# Running the Numbers on the Flat Homeowner Deduction

[Read Part 1: Proposal: Replace the Mortgage Interest Deduction with a Flat Homeowner Deduction]

Have you figured out what the deduction would be if you did this, and made it deficit neutral? That would be an interesting exercise.

Good question. Let’s do that.

According to various sources, the current cost of the mortgage interest deduction is about \$131 billion, so let’s use that as our baseline cost. According to the U.S. Census Bureau, there are about 75 million owner-occupied homes in the country. So, let’s do the math.

\$131,000,000,000 divided by 75,000,000 gives us about \$1,750 per household to work with. If we assume that the average homeowner is in the 28% tax bracket (\$139,350 – \$212,300 of income for married filing jointly), that translates to a flat homeowner deduction of \$6,250. If the average homeowner is in the 25% tax bracket (\$69,000 – \$139,350, which seems more likely to be closer to the nationwide average), we can give them a \$7,000 deduction.

So, how does that compare to the mortgage interest deduction? According to Q2 data from the NAR the nationwide median price of homes sold in Q2 of this year was \$171,900. If a buyer purchased said home with just 3.5% down at a 4.5% interest rate, they would pay approximately \$7,410 in interest during the first year of their mortgage. If they put 20% down they pay \$6,143 in interest. If you are in the 25% tax bracket and you deduct \$6,143 from your income, your tax savings is \$1,536—about \$200 less than the flat homeowner deduction I am proposing. And don’t forget that the amount of interest you pay decreases every year of your mortgage, consistently shrinking and eventually eliminating your tax savings under the current system.

Obviously people who pay far above the national median price will get a much smaller benefit from this system than they do under today’s policy, but again, so what? If you’ve got the money to pay two or three times more than the average American for a home, why should the government be obligated to subsidize your purchase to a larger degree than for people who can only afford a more modest home?

It looks to me like the numbers work out. A revenue neutral deduction at \$7,000 (~\$1,750 tax savings) per owner-occupied home would be fair, or we could give the budget a bit of a boost and just make it a \$5,000 deduction (~\$1,250 tax savings). What do you think? Is my math screwed up, or would this actually work?

Tim Ellis is the founder of Seattle Bubble. His background in engineering and computer / internet technology, a fondness of data-based analysis of problems, and an addiction to spreadsheets all influence his perspective on the Seattle-area real estate market.

1. 1
The Tim says:

P.S. – I mentioned this in the comments yesterday, but I’d like to remind readers that the option I would most prefer is to completely eliminate the mortgage interest deduction (and other government meddling in the market via the tax code). I’m proposing this because I think it’s more likely to actually happen.

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doug says:

It makes logical sense that this would be of a net benefit to almost all homeowners, especially if they aren’t regularly trading up and constantly running a mortgage.

And may I say you whipped that up really quickly; I made that comment about an hour ago!

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Suitably Skeptical says:

The nice thing about the flat deduction is that it favors lower income house buyers. Under your scenario, the average homeowner with 10% down payment earns a \$6777 interest deduction. Actually, this deduction will be less than \$1000 incremental for a single person (with a std deduction of \$5800), and will be absent for a married filing jointly taxpayer (\$11,600 deduction). It’s reasonable to assume that, on average, these folks have other itemizable deductions of maybe 2% of income – let’s round up and call other deductions around \$3000…..
…forgot to ask if real estate taxes would remain deductible…they probably amount to around 1% of house value, so \$1700.
So for the average married taxpayer, there is no incremental deduction…and for the average single taxpayer, there is an incremental deduction of only \$5700 * .25 = \$1,425 in tax savings.
The upshot…..the tax credit would benefit poorer homeowners more (since, ostensibly, they could take it in addition to the standard deduction)….and thus would have more the impact that the government promotes with this deduction (making homes more affordable).
The Republicans would kill this as a stealth tax on the “job creators” and so the fantasy would fall in flames.

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per_se says:

Tim, I think you need to adjust your calculations a bit. Those are the marginal tax rates. The average effective tax rate for all tax payers is something like 22%. If you take out the top 20% of income earners the average is closer to 16%. So you’d actually be talking about something like an \$8,000-\$11,000 deduction.

That also doesn’t factor in the number of homes that don’t have a mortgage.

5. 5
The Tim says:

RE: per_se @ 4 – Let’s say your family makes \$120k. That puts you in the 25% bracket. Take a look at the IRS page I linked to see how to calculate your tax bill.

