Posted by: Clark Lundberg
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Posted date:
November 5, 2012

In the run up to the 2012 presidential election, tax reform has been a hot topic. Republican candidate Mitt Romney has made a number of statements proposing various caps on itemized deductions, mentioning a limit of $25,000 during the first presidential debate. While we’re counting down the final hours until this heated presidential race ends, we decided to take a look at the effect such a cap would have on homeowners nationwide. Because mortgage interest is typically a large percentage of total itemized deductions for middle-class homeowners, it stands to reason that a cap on total deductions could have a considerable impact on how much mortgage interest could be deducted come tax time (the degree to which this deduction actually boosts home values or the overall homeownership rate is another question entirely).

Our analysis focuses on the breadth of the deduction cap effects (the percentage of homeowners affected in a given area) as well as the depth of the effects (how strongly the cap would affect homeowners). We measure the impact of the cap by looking at how much of the mortgage interest deduction homeowners would typically lose with a $25,000 cap on total itemized deductions. This is done using a combination of ZIP code-level IRS and Census data, and household-level mortgage data, to determine how individual homeowners in a ZIP code would be affected by the cap. We break out our results in the interactive map below.

In general, the effects are not widespread; they are limited to a fairly small number of metropolitan areas. Naturally, metropolitan areas with higher home values (and correspondingly higher mortgages and itemized deductions) are likely to see a larger number of homeowners affected by a cap on deductions. Similarly, we find that across the U.S., areas with median household incomes exceeding $100,000 will see the largest effects on their mortgage interest deductions. That said, we found that in some metropolitan areas, high home prices relative to income lead to large effects for those not among the wealthiest. Median household incomes in 38 percent of the top 50 most affected ZIP codes have are less than $75,000, and 22 percent have median household incomes of less than $50,000. However, these effects are almost entirely limited to the New York metropolitan area. In short, a $25,000 cap on itemized deductions would not have a broad impact on most homeowners, and the bulk of the effect would fall on higher-income households. But there are still many lower-income households that could get caught by a deduction cap.

**Methodology**

We use ZIP code-level tax data to compute mortgage interest deductions as a percentage of total itemized deductions for different adjusted gross income bands. We then obtain a representative income band for a ZIP code using median household income by ZIP code from Census data. We then sample from the population of homeowners with mortgages in each ZIP code and figure each homeowner’s mortgage interest assuming a fixed 3.5 percent mortgage rate. This assumption is based on current rates and is quite conservative given that historical rates have been much higher. We then use the representative mortgage interest share computed above to impute total itemized deductions for each homeowner in our sample and see how many would be affected by the deduction cap. To estimate the impact of the cap we assume that households will claim their other deductions before claiming their mortgage interest. Under this assumption, the amount a homeowner claims in excess of the cap represents a loss to their mortgage interest deduction. We then calculate the percentage of this loss relative to their mortgage interest as a proxy for the impact of the cap. Finally, our ZIP code-level measurement is averaged over homeowners in a given ZIP code.