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Washington -- Ending tax breaks for oil, corporate jets and hedge fund managers is nearly every Democrat's favorite way to reduce the federal debt. But one of the biggest tax breaks of all is heavily skewed to wealthy residents of San Francisco, San Jose and California's other upscale coastal cities.
It's the mortgage interest deduction, and its benefits are heavily concentrated in a handful of pricey cities, none of which votes Republican.
As the new super committee of Congress sets about finding another $1.5 trillion in deficit reduction by Thanksgiving, tax breaks of all kinds, including the interest deduction, are getting new scrutiny. Beloved by the public and the real estate industry, the deduction will cost the government more than $1 trillion over the next decade.
But few homeowners, even those claiming the deduction, know how skewed it is by region and by income. For young, affluent San Franciscans, it is tailor-made.
Just three metro areas - greater New York, Los Angeles and San Francisco - receive more than 75 percent of the subsidy, according to a 2004 study by economists Todd Sinai and Joseph Gyourko. Mortgaged homeowners in the San Francisco and San Jose region receive $4.6 billion a year from a tax break for what are known as McMansions, according to a study this year by John Burns Real Estate Consulting in Irvine.
The tax break is available to anyone who borrows up to $1 million for a mortgage - including for a vacation home - or takes as much as $100,000 in a home equity loan.
Bigger deductions
The bigger the mortgage and the higher one's income, the bigger the deduction. A person in the top tax bracket of 35 percent who borrows $1 million can get a tax break of $17,500. That's on top of a slew of other subsidies such as preferential capital gains taxes on the sale of a primary residence, deduction of local and state property taxes, and subsidies to mortgage giants Fannie Mae and Freddie Mac.
By comparison, households earning less than $75,000 get less than $200 in savings from the deduction. More than three-fourths of taxpayers do not itemize, and so don't claim the deduction at all. Those who rent or have paid off their mortgages, most of them seniors, get no benefit.
The chief recipients are younger, well-off households that receive "a big incentive to increase the size of their mortgage or house," said Eric Toder, co-director of the Tax Policy Center, a joint research group of the Urban Institute and Brookings Institution. "In areas like San Francisco, where it's not easy to build more housing, it drives up housing prices by a substantial amount."
Pricey markets favored
The value of the deduction rises with the cost of a home, suiting pricey real estate markets such as San Francisco and Manhattan, or hot vacation spots such as Aspen, Colo. Altos Research, a real estate research firm, put the median price of a home in San Francisco at $706,000 as of Aug. 24. Trulia.com market research said average listing prices ranged from $4.3 million in Pacific Heights to $640,000 in the South of Market area as of mid-August.
Californians receive 2 1/2 times as much in mortgage interest deductions as Texans, and have for decades. Residents of the Dakotas, Mississippi and Arkansas regularly receive among the lowest share of benefit. McAllen, Texas, mortgage holders get about $23 million a year from the deduction, but Petaluma and Santa Rosa homeowners get more than $300 million, according to the John Burns Consulting study.
The deduction is the second-largest federal tax expenditure - a subsidy program that operates through the tax code. The largest is the exclusion of employer-paid health insurance from taxes. Such tax breaks, economists say, are identical to granting a direct subsidy. Tax rates for everyone have to be higher to make up for the revenue loss. Once created, tax expenditures need no congressional review.
"Among the very large tax expenditures, I think the mortgage interest deduction is one of the worst," Toder said.
That's because it encourages people to increase debt, distorts the housing market, sucks investment from more productive activities and subsidizes the well off, economists said.
"All that said, I love mine," conceded Maya MacGuineas, president of the centrist Committee for a Responsible Budget, who has proposed with Harvard economist Martin Feldstein to cap all tax subsidies, including the deduction, at 2 percent of income.
"An easier way to improve our tax code than going after each individual tax break, which each has its own constituency, is to find a way to kind of wrap them all together and cap them," she said. "So if one guy has three tax breaks, and another guy has 27, those 27 are probably going to end up in total being capped so they don't exceed 2 percent of total income."