If you deduct zero dollars you pay \$22,250 in taxes (\$9,500 + (25% * (\$120,000 – \$69,000)).
If you deduct \$7,000, you pay \$20,500 in taxes (\$9,500 + (25% * (\$113,000 – \$69,000)).
Difference: \$1,750

I don’t get what point you’re trying to make about the homes that don’t have a mortgage. I counted all owner-occupied homes, mortgage or not, to get the 75,000,000 number.

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RE: The Tim @ 5

But Tim, Think of All the Tax Accountants You’d Put Out of Business

When a good lion’s share of us would the go 1040EZ and just do our taxes ourselves.

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KZ43 says:

I may be wrong, but it also appears you are leaving out the fact that families may opt for the standard deduction if the dollars makes sense.

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The Tim says:

RE: KZ43 @ 7 – How would that be different in the existing system vs. my proposal? In both cases, some people will simply take the standard deduction…

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AT63 says:

I would like to see the deduction extended to the renters. Why should the “well-off” group gets favarable tax treatment and the renters (perceivably not as well-off) does not get some kind of deductions on their rental payment?

This will also benefit IRS since I know some of the landlords do not file tax on their rental income. By allowing the rental to file claims, IRS would be able to find out the tax cheats…

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RE: The Tim @ 5

The Census Bureau Is Currently Working a Solution To the Following Data Understandably Missing from Your Analyses

I know this, because I was picked randomly this month to provide my home ownership status and my household income to the Census Bureau. So what is the average household income of home owners?????

Lord only knows Tim. Google it, you’ll come up empty.

Here’s the best data SWE could find for my educated estimate:

http://www.visualeconomics.com/how-the-average-us-consumer-spends-their-paycheck/

You’ll note the avg income is \$63K per household and 67% own homes, I’d say approximately \$60K is a good estimate.

Assuming SWE is right [and I do think your \$125K household income is way too high for avg household income home ownership, even Pink Pony Seattle], the tax bracket is more in the 10-15% bracket, especially with child tax credits and day care deductions avg’d in.

Mother Jones has a good chart on the top 10% of American household incomes at \$165K.

http://motherjones.com/politics/2011/02/income-inequality-in-america-chart-graph

The problem with that chart is averaging; i.e., if you remove the millionaire/billionaire top 1% of American household incomes and do just a 2-10% spread, not a 1-10% spread, the numbers averaged are totally skewed. I looked up the 1-10% groups as individual groups 1-10 without millionaire/billionaire skewing and the BLS documented approximately \$100K on up and you’re in the top 10% [10] group, not the \$165K which includes millionaire and billionaire with higher income groups 2-5 skewing.

I documented the URL in the Seattle Bubble archives too.

More fire for using \$60K for the avg household income owning homes in America, and most likely Seattle too [Hades, its not like Seattle has monstrous incomes compared to the rest of country, we don’t].

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gr8day says:

I agree with AT63.

See my post on yesterday’s topic: Proposal: Replace the Mortgage Interest Deduction…”

The mortgage interest deduction only helps those in debt and especially those in a lot of debt. It does NOTHING for the renter who is usually less affluent. It does NOTHING for the retired who often have their home paid for, and again are less affluent. Why do those in debt get tax breaks? It was their free-will choice to borrow money. It seems like the renter and the retired should be able to get tax breaks for their housing expenses, just as much as those that are able to borrow money.

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RE: gr8day @ 11

I’m With the Renter Too

Its progressive to go to bat for the little guy majority and corporate stooge to give the fringe minority elite rich all the tax deductions.

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Besides being completely unfeasible politically, completely eliminating the mortgage interest deduction will, in essence, raise taxes for an awful lot of people. Yes, there are much more worthy things to spend taxpayer money on, but tax increases, especially directed at wealthier folks, will have a lot of opposition in congress.
Also, deductions, other than the exemptions for children and the standard deduction, are itemized, and lower income homeowners itemize much less than higher income folks, so if we’re going to do something flat it probably needs to be a credit rather than a deduction, so all can benefit..
I don’t think the deduction has actually promoted homeownership as much as encouraging people to buy more expensive homes.
Just throwing out the mortgage interest deduction without replacing it with something else will have a negative effect on the economy, as people will have less money to spend on other things. I know, I sound like a danged Republican here who protest when the suggestion that income taxes be raised on wealthier Americans. But isn’t this the same thing? These are the job creators, fergawdsakes.
And for those of who are complaining about renters not getting this deduction: you are.
Your landlords are getting this deduction and if they didn’t get it they’d have to raise your rent. This is trickle down economics.
People shouldn’t be encouraged to borrow money, but those who pay cash for a home don’t need a subsidy, and those who have paid off their mortgages are already seeing much lower expenses without a house payment, so it makes sense to help out interest payers. So if I were making policy, i wouldn’t give this subsidy to all homeowners, just those who are paying interest. I’d make it a credit. And a flat amount would suit me just fine.

