Killing the Mortgage Deduction Won’t Harm Stocks

by Dan Burrows | November 30, 2012 12:13 pm

Wow, you know U.S. finances are in bad shape if reforming the sacred but controversial tax break on mortgage interest payments is up for debate.

This is what you get when you try to effect social policy through the tax code. The federal government seems to think home ownership is an inalienable right and unambiguously good. So it fosters folks putting down roots — and downpayments on houses — by allowing homeowners to take a tax deduction on their mortgage interest payments.

The bad part of this scheme (apart from the fact that it benefits the wealthy more than everyone else, encourages folks to take out bigger mortgages than they otherwise would and even extends to vacation homes) is that it deprives Uncle Sam of about $100 billion a year in revenue.

And, man, does Sammy need the money.

House Republicans shot down[1] the Obama administration’s opening gambit on how to avoid the so-called fiscal cliff — that combination of hundreds of billions of dollars in automatic tax hikes and spending cuts that would amount to a crushing austerity program for the fragile U.S. economy next year.

Fortunately for most homeowners, the mortgage-interest tax deduction isn’t really on the table — at least not yet. True, Obama wants to limit deductions of all kinds for the highest-income taxpayers, but fears for this particular tax break appear to be overblown for now.

Additionally, in a balm for investors (especially those potentially taking a hit if the deduction goes away), there’s likely to be little to no effect on their stock portfolios.

First off, eliminating the deduction when the housing market is still so fragile and a critical component of the economic recovery would be folly, as well as politically almost impossible — at least at this time.

Let’s face it: They’re not going to have a serious discussion, much less make this major change to the tax code, in a matter of weeks or even months. Hell, it could take years — if it ever happens at all.

Furthermore, even in a worst-case scenario in which the tax break is completely eliminated and, in turn, those funds totally disappear from the equity market on a one-to-one basis, the impact simply isn’t big enough to hurt equity prices.

Just look at the arithmetic: Plans to phase out the mortgage-interest deduction are forecast to increase federal revenue by $215 billion through 2021. That’s $215 billion coming out of homeowners pockets’ over the next decade — billions they would not otherwise be able to put into stocks.

And it’s a drop in the stock market bucket.

Even if the deduction were wiped away overnight — pulling $100 billion in potential investment funds in a year — it’s simply not enough to whack equity prices. (That’s even if all of it suddenly disappeared from the equity market in a flash, which it wouldn’t.)

For one thing, the market capitalization of all U.S. listed stocks comes to about $15.6 trillion. That means a sudden mortgage interest deduction hit of $100 billion would represent 0.6% — a fraction of a percent — of total market value.

More important, we already know what stocks are capable of doing when retail investors pull out en masse. Hell, more than $560 billion in cash has poured out of U.S. stock funds since the bear-market bottom of March 2009. Yet the stock market doubled — doubled — over the same period.

Investors have plenty to worry about when it comes to the looming fiscal cliff showdown. But homeowners pulling cash out of stocks and clobbering the market because they lose a tax break isn’t one of them.

  1. House Republicans shot down:

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