The New York Times reported that Senate Democrats and Republicans reached a tentative deal on the new housing bill. Among the various provisions is a federal income tax deduction for property tax paid by taxpayers who don’t itemize deductions. Single taxpayers get a $500 deduction. Married taxpayers filing a joint return get $1,000. [Update: This has become law for 2008 and 2009. See follow-up post $500 Or $1,000 Property Tax Deduction for People Who Don’t Itemize Deductions.] Presidential candidate senator Barack Obama also proposed a "universal mortgage credit" which gives a refundable tax credit to taxpayers who pay mortgage interest but don’t itemize deductions.
The rationale behind these proposals is that the mortgage interest deduction and the property tax deduction benefit only the well-off. They say people who don’t itemize their deductions don’t get those deductions. From Obama’s Tax Fairness Plan:
"Owning a home is the culmination of the American dream that so many Americans work so hard for. The tax code is supposed to encourage home ownership with a mortgage interest deduction, but it goes only to people who itemize their tax deductions. Like so much in our tax code, this tilts the scales toward the well-off. The current mortgage interest deduction excludes nearly two-thirds of Americans who do not itemize their taxes."
Is that so? On the surface, yes. If you don’t itemize your deductions, you use the standard deduction, which in 2008 is $5,450 for single and $10,900 for married filing jointly. If you pay mortgage interest and/or property tax, but if they are not large enough, you still use the standard deduction. That’s why by definition Americans who don’t itemize their deductions don’t show a mortgage interest deduction on their tax return.
However, to say that those Americans don’t benefit from the mortgage interest deduction or the property tax deduction is a misunderstanding of how taxes and math work. The tax law says everybody is allowed to itemize their deductions. Everybody starts out listing their mortgage interest, property tax, state income tax, plus any other deductions they are allowed. Say for a married couple filing jointly, those deductions add up to $6,000, then the IRS tells them
"Guess what, you are lucky. We are going to let you deduct even more than what you’ve already got here. Would you like us to top off your deductions to $10,900?"
Now they can take the IRS up on the offer or say "no thanks" and stick to their original list of deductions, which include their mortgage interest, property tax, state income tax, and everything else. In reality, when one has less in deductions than the standard deduction, nobody declines the sweet offer from the IRS because they get to deduct all the deductions they are allowed, plus a bonus deduction offered by the IRS.
Now tell me who’s better off? The taxpayers who don’t itemize their deductions but end up deducting even more than their deductions, or the taxpayers who itemize their deductions? The non-itemizers get to deduct everything they are allowed plus a bonus deduction they receive from the IRS. Itemizers don’t receive such bonus. The non-itemizers are already better off than the itemizers. If we allow a new property tax deduction under the proposed housing legislation or a new "universal mortgage credit" under Obama’s tax plan, the non-itemizers will deduct their mortgage interest and property tax twice, plus taking a bonus deduction from the IRS. Does that sound fair to you?
I’m afraid our legislators and presidential candidates don’t understand how taxes and math work because they don’t do their own taxes.