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Tim McB says:

Exactly. Totally agree Ira. People forget about landlord deductions. In essence the tax deduction is a backdoor subsidy for all sorts of housing; which is similar to how we backdoor subsidize oil in this country by giving tax breaks to oil companies. Sure they pocket some of the difference but take away the tax breaks and costs go up.

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I’m With You Ira

The term conservative and liberal are as extinct as the dinosaur in my book.

Wanna be liberals with top 10% incomes make rash statements, like Clinton did, saying \$200K incomes are Middle Class or class bashing conservatives like Bush telling us \$10/hr is great pay. But in my book, they’re both in the dunce hat corner.

Let’s face it Ira, the s_it has hit the fan.

Ya can’t have entitlements now-a-days without cutting everything in the budget. Hades, Medicaid/Medicare are currently jokes, they pay a small percentage of the actual medical wage costs [most of the expense of health care] and such, yet somehow we’re suppose to allow our hospitals to go bankrupt anyway with even more cuts. So the answer is slash doctor/nurse pay and keep interest deductions for real estate? Hades, real estate is doomed with more health care wage cuts and layoffs too, but let’s be pragmatic, how else do we pay the bills?

When Moses came down from the mountain with his Ten Commandments, the hoards were worshipping the Golden Cow, instead of God, while he was gone. Is real estate the Golden Cow today, as Obama comes down the mountain with his Senate failure Jobs Bill?

In simpler terms, the budget will be cut to match the tax base….across the board too, the Golden Cow included.

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Mark says:

“Obviously people who pay far above the national median price will get a much smaller benefit from this system than they do under today’s policy, but again, so what? If you’ve got the money to pay two or three times more than the average American for a home, why should the government be obligated to subsidize your purchase to a larger degree than for people who can only afford a more modest home?”

So just because I live in an area with a higher cost of living I should be penalized? Where we live houses cost more, living expenses are more, taxes are more (state income and local sales) etc. etc. Yes, salaries are higher but making \$100k here versus \$100k in say Kansas are two very different things.

Don’t get me wrong, I agree the system is broken but the whole system is complete messed up. The tax code needs to simplify the matters but to say that the upper percentage don’t pay enough taxes is honkey. The top 1% pay 40% of all income tax.

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Pegasus says:

RE: Ira Sacharoff @ 13 – How about rather than a credit we just fine renters? Kinda like the new healthcare legislation. No residential property ownership results in a \$4000 dollar annual fine or tax. The fine would make the costs of home ownership more competitive with renting and would result in a huge demand that would employ millions as construction boomed again. Property and income taxes received would boom again. No more deficit! According to the real estate industry home owners are better citizens, have more wealth, etc, etc. What a wonderful world we would be building. Deadbeats not paying up could be jailed for failing to pay taxes. Utopia!

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RE: Pegasus @ 17 – Pegasus works for NAR! ;-) :-)

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gr8day says:

RE: Ira @13-

You stated: “Your landlords are getting this deduction and if they didn’t get it they’d have to raise your rent. This is trickle down economics.”

This may be correct for some….but most landlords I know are basing the rent on what the market will bear…not just their costs, including the mortgage interest tax credit. That is….if they are in debt on the property and qualify for the credit.

Sometimes I think this recession started when the mortgage interest deduction started. The deduction set in motion for people to do something they otherwise might not have done.

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ARDELL says:

RE: gr8day @ 19

I don’t think you can blame “this recession” on “when the mortgage interest deduction started”… given it started in 1894. To the best of my recollection all interest, on all forms of debt, was deductible from 1894 until 1986.

Via The Tax Reform Act of 1986, Congress removed the interest on all forms of “consumer debt” from being deductible, except for the mortgage interest deduction. That is why people tried to get around that by building their car and other debt into their mortgages to recapture the deduction of the interest on their other consumer debt. They did this mostly via Home Equity Loans to pay off their cars and credit cards and then deduct the interest on the Home Equity Loans. Then there were “new rules” imposed about deducting Home Equity loan interest for amounts not used for home improvements…and so on and so on.

But as far as a I know, someone correct me if I am wrong, the mortgage interest deduction has been in place since 1894.

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John Bailo says:

Why not create a deduction for people whose eyes are blue?

Or who are between 5′ 9″ and 6′ 1″ ?

