Before the pandemic, California battled the highest levels of poverty, income inequality, and the largest unhoused population in the country. The state also placed the second-lowest in homeownership per capita. Now due to COVID-19, California can expect long-term budget deficits for the next few years. Yet despite all this, the state continues to subsidize wealthy homeowners through the mortgage interest deduction. By eliminating the mortgage interest deduction on vacation homes and reforming the mortgage interest deduction on primary homes to match federal law, we would free up about $500 million in California’s annual budget. It’s time to peel away a layer of one of the real estate industry’s most sacrosanct programs: the mortgage interest deduction.
A Short History: The Mortgage Interest Deduction
The mortgage interest deduction was instituted federally in 1913. Owning property was less common then, and most people who purchased homes paid upfront rather than taking out a mortgage. The reason for the mortgage interest deduction was that in a nation of small proprietors, it was difficult to separate business and personal expenses, so at first the federal government just allowed a deduction of all interest when filing taxes. Although federal tax laws changed over the years, the mortgage interest deduction remained, perceived to be a tool to encourage homeownership in the U.S. A few decades later, when homeownership expanded to White middle-class suburbs, the mortgage interest deduction was adopted at the state level hoping it would increase homeownership.
We’re Subsidizing the Rich and Don’t Even Realize It
Now the fun part: the mortgage interest deduction isn’t used by most California homeowners. Only people who itemize their tax deductions can claim it. The deduction cap is set at $1 million of a home’s value. Most Californians never benefit because our standard tax deduction at the end of the year gives us more money compared to itemization.
The mortgage interest deduction grows with your mortgage, so if you take out a larger mortgage, you receive the bigger deduction. Who takes out large home mortgages and usually itemize their taxes? Oh no, you guessed it. The wealthy elite!
Households with at least six-figure incomes receive more than four-fifths of the total value of mortgage interest and property-tax deductions. And it doesn’t stop there: The mortgage interest deduction applies to second homes and/or vacation homes too! So the rich get away with deducting up to $2 million yearly from their state taxable income. Even the Trump administration thought that the MID cap was excessive and capped the federal deduction at $750,000 per home.
California has around 40 million people, but only 224,000 Californians claim the tax break on primary home mortgages, saving an average of $750 per year. On top of that, only 175,000 Californians (many are part of the first group mentioned) utilize the MID tax break on vacation homes, saving an average of $1,000 per year on top of the $750 they saved on the first home.
This regressive tax break that disproportionately benefits people with higher incomes and larger mortgages is also an entitlement, meaning that the government is forced to immediately grant the mortgage deduction to whoever applies for it. To put this in perspective, the waitlist for Housing Choice Vouchers or rental assistance is about 11 years long.
The homeownership rate for Californians is second-lowest in the nation at 53.8%. The figures look worse when broken down by race with, respectively, only 34.5% of Black people & 41.9% of Latinos owning a home in California. About 62.7% of White people in California own a home, nearly double the Black homeownership rate.
Why is homeownership so important? Well, homeowners have a net worth that is 36 to 45 times higher than that of renters.
The mortgage interest deduction primarily benefits richer, whiter families in California at the cost of $500 million a year. So during a housing crisis when most Californian residents can’t afford to purchase or live in one home, why are we subsidizing two homes for the rich?
Thought Exercise: What Would You Do with $500 Million a Year?
Every year, the California legislature actively chooses to preside over the state with the highest levels of poverty, income inequality, and the largest unhoused population in the country. Fortunately, we have legislative champions like Assemblymember David Chiu (D-San Francisco). He took the lead on this issue and in 2019 introduced a bill to repeal the MID for vacation homes and to cap the MID to equal that of the federal level to fund homeless services.
So in the spirit of Assemblymember Chiu’s bold leadership, let’s think of ways we would use $500 million a year in California. I’ll start with four possibilities:
- Expand the California Housing Finance Agency’s down payment assistance for first-time homebuyers program. Rather than subsidizing a person’s second home, we can help approximately 43,000 - 50,000 Californians to buy their first home every year. In terms of racial equity, 65-70% of CALHFA loans go to BIPOC residents — closing the homeownership gap.
- Increase funding to California’s Public Housing Authorities to increase Housing Choice Vouchers. To help reduce wait times for housing vouchers, the money allocated to the program would give 24,500 of California’s most vulnerable a stable home.
- Create the country’s first Baby Bond Program. Baby bonds start from the idea that every person has a birthright to capital. The state would make an initial investment of $1,000 for every child and then a sliding scale of future investments, determined by a family’s wealth. If instituted, low-to-middle class adults would have an average of $25,000 to $70,000 to finance an education, start a business, or use as a down payment on a home. To make the initial $1,000 investment per child, the state would have to pay $472 million annually. If the state pays for the ongoing costs (that’s a lot less than the initial investment) we could essentially uplift California’s middle class and help close the racial wealth gap. In a few weeks I’ll have more to say about this idea.
- Fund 10,000+ Tiny Homes annually -- first for the unhoused, then for people’s backyards. It’s that simple: In a few years time we can house everyone living on the streets in California. After that, we can finance more “naturally affordable” accessory dwelling units throughout the state.
Mortgage Interest Deduction Reform Is Long Overdue
California’s mortgage interest deduction mostly benefits wealthy homeowners. Instead, let’s develop a government program that meets the MID’s original purpose: supporting homeownership. California’s state budget is constrained even in the best years, and COVID-19 will make it worse for some time. I hope the legislature will introduce a partial MID repeal to its annual budget this year. It’s time to take a fiscally responsible approach and use MID funds where they’re truly needed — to help Californians deal with this severe housing crisis and to close the racial wealth gap.
Personally, I can’t think of one person that I know who owns two homes in California. But I can think of at least 10 people who have dealt with housing insecurity. So why are we still subsidizing expensive homes and luxurious second homes?