The mortgage interest deduction (MID) is one of the oldest and largest tax expenditures in the federal income tax and is the largest single federal subsidy for owner-occupied housing. The president’s fiscal year 2010 budget reports that, in 2012, the MID will cost the federal Treasury an estimated $131 billion, much more than the total of all outlays by the Department of Housing and Urban Development ($48 billion). Homeowners also benefit from other federal tax preferences, including the deductibility of residential property taxes on owner-occupied homes ($31 billion), and exclusion of tax on the first $250,000 ($500,000 for joint returns) of capital gains on housing ($50 billion). The MID was not originally placed in income tax law to subsidize home ownership. When the modern federal income tax was enacted in 1913 shortly after ratification of the 16th Amendment to the U.S. Constitution, all interest payments were made deductible on the grounds that interest payments were an expense of earning business and investment income. Congress made no distinction, however, between interest incurred for the production of taxable income (such as interest on business loans) and interest incurred to generate non-taxable “imputed” returns from homes and consumer durables.1 The deduction had little effect on housing investment before World War II because only the very highest-income individuals paid any income tax. The conversion of the income tax from a “class” to a “mass” tax during World War II, followed by a large postwar growth in homeownership rates fueled by the increased availability of long-term mortgage finance, converted the mortgage interest deduction from a provision used by only a few taxpayers into a major subsidy for middle- and upper-middle-income homeowners. By the time the Treasury and congressional agencies began publishing annual lists of tax expenditures in the 1970s, the mortgage interest deduction had become one of the largest single preferences in the tax law. The 1986 Tax Reform Act (TRA 86) eliminated many tax preferences in the federal income tax to finance lower marginal tax rates and higher personal exemptions, but left the deductibility of mortgage interest largely intact.2 TRA 86 eliminated the deductibility of all consumer interest, including credit card debt and loans to finance cars, furniture, and other consumer durable items.

But TRA retained the deductibility of mortgage interest on loans up to $1 million. In addition to the deduction on new (and re-financed) mortgage loans, taxpayers may deduct up to $100,000 of 1 Subsequently, however, Congress did eliminate the deductibility of interest on debt used to finance the purchase of tax-exempt municipal securities, with an exception for commercial banks. The exception for commercial banks was repealed in 1986. 2 The original Treasury Department tax reform proposal was developed in 1984 in response to a request by President Reagan in January 1984 to develop a plan to “simplify the tax code so that all taxpayers big and small are treated fairly and make the tax base broader so that personal tax rates could come down, not go up.” The president asked the Treasury to present their recommendations after the 1984 election. The president allowed the Treasury wide discretion to eliminate tax preferences, with the exception of a specific commitment in a May 1984 speech that the administration would retain the home mortgage interest deduction.