Why should the Government do this type of social engineering at all.

A good case can be made that a highly mobile workforce…that can respond to changing conditions around the nation and the world, not being tied to a home, could be a net plus for our country.

Why not a standard deduction for those who choose to rent?

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whatsmyname says:

Why not a standard deduction for those who choose to rent?

John, There is a standard deduction. It is aimed at those who rent.

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whatsmyname says:

RE: gr8day @ 11
I really enjoyed your logic that older persons owning their homes debt free is an indication of their lack of affluence. Better still, that they need a deduction for their apparent lack of housing expense. Keep ’em coming.

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Ooi says:

RE: The Tim @ 8 – First, this would be a windfall to those who own their homes and have already deducted all their interest at the expense of new buyers who are paying mostly interest at the beginning of their loans. Second, the bottom 50% of filers pay no income tax now, so your proposal will either not impact them (creating a windfall to the gov’t) or it will cause their income tax to increase if their actual interest deduction is the reason they pay no income tax and their actual deduction is higher than the proposed amount. This makes the proposal regressive.

Finally, if the deduction was wholly eliminated, homeowners would likely then be able to capitalize the interest expense into their basis in the property. In that case, aside from the difference in ordinary and capital rates and the time-value of money (which are not insignificant) the Govt would just collect the tax sooner rather than later.

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WestSideBilly says:
The nice thing about the flat deduction is that it favors lower income house buyers.

Which is why it has 0% chance of ever happening.

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WestSideBilly says:

RE: ARDELL @ 20 – I don’t think that’s quite right, I believe it was 1913 or 1914 when the Constitution was amended to make income taxes legal. The 1894 effort was voided by the SCOTUS, so there was no tax to apply for a deduction against.

Otherwise, accurate assessment.

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RE: WestSideBilly @ 26 – The passage of the income tax amendment actually led the way for the Prohibition amendment, because without the income tax amendment the government would not have had enough money without alcohol. Alcohol taxes were something like 70% of government revenue prior to the income tax.

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gr8day says:

RE: Whatsmyname @23
You stated: “I really enjoyed your logic that older persons owning their homes debt free is an indication of their lack of affluence.”

This is my perspective – My grandmother lives in a house that is fully paid for. It is about 900 sf, was built in about 1950 and is worth about \$100K. It needs about \$20k in repairs to put it on the market. She has very little in savings. She lives month to month on her SS. I would not classify her as “affluent”. She was in my thoughts as I wrote the post.

I am sure there are those that own their \$500,000 home debt free, and perhaps they could be called “affluent”. However, I have never met these people, as they are not in my circle of friends/family.

So, when I stated that the home interest tax deduction does “NOTHING for the retired who often have their home paid for, and again are less affluent” I was thinking of those in situations like my grandmother.

I recently read an article on Reuters (July 11) that concluded that the home interest deduction was not a middle-class tax break, but an upper-middle class tax break. I am not convinced that the upper middle class need a tax break right now.

29. 29

By gr8day @ 28:

I am not convinced that the upper middle class need a tax break right now.

More to the point, it’s not likely the type of tax break that would lead to any significant employment. Perhaps a gardener for an hour once or twice a month.

That’s the distinction I’ve been trying to make when I suggest tax policy. Don’t raise taxes on entities that actually create jobs, and possibly even lower taxes on such entities to help create jobs. But anyone who creates significant jobs can deduct their interest on business loans regardless of whether or not it’s secured by their house, so they don’t need the mortgage interest deduction.

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gr8day says:

RE: income tax history

According to The Tax Foundation (www.taxfoundation.org), “The first modern federal income tax was created in 1894. Interest — all forms of interest — was deductible; the Supreme Court, however, quickly ruled that the tax was unconstitutional. In 1913, the Constitution was amended and a new income tax was enacted. Once again, interest was deductible.”

“When Congress made interest deductible, it was probably thinking of business interest. Just as today, the aim was to tax a business’s profits after expenses had been netted out, and interest was an expense like any other. In a nation of small proprietors, basically all interest looked like business interest. Whether it was interest on a farm mortgage, or interest on a loan to purchase a tractor, or interest charged to a general store that purchased its inventory on credit, it all would have looked like a business expense. Credit cards did not exist. So Congress just said, “Deduct it.” The article states that fewer that 1% paid any income taxes – the Andrew Carnegie types.

There was also a change when the FHA/Fannie Mae started insuring loans: “Before then, the corner bank would issue a mortgage and wait for the homeowner to pay them back; now savings and loans could replenish their capital by selling their mortgages to Fannie Mae — meaning they could turn around and issue a new mortgage to someone else.”