Total tax expenditures now cost nearly $1.3 trillion a year, as much as this year's deficit.
'Politically challenging'
"Tax expenditure reform has to grapple with mortgage interest deduction, because it's such a large element tax expenditures," said study co-author Sinai, a professor of real estate and public policy at the University of Pennsylvania's Wharton School. "The big beneficiaries are the Northeast and the West Coast, places with high-income residents and high house values. It's politically challenging to enact a policy that takes that away."
The deduction has existed since the income tax was established in 1913, but was an accidental creation intended as a general interest deduction for businesses. After World War II, it was justified as a way boost to homeownership and its presumed benefits of encouraging people to take better care of their homes and be better citizens. Economic studies have shown, however, that the deduction actually only encourages people to buy bigger houses.
San Francisco real estate agent Eric Geleynse with Frank Howard Allen Realtors said in an e-mail that he understands the arguments for ending the deduction, which he concedes is "inherently unfair to renters." But with California home prices down more than half from their 2007 peak, he said that tampering with the deduction now "would be a very big mistake because it would be kicking the entire industry while it is down and struggling to get back up."
Realtors and builders, whose profits are higher on expensive houses, have fought to preserve the deduction. Former President Ronald Reagan's 1986 tax reform eliminated interest deductions on consumer loans, but Reagan promised the National Association of Realtors, "I want you to know that we will preserve the part of the American dream which the home mortgage interest deduction symbolizes."
Former President George W. Bush's tax reform commission met stiff Democratic resistance when it tried to limit the deduction, at the time prompting liberal economist Jason Furman, who later served in the Obama administration, to urge progressives to rethink their opposition.
Several prominent panels that have laid the groundwork for the new deficit reduction committee - including the Bowles/Simpson commission sponsored by President Obama and a plan by former Clinton administration budget chief Alice Rivlin and former New Mexico Republican Sen. Pete Domenici - call for replacing the deduction with a tax credit.
The deduction is "ingrained in the notion of the American dream," said Dean Stansel, an adjunct fellow with the libertarian Reason Foundation and an economist at Florida Gulf Coast University. "As it turns out, only 25 percent of people take the deduction."
It's the mortgage interest deduction, and its benefits are heavily concentrated in a handful of pricey cities, none of which votes Republican.
As the new super committee of Congress sets about finding another $1.5 trillion in deficit reduction by Thanksgiving, tax breaks of all kinds, including the interest deduction, are getting new scrutiny. Beloved by the public and the real estate industry, the deduction will cost the government more than $1 trillion over the next decade.
But few homeowners, even those claiming the deduction, know how skewed it is by region and by income. For young, affluent San Franciscans, it is tailor-made.
Just three metro areas - greater New York, Los Angeles and San Francisco - receive more than 75 percent of the subsidy, according to a 2004 study by economists Todd Sinai and Joseph Gyourko. Mortgaged homeowners in the San Francisco and San Jose region receive $4.6 billion a year from a tax break for what are known as McMansions, according to a study this year by John Burns Real Estate Consulting in Irvine.
The tax break is available to anyone who borrows up to $1 million for a mortgage - including for a vacation home - or takes as much as $100,000 in a home equity loan.
Bigger deductions
The bigger the mortgage and the higher one's income, the bigger the deduction. A person in the top tax bracket of 35 percent who borrows $1 million can get a tax break of $17,500. That's on top of a slew of other subsidies such as preferential capital gains taxes on the sale of a primary residence, deduction of local and state property taxes, and subsidies to mortgage giants Fannie Mae and Freddie Mac.
By comparison, households earning less than $75,000 get less than $200 in savings from the deduction. More than three-fourths of taxpayers do not itemize, and so don't claim the deduction at all. Those who rent or have paid off their mortgages, most of them seniors, get no benefit.
The chief recipients are younger, well-off households that receive "a big incentive to increase the size of their mortgage or house," said Eric Toder, co-director of the Tax Policy Center, a joint research group of the Urban Institute and Brookings Institution. "In areas like San Francisco, where it's not easy to build more housing, it drives up housing prices by a substantial amount."
