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Mortgage break’s loss feared

“America’s favorite tax deduction”—that of interest on mortgages up to $1 million—saves homeowners thousands of dollars a year. Supporters tout it as a subsidy central to the American Dream since 1913. But as Washington lawmakers debate how to narrow the budget deficit, the deduction has come under scrutiny as a giveaway to the rich and to the real estate industry. Phasing out the deduction—as the U.K. did—by 2021 would save the federal government $215 billion that year.

In New York City, however, where home prices dwarf those in most of the country, capping the deduction would cut deep into the middle class and have a disproportionately negative effect, according to economists. Nonwealthy home shoppers are worried they would be priced out, and the real estate industry fears it would sink prices in an already weak market, perhaps triggering another recession.

“In general, we see it as adverse to the city,” Frank Braconi, chief economist for the city comptroller, said of the potential loss of the deduction. “Here it will fall on people who are decidedly middle class, not affluent, given the cost of living in the city.”

One of the revenue-raising proposals being discussed—a cap on deductions including the one for mortgage interest—would spare middle-class homeowners in most of the country. The burden would be borne by those buying homes for more than $500,000, enough for a lavish abode in many areas. But that amount nets a modest apartment in much of New York City. A cap would affect the entire housing market, not just that of the 1%.

‘Don’t hurt the wrong people’

“If you’re living in New York and making $200,000, you’re not rich,” said Dottie Herman, chief executive of real estate firm Douglas Elliman. “If you’re buying something for $750,000, you’re not buying a mansion. It will hurt the housing business, and it’s going to hurt all the wrong people. For first-time buyers and younger people, this would make them think twice.”

In New York City, according to the city’s Independent Budget Office, about 450,000 tax filers used the deduction in 2010, shielding an average of $16,200 from taxation—far above the national average of $10,638. That reflects the city’s pricier real estate. In Manhattan, the average price of a home is $1.4 million, compared with $170,000 nationwide, according to real estate appraiser Jonathan Miller.

“These standards are being applied to a generic overlay in the country, when there’s such disparity between housing prices in Oklahoma City and Manhattan,” he said.

If the deduction were to end, one thing that would limit the impact on the city is that nearly two-thirds of residents here are renters. The share of 2010 tax filers in the city claiming the deduction was 13%, compared with 26% nationally.

The federal deduction is worth about $3,000 in tax savings to the 45% of New York families earning between $50,000 and $200,000 who itemize deductions, according to James Parrott, chief economist at the Fiscal Policy Institute. “For families whose incomes have been relatively stagnant for the past several years, this change would certainly cut into their living standard,” he said.

Congress and the Obama administration might also end the deduction for real estate taxes. For a married couple with a combined income of $217,450 and a $300,000 mortgage, the mortgage-interest and property-tax deductions can be worth more than $10,000 a year, according to attorney Robert Barnett of law firm Capell Barnette Matalon and Schoenfeld.

Missing out on that would make potential buyers think twice. “It will have a depressing effect on homeownership,” said Mr. Braconi of the comptroller’s office.

A differing view

While experts agree that capping the interest deduction would push real estate prices down, some don’t see that as a negative. “This deduction is a huge distortion,” said Nicole Gelinas, senior fellow at the Manhattan Institute, a conservative think tank. “You’re just pushing up housing costs. It’s a giveaway to the real estate industry. And many city residents”—namely renters—”pay a higher tax to subsidize someone who has a big mortgage.”

The deduction “encourages people to buy more house than they can afford, it contributed to the housing bubble, and it drives up housing costs,” said E.J. McMahon, another senior fellow at the think tank. “It’s simply not a good thing.”