The Effects of Lowering the Cap on the Home Mortgage Interest Deduction

Recent reports suggest that the Trump administration is looking to limit the home mortgage interest deduction as another means to pay for lower tax rates as part of tax reform.

Against both current law and the House GOP Blueprint, lowering the cap on the home mortgage interest deduction would raise about $300 billion over the next decade from primarily high-income taxpayers.

Under current law, individuals who itemize their deductions can deduct mortgage interest paid on up to $1 million of home mortgage debt principal. This effectively creates a limit on the amount of mortgage interest a taxpayer can deduct.

Lawmakers could broaden the individual income tax base by further limiting the home mortgage interest deduction on loans up to $500,000 worth of principal. This would reduce the amount of mortgage interest individuals could deduct against their taxable income, especially for high-income taxpayers, who tend to have larger houses, more mortgage debt, and live in areas with more expensive homes.

We estimate that capping the home mortgage interest deduction to mortgage debt of $500,000 would raise $319 billion over the next decade. This is enough revenue to reduce the corporate tax rate by about 3 percentage points. This estimate assumes that the cap would apply to all existing mortgages. Any phase-ins would reduce the amount this cap would raise over the next decade. For example, lawmakers could apply this limitation to mortgages received after enactment.

Reducing the cap on the home mortgage interest deduction would increase taxes primarily for high-income taxpayers. The largest tax increase would fall on taxpayers in the top 1 percent. They would see their after-tax income fall by 0.62 percent. A small number of taxpayers in the middle quintiles would see a tax increase, but it would average less than one-tenth of 1 percent.

The estimates above represent how much this cap would raise if fully enacted starting in 2017 and would apply to all existing mortgages. Lawmakers may want to ease the impact of this cap on taxpayers and the housing market by phasing it in over a number of years. Lawmakers may also likely apply the cap to only new mortgages. Interest from mortgage debt acquired before enactment would still be deductible as an itemized deduction under current law.

There are many ways lawmakers could go about doing this, but I will model a policy similar to one that Tax Policy Center modeled late last year. This proposal would slowly phase-in the cap from $1 million acquisition debt to $500,000 acquisition debt over five years. Using NAHB data, I will also only apply the cap to newly acquired mortgages.

We estimate that phasing in the cap over five years and only applying it to new mortgage debt would raise $95.5 billion over the first decade, which is about 30 percent of the revenue impact of a fully-phased in cap.