It has been referred to as an American birthright, the most sacred tax break, something so sacrosanct that the mere thought of tampering with it was unpatriotic.

And Canadian taxpayers have long coveted our southern neighbour’s beloved mortgage-interest deduction, which permits U.S. homeowners to deduct their mortgage interest from their income for tax purposes.

While such a policy applied in Canada would be extremely popular, it is unlikely to see the light of day, especially given its role in the recent U.S. housing crisis.

Homeowners may have been influenced, at least partially, by the tax writeoff to seek larger homes with larger mortgages.

Last week, Professor Dennis J. Ventry Jr., of the University of California Davis School of Law, presented a paper entitled, “The Accidental Deduction: A History and Critique of the Tax Subsidy for Mortgage Interest” at a U.S. tax conference. In it, Dr. Ventry traces the history of the U.S. mortgage-interest deduction “from accident to birthright, from one of many deductible personal-interest items to one of the few left standing, and from a nominal tax offset to the second-most expensive tax subsidy.”

He also includes a eulogy to the mortgage-interest deduction that draws on criticisms of the subsidy from two generations of tax reformers and tax policymakers that are more applicable today than at any time during the deduction’s nearly 100-year history.

Believe it or not, the mortgage-interest deduction was never intended to be a way of promoting home ownership.

Rather, it had its origins in a general deduction for personal interest, which originated in 1913 and has since been curtailed.

In Canada, interest expense is deductible only for the purpose of earning income from business or investments. That’s why Canadian taxpayers can generally only write off mortgage interest on rental properties.

Perhaps the biggest criticism aimed at the U.S. mortgage-interest deduction is that there is no corresponding taxable income arising from your personal residence to justify the tax deduction.

In order to truly rationalize the deduction, many critics argue that homeowners should be required to declare some sort of notional, taxable rental income associated with living in their own home.

Prof. Ventry’s paper cites numerous other problems with the deduction, including its role in artificially raising U.S. housing prices, encouraging Americans to buy bigger and more expensive homes.

The deduction also disproportionately favours higher-income taxpayers, since the deduction is worth more for those in a higher marginal tax bracket.

But ultimately, the deduction distorts the entire “rent vs. buy” decision by providing what is essentially a tax subsidy to mortgage-laden homeowners at the expense of debt-free tenants and other taxpayers.

In his conclusion, Dr. Ventry calls for a repeal of the mortgage-interest deduction, potentially replacing it with a targeted tax credit for homeowners that is unrelated to the price of the home and the amount borrowed.

Financial Post

Jamie.Golombek@cibc.com

Jamie Golombek, CA, CPA, CFP, CLU, TEP is the managing director, tax and estate planning with CIBC Private Wealth Management in Toronto