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This deduction could be a sticking point in the tax debate

A cap on mortgage interest deductions proposed in the tax reform bill unveiled Thursday seemed like the one thing Republicans and Democrats could agree on.

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Sam Petulla (CNN)
(CNN) — A cap on mortgage interest deductions proposed in the tax reform bill unveiled Thursday seemed like the one thing Republicans and Democrats could agree on.

Robert Reich, who was Housing and Urban Development secretary during the Clinton administration, has said the current deduction "is not fair" and "we ought to limit it," which is exactly what the new GOP plan does.

The American Enterprise Institute called the policy "the best part" of a tax plan proposed by former House Ways and Means chairman Rep. David Camp that was central to previous tax reform conversations.

But the deduction reduction is not rainbows and sunshine to all. Disagreement over capping the mortgage interest deduction could play a central role in whether the today's Republican tax bill, the "Tax Cuts and Jobs Act," is passed as is or needs to be amended.

The tax burden shifts from lowering the deduction cap could be felt disproportionately in states where Republicans are looking for support to pass a final bill. Prominent real estate agent and homebuilder trade groups are rankled and have come out with strong statements criticizing the bill. Homebuilder stocks were falling Thursday in response.

Currently, Americans can deduct interest payments on their first $1 million of debt. The bill, which applies to new mortgages, sets a lower cap. Interest payments can only be deducted on the first $500,000 in loans.

Critics of a lower cap to the mortgage interest deduction, like real estate agent and home-building trade groups, say it will reduce home values and depress new homeownership. Supporters of the lower cap push back that these deductions effectively subsidize bigger or more expensive homes in upscale markets.

Analysts have pointed out that these debates may not matter nearly as much as they might have in past tax reform debates, like Camp's 2014 bill. Other changes in the bill released Thursday, such as doubling the standardized deduction most families can take and elimination of other deductions, could greatly lower the number of people who take the mortgage deduction and reduce its value. Instead, they estimate, many more tax filers will take that standard deduction, which increases under the proposal from $6,350 today to $12,000.

An earlier analysis of the framework released in September that laid the groundwork for today's bill made by the Tax Policy Center found that only 4% of households would claim the mortgage interest deduction, down from 21% under current law. The House GOP proposal keeps a $10,000 deduction on property taxes.

In a statement, The National Association of Realtors said today's proposal appears to put "home values and middle class homeowners at risk." The National Association of Home Builders made a similar statement, saying the change "strips the tax code of its most vital homeownership tax benefit."

Homebuilder stocks fell over 2% on Thursday's news.

A larger issue for passing a final bill may be that the deduction is larger in coastal states, where home values are higher. Jared Walczak, a senior policy analyst at the Tax Foundation, said that those who will be affected by the mortgage deduction change will "likely reside in high-income states, and particularly coastal states."

New Jersey and New York are two states that could be most sensitive to a change. Support from Republican lawmakers in these states is important to passing a final bill. Earlier health care reform proposals stalled in part because moderate members from these states felt they were not better off, and the House budget resolution vote passed by only four votes because members in these states voted against it.

The "Tax Cuts and Jobs Act" released by the House GOP makes a concession to moderate members' states but stops from giving them everything they asked for. Members from these states wanted to restore the state and local tax deduction (SALT) in its entirety. That cut is removed from today's bill.

As compromise, today's bill restores an itemized property tax deduction for up to $10,000 in taxes. Just six states -- California, New York, New Jersey, Texas, Illinois, and Florida -- claim more than 50% of that property tax deduction. Members from New York and New Jersey have been holdovers throughout the tax reform debate.

Today's change also works to address the issue of whether the bill truly benefits the middle class more than high earners. As CNN Money's Jeanne Sahidi has written, the majority of the SALT deductions are claimed by those who make less than $50,000 come from property taxes. By contrast more than 70% of the SALT deductions from those making more than $200,000 are due to income.

Still, restoring the property tax deduction only goes some of the ways to restoring the SALT deduction. Earlier analyses have found that the property tax deduction accounts for approximately one-third of all state and local tax deductions.

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