It goes on to state “…the mortgage interest deduction essentially treats individuals’ housing expenses like a business expense, allowing them to deduct it from taxable income.”

This was before credit cards, HELOCs, revolving credit, student loans etc. Think “Little House on the Prairie.”

Interesting history

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ChrisM says:

RE: gr8day @ 30 – Think “Little House on the Prairie.”

Funny you mention that, I’ve been reading the series to my little girl, and got interested enough I read a biography of Laura Ingalls Wilder. Her father had chronic debt problems. At one point (not included in the Little House series!) they skipped town and shafted their landlord out of at least a month’s rent.

Farmers at the time were highly encouraged to get into debt to purchase their seed & farming supplies, as well as the material to build their houses. Lots of new farm gadgets were coming out, including steam powered threshers.

Additionally, the govt “giveaway” of land was very negatively depicted by Ingalls – more than once she called it the govt betting you couldn’t improve the land in five years. In which case the govt would get the presumably marginally improved land back.

Ingalls’ parents and Ingalls and her husband both got over their heads with debt.

The Dust Bowl also had the same debt problem. A fascinating book here:
http://www.amazon.com/Worst-Hard-Time-Survived-American/dp/0618773479/

on the dust bowl – again, the banks were happy to make speculative loans, on the assumption the land value would only go up. Poor farming practices destroyed the land and hilarity ensued.

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ARDELL says:

The reason I posted an historical recount is to point out that the only reason all interest deductions were eliminated in 1986 EXCEPT the Mortgage Interest Deduction, was because NAR Lobbyists raised holy hell. Reagan promised them (before 1986 when they were working up the 1986 Tax Reform Act) that he wouldn’t touch the mortgage interest deduction. That is why it is the only interest deduction that remains. Not for fundamental reasons at all. So the question isn’t about practical or logical…it is “Is NAR weak enough for anything like this to pass?” some 25 years later.

As to RE taxes being deductible, ALL taxes paid are deductible…with some limitations. There is no separate rule about RE taxes anymore than there used to be a separate rule for mortgage interest. From 1894 (instituted in 1913 or 1914) it was always the intention for all interest and taxes paid to be tax deductible. Sales taxes, State taxes paid…all kinds of taxes…including RE taxes.

Now I have to wonder…why would we want to get rid of something that has been around since 1894/1913? Is nothing sacred in this Country anymore…except the right to bear arms? :)

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whatsmyname says:

RE: gr8day @ 28
Thanks for your perspective. I get your imagery, and agree that your grandmother and people in her situation are not affluent. But I would imagine that virtually all tax deductions would “do NOTHING” for them, because as you describe it, they probably don’t pay income taxes.

Can the middle (or upper middle) classes pay more taxes? Certainly they could, but why take away something people have had for a hundred years before relinquishing a new and “temporary” tax cut for the rich which is not yet 12 years old?

This is the perfect metaphor as every day and everyplace in this country is filled with discussions and ideas of how to send the middle (and lower) classes back to the 1890’s so that the richest won’t have to go back to the 1990’s.

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whatsmyname says:

By Pegasus @ 17:

RE: Ira Sacharoff @ 13 – How about rather than a credit we just fine renters? Kinda like the new healthcare legislation. No residential property ownership results in a \$4000 dollar annual fine or tax. The fine would make the costs of home ownership more competitive with renting and would result in a huge demand that would employ millions as construction boomed again. Property and income taxes received would boom again. No more deficit! According to the real estate industry home owners are better citizens, have more wealth, etc, etc. What a wonderful world we would be building. Deadbeats not paying up could be jailed for failing to pay taxes. Utopia!

Pegasus,
This is your finest work ever. The \$4,000 annual tax/fine neatly complements the property taxes that the homeowner already pays. I think you should even get a tax deduction for it. I agree with everything you wrote except the part about jailing deadbeat renters. This would place an unneeded burden on vacancies and landlord cashflows. Instead, we should simply add the delinquent amount to their income taxes. We could create an offsetting tax credit table for poor renters, (because we care). It would never quite even out, but this is America and that’s how we do it.

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ChrisM says:

Not sure how prevalent this knowledge is, but many counties in Washington state have property tax deferral programs for senior citizens, as well as lower-income people.

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[…] the Mortgage Interest Deduction with a Flat Homeowner Deduction – Also, the follow-up: Running the Numbers on the Flat Homeowner Deduction. Personally, I’d favor eliminating the homeowner mortgage interest deduction entirely, but […]