seem to be seeing an attempt to establish a new American aristocracy similar to the aristocracy that existed at the end of 19th century and during the beginning of the 20th century.
I have been amazed at the erroneous economic theories that are being promulgated by people in positions of responsibility, even when most economists are busy writing books about how erroneous these theories are. The advantage of eliminating the mortgage interest tax deduction is one example of erroneous economic theories being advocated by people who claim to be knowledgeable about business and the economy. In aristocratic societies, economic reality matters little, because the aristocracy has enough power to win regardless of the state of the economy. Aristocrats in an aristocratic state can make money while destroying the economy. That is what we are seeing today. I think that most of the American people have been fooled for some time that this is not happening. Now the outrageous economic reasoning being promulgated is getting so bad that the American people are coming to realize that economic predictions being made by aristocrats may not be accurate and that we need leadership that will work for the good of all Americans. It is the power of democracy that society becomes most powerful when all people are able to prosper. Even the rich will be richer if the economy improves. The power of America is due to our economic power. If we allow our economy to continue to deteriorate, then we will destroy the power of America. It is only a matter of time before Canada or Europe or the United Kingdom start to learn of the economic power that can be achieved when all of the people in their societies prosper. Then the age of American superiority will be over unless we fix our own house now.