Despite a new Republican Congress and pleas from mortgage lenders, a sacred cow in the real estate industry the mortgage interest deduction is likely to become a key deficit reduction target in 1995.

Thirteen mortgage and real estate industry trade groups have joined forces to vehemently oppose the Clinton administration idea that could drastically reduce the deduction.

Clinton administration Budget Director Alice M. Rivlin recently focused attention on the issue, along with other politically touchy programs such as Medicare and Medicaid, in a memorandum circulated to the White House staff summarizing deficit-reduction options for 1995.

Although Rivlin said the administration is not actively considering any of these things in the memo, which she prefers to call a catalog of ideas, such consideration is nonetheless likely to be discussed when the new Congress arrives in January.

Republican leaders have pledged to cut taxes for the middle class in 1995, which will force them to look elsewhere for money to balance the budget and targeting the mortgage interest deduction might prove less explosive in the realm of public opinion than, for example, cutting Medicare or Medicaid.

In their letter to President Clinton dated Nov. 4, the trade groups including the Mortgage Bankers Association, Savings & Community Bankers of America and National Association of Home Builders, vigorously opposed the Rivlin suggestion and said that further limiting the deduction would significantly restrict investment in housing construction and ownership, resulting in the loss of property values nationwide and reducing local jurisdictions tax receipts.

Studies have shown that capping an amount of principal eligible for the deduction by even a modest amount will result in a reduction in home values across the board, and increase default rates, the groups said. This could increase the rate of default and loss rate, which could precipitate considerable bank and thrift losses.

Rob Joseph, MBA legislative counsel, explained that the losses to homeowners, communities and real estate firms could be significant because local tax receipts are based on property taxes. If the amount of deductible interest for homes is capped, the property values would decline, as would tax revenues for local jurisdictions, he said.

The resulting effect is that fewer people will want to build, and fewer people will want to buy, which would hurt the economy significantly because real estate, when coupled with other related industries, make up a large portion of our gross domestic product. The idea of reducing the mortgage interest deduction has floated around for years. But except for several minor adjustments, including one that capped the deduction at $1 million worth of mortgage debt, the mortgage tax break has been untouchable. But with Republicans now on the spot to prove their Contract With America will work, some sacred cows, including this deduction, may fall.

Targeting the deduction has been on the Clinton administration agenda before. Most recently it was singled out as a possible target while the administration wrestled with its Budget Reform Initiative in 1993. It decided, however, to leave the deduction alone out of fear that limiting it deduction might impair local communities and the national economy, the MBA said.

A new crop of ideas will develop during the next congressional session, and many may resemble previous ideas. For instance, in assessing ways to reduce the federal deficit, the Congressional Budget Office in 1992 noted that $23.5 billion could be raised over the next five years by limiting taxpayers to deducting $20,000 in interest payments a year (the deduction on a new $235,000, 30-year mortgage at 8.5% interest) for couples filing joint returns.

Some housing activists have also suggested lowering the maximum mortgage deduction for the wealthiest 2% of Americans and using the resulting additional tax revenue to meet the housing needs of the poor and nearly poor. This would make the deduction less valuable to taxpayers in the top brackets by introducing a schedule for writing off mortgage interest against income. Those suggestions, particularly the latter, may have carried weight in the pre-Republican Congress days, but they aren't likely to get much attention now.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.