Deductions May Be Cut : Deficit Cure May Bring Ill Effects

Regardless of who is elected President on Tuesday, one of the first items he’ll have to address when he takes office next January is the nation’s $155-billion federal budget deficit.

Neither Vice President George Bush, the Republican presidential nominee, or Democratic challenger Michael S. Dukakis has presented concrete plans to trim the deficit, and they don’t like to talk about. But exactly how the winner goes about reducing the nation’s red ink--and how successful those efforts prove to be--will have a direct impact on homeowners and renters.

Many taxpayers could find their ability to deduct mortgage interest payments limited, while federal outlays for popular housing programs could be scaled back, some experts say. A possible tax hike could make it tougher for Americans to meet their monthly mortgage obligations or rent payments.

Interest-Rate Rise Seen

If nothing gets done, interest rates--which economists say are already artificially high because of the deficit--could rise by as many as three points as the government seeks to attract investors willing to finance its budget shortfall.

“The most obvious impact that the federal deficit and all the debt we’ve piled up has on housing, is that it puts upward pressure on interest rates,” said John Tuccillo, chief economist of the National Assn. of Realtors.

As the red ink keeps flowing, Tuccillo and other economists say, the federal government has to borrow more to make ends meet. The primary way of doing that is to sell Treasury securities, such as bonds.

To entice investors to buy government securities instead of investing their money elsewhere, the Treasury has to keep offering attractive--often times, higher--interest rates. This tends to push other rates, including those charged on mortgages, higher as well.

Higher Mortgage Payments

In turn, the higher mortgage rates make it impossible for many people--especially first-time buyers--to purchase a home, economists say.

Those who can still get loans despite the higher rates must devote more of their income to making monthly mortgage payments, or must settle for smaller, less expensive homes to keep their payments under control. Longtime homeowners with adjustable-rate mortgages also pay more, as the interest rate on their loans moves upward.

While higher mortgage rates perhaps are the most obvious results of the deficit, the red ink also affects housing in more subtle ways.

“When you owe all this money, it affects all aspects of public policy and programs,” said David Seiders, chief economist for the National Assn. of Home Builders and former senior economist at the Federal Reserve Board.

As an example, Seiders said, housing-related programs, ranging from the popular Federal Housing Administration loan program to federally subsidized low-income housing, “have been hurt over the past several years” as the government cut back its financial support in an attempt to keep spending under control.

Changes have also been made in bond programs aimed at providing low-cost loans to build or buy affordable housing. Those changes, designed to trim the deficit, have raised buyers’ and builders’ borrowing costs and thus increased the price of certain types of housing.

And even though the housing industry has enjoyed a prolonged boom, some say those good times could have been even better--and would last longer--if the deficit was lower.

Building Boom Ebbing

The construction industry accounted for a record 561,000 jobs in California alone last year, according to one trade group, but that number has since been reduced by several thousand because the long building boom is winding down.

Although construction work was expected to decline because of its cyclical nature, an upturn in interest rates this year--some of it linked to the deficit--has hastened the downturn. “Housing is still the most interest-rate sensitive segment of our economy,” Seiders said.

Interest on federal borrowing is running about $150 billion a year, a whopping 14% of the federal budget. That’s money that some economists say would be better spent on retooling America to make it more competitive in the global economy, or to retrain workers and create jobs.

Although homeowners and renters are already hurting from the nation’s budget deficit, they may find the next President’s efforts to reduce the deficit equally painful.

Limit on Deductions

A growing number of members of Congress are talking about putting further limits on tax deductions that homeowners can take for mortgage-interest payments. Those write-offs will cost the Treasury an estimated $36 billion in 1989.

President Reagan signed legislation earlier this year that put the first-ever limits on such deductions, preventing homeowners from writing off interest on more than $1 million in mortgage debt. Although the new cap affects relatively few borrowers, some experts say it opened the door for Congress to enact even lower caps in the future.

“It would be very unfair to (affected) homeowners, but the idea of scaling back these deductions even further seems to be gathering steam,” said Sanford R. Goodkin, executive director of Peat Marwick Main & Co./Goodkin Real Estate Consulting Group.

“What was once sacrosanct--deductions for mortgage interest payments--has been put on the bargaining table.”

Lower Home Values

One congressman already has suggested a $15,000-limit on annual mortgage write-offs.

Lowering the current limit would effectively raise people’s taxes, because less of their income would be sheltered from the Internal Revenue Service. A lower cap might also put downward pressure on home values because prices reflect, in part, the generous benefits available under the current tax code.

“Cutting back those deductions would hurt first-time home buyers, too,” said Seiders, the builders’ economist. “A lot of people couldn’t buy their first home if it weren’t for the tax deductions.”

First-time buyers would also be hurt if efforts to trim the deficit include cost-cutting changes in the FHA loan program, or in low-interest bond programs used to finance the purchase or construction of affordable housing.

Foresee Tax Increase

Some housing advocates also fret that next year’s probable belt-tightening leaves little chance of restoring deep cuts made in federal housing subsidies during the Reagan years. Such outlays have been slashed from about $25 billion in 1981, when the President took office, to about $7 billion today.

Although neither Dukakis nor Bush is anxious to raise taxes, economists say any efforts to reduce the deficit will likely have to include some type of a tax hike. That would also make it harder to buy a home or pay the rent, because the government would be taking a bigger bite out of everyone’s paycheck.

Although reducing the deficit will be a painful exercise, many economists say it must be done.

“If the next President doesn’t make any progress in reducing the deficit, I think we’ll see a two- or three-point run-up in (interest rates) rates toward the end of next year or in 1990,” Tuccillo said. “And any problems that the deficit is causing now will just get worse.”