Pricey markets favored
The value of the deduction rises with the cost of a home, suiting pricey real estate markets such as San Francisco and Manhattan, or hot vacation spots such as Aspen, Colo. Altos Research, a real estate research firm, put the median price of a home in San Francisco at $706,000 as of Aug. 24. Trulia.com market research said average listing prices ranged from $4.3 million in Pacific Heights to $640,000 in the South of Market area as of mid-August.
Californians receive 2 1/2 times as much in mortgage interest deductions as Texans, and have for decades. Residents of the Dakotas, Mississippi and Arkansas regularly receive among the lowest share of benefit. McAllen, Texas, mortgage holders get about $23 million a year from the deduction, but Petaluma and Santa Rosa homeowners get more than $300 million, according to the John Burns Consulting study.
The deduction is the second-largest federal tax expenditure - a subsidy program that operates through the tax code. The largest is the exclusion of employer-paid health insurance from taxes. Such tax breaks, economists say, are identical to granting a direct subsidy. Tax rates for everyone have to be higher to make up for the revenue loss. Once created, tax expenditures need no congressional review.
"Among the very large tax expenditures, I think the mortgage interest deduction is one of the worst," Toder said.
That's because it encourages people to increase debt, distorts the housing market, sucks investment from more productive activities and subsidizes the well off, economists said.
"All that said, I love mine," conceded Maya MacGuineas, president of the centrist Committee for a Responsible Budget, who has proposed with Harvard economist Martin Feldstein to cap all tax subsidies, including the deduction, at 2 percent of income.
"An easier way to improve our tax code than going after each individual tax break, which each has its own constituency, is to find a way to kind of wrap them all together and cap them," she said. "So if one guy has three tax breaks, and another guy has 27, those 27 are probably going to end up in total being capped so they don't exceed 2 percent of total income."
Total tax expenditures now cost nearly $1.3 trillion a year, as much as this year's deficit.
'Politically challenging'
"Tax expenditure reform has to grapple with mortgage interest deduction, because it's such a large element tax expenditures," said study co-author Sinai, a professor of real estate and public policy at the University of Pennsylvania's Wharton School. "The big beneficiaries are the Northeast and the West Coast, places with high-income residents and high house values. It's politically challenging to enact a policy that takes that away."
The deduction has existed since the income tax was established in 1913, but was an accidental creation intended as a general interest deduction for businesses. After World War II, it was justified as a way boost to homeownership and its presumed benefits of encouraging people to take better care of their homes and be better citizens. Economic studies have shown, however, that the deduction actually only encourages people to buy bigger houses.
San Francisco real estate agent Eric Geleynse with Frank Howard Allen Realtors said in an e-mail that he understands the arguments for ending the deduction, which he concedes is "inherently unfair to renters." But with California home prices down more than half from their 2007 peak, he said that tampering with the deduction now "would be a very big mistake because it would be kicking the entire industry while it is down and struggling to get back up."
Realtors and builders, whose profits are higher on expensive houses, have fought to preserve the deduction. Former President Ronald Reagan's 1986 tax reform eliminated interest deductions on consumer loans, but Reagan promised the National Association of Realtors, "I want you to know that we will preserve the part of the American dream which the home mortgage interest deduction symbolizes."
Former President George W. Bush's tax reform commission met stiff Democratic resistance when it tried to limit the deduction, at the time prompting liberal economist Jason Furman, who later served in the Obama administration, to urge progressives to rethink their opposition.
Several prominent panels that have laid the groundwork for the new deficit reduction committee - including the Bowles/Simpson commission sponsored by President Obama and a plan by former Clinton administration budget chief Alice Rivlin and former New Mexico Republican Sen. Pete Domenici - call for replacing the deduction with a tax credit.
The deduction is "ingrained in the notion of the American dream," said Dean Stansel, an adjunct fellow with the libertarian Reason Foundation and an economist at Florida Gulf Coast University. "As it turns out, only 25 percent of people take the deduction."
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