Federal Reserve Bank of Minneapolis President Narayana Kocherlakota suggested replacing the mortgage interest tax deduction with a tax credit to help homeowners with a down payment. When President Obama released his 2012 budget, the deduction considered a “sacred cow” to homeowners and many trade groups became endangered. Lawmakers continue to hunt for revenue generators as part of the ongoing negotiations on the federal debt limit. Analysts at Washington think tank MFGlobal said in a recent note that cuts to the mortgage interest tax deduction are more likely to become part of the debate. The congressional Joint Committee on Taxation estimated in March the deduction would cost the government $484 billion from 2010 to 2014. Kocherlakota said the deduction encourages homeowners further into debt and, thus, undercuts financial stability in light of the financial crisis. Interest on a mortgage taken out to buy or improve a home can be fully deducted if the amount of the loan is less than $1 million for married couples and $500,000 for singles. The deduction for home equity loans taken out for anything else is limited to $100,000 for couples and $50,000 for singles. While more than one-third of U.S. tax returns itemize deductions, 60% of households making more than $50,000 itemize. That increases to more than 75% of households making more than $75,000. Kocherlