Dianne Feinstein's Misunderstanding of the Mortgage Deduction
Many tweeters have been making fun of the following Dianne Feinstein tweet:
The Republican tax bill caps the mortgage interest deduction at $750,000 for new mortgages. In California, seven counties have average home prices that are more than $750,000: Alameda, Marin, Orange, San Francisco, San Mateo, Santa Clara and Santa Cruz counties. #GOPTaxScam
They point out, probably correctly, that this is not the usual messaging that the Democratic Party uses. I’ll let you read some of the comments.
But my criticism is more on the straight economics, not the politics.
Feinstein’s point pretty clearly, or else she wouldn’t have hash tagged #GOPTaxScam, is that this tax bill is really bad for people whose houses are worth more than $750,000.
First, the drop in the mortgage deduction cap from its current $1 million to $750K is grandfathered. So the vast majority of owners of expensive homes will not be directly affected by this reduction of the cap at all.
Second, not that many people who will buy houses for more than $750K will finance them with all debt. Most of them will pay a substantial down payment. Take someone who buys a house for $1 million. That person will likely pay at least 10% down. So the mortgage would be, at most, $900K. Of that, the buyer could deduct interest on $750K. So with an interest rate of, say, 4%, the buyer couldn’t deduct 4% of $150K annually, which is $6,000. At the old marginal tax of, say, 28%, the buyer loses $1,680 in extra federal taxes. That’s not a large amount, especially for someone who can afford a million dollar home.
Third, I’ve overestimated the loss in the second point above, because that person’s marginal tax rate is likely to be lower. The person who is currently in the 28% bracket is likely to be in the 24% bracket. So, although he or she loses on the mortgage deduction, he/she gains from the lower tax rate.
Now you might say, “What about the person who buys a house for $1.5 million? There are lots of those in the counties that Feinstein names and in many other counties in California. Won’t that person be badly hurt by the reduction in the cap?” Answer: No. Remember that it’s a reduction in the cap from $1 million to $750K, not an introduction of a cap where there was none before. So the maximum hurt is the reduction of the mortgage interest amount on the $250K difference between $750K and $1 million. 4% of $250K is $10,000. So the increase in taxes is $2,800. Again, this would be offset by lower marginal tax rates.
Commenter Vivian Darkbloom notes a mistake in my post. Rather than go through and correct all the arithmetic, I’lll leave that as an exercise for those who are interested. Vivian points out that the maximum mortgage loan on which interest was deductible before the tax bill was not $1 million, but $1.1 million, because of the maximum $100K of home equity loan on which interest was deductible. So it falls from $1.1 million to $750K.