Mortgage controversy

One of the sacred cows of American tax breaks that many have blamed at least partially for the U.S. housing collapse is coming under fire in the United States.

At a forum last week in Washington, D.C., the real estate industry found itself the target of both the right and the left over mortgage interest deductibility, something Canadians have drooled over for decades because it lowers taxable income substantially.

Americans claimed about $500billion in deductions related to mortgage interest last year, resulting in $100-billion in tax breaks.

While the United States seems to have solved its immediate debt impasse, those looking for ways to balance the budget continue to eye mortgage interest deductibility as one of the answers.

The debate centres around whether Americans have sought bigger homes than they might otherwise have purchased and mortgages that they are reluctant to pay down because of the huge tax break available.

"It makes a big difference," says Ted Rechtschaffen, a certified financial planner in Toronto and president of TriDelta Financial.

No such interest deduction rules exist in Canada for principal residences despite various lobbying attempts over the years.

In 2003, the Ontario Conservatives led by Ernie Eves pledged to make Ontario the first province to allow consumers the tax deduction. But the Liberals won the election and nothing happened.

Few people in the Canadian real estate industry were lobbying for it because the housing industry was doing well and, eight years later, it is doing even better.

U.S. realtors say if mortgage industry rules were changed at this point, it would destroy any hopes of recovery in the sector.

"It is the worst possible time to discuss it because of the fragility of housing," said Lawrence Yun, chief economist and director of research with the National Association of Realtors.

He noted editorial writers from the Wall Street Journal and the New York Times have found common ground to attack mortgage interest deductibility as did groups on the far left and far right that were part of the forum organized by the Washington, D.C.-based Urban Institute.

"Mortgage interest deductibility was in place for 100 years," said Mr. Yun, about whether it caused the U.S. housing bubble. "Perhaps it caused some aspects, but not by itself."

The U.S. government wasn't thinking of personal mortgages when it first allowed interest expenses to be deducted for businesses and investment. "We could almost call this an accidental tax subsidy," said Eric Toder, institute fellow with the Urban Institute, noting that 100 years ago, few paid taxes and or even had a mortgage.

But after the Second World War, the U.S. economy expanded and people began buying houses with debt. By 1986, the U.S. eliminated consumer interest as a deduction but continued to allow deductions on home loans of up to US$1-million and US$100,000 on home equity lines of credit.

"Nothing has changed, but it is definitely now on the table as never before," Mr. Toder said.

U.S. studies have shown the tax break tends to benefit the wealthy with 65% of people making US$50,000 to US$200,000 claiming the deduction despite being only 31% of the population.

The benefit also tends to help more in places with expensive housing, and the conference heard three major markets - the New York/New Jersey area, the San Franciso Bay area and Los Angeles - reap 75% of all interest deduction benefits for the entire United States.

Mr. Rechtschaffen says there is little doubt that if the tax break existed in Canada, he would be advising clients to take advantage of it.

"Should you pay your mortgage or not? It depends on what your aftertax interest rate is," he said.

At 5%, you start paying off your mortgage. Start lowering the effective rate with tax breaks and now who wants to pay off their mortgage? Not that many people, which is what Americans found out.

And while mortgage interest deductibility may not have caused the bubble, it sure didn't help. Like most U.S. tax policy, it now seems impossible to unwind.

It's no wonder no one in Canada wants to visit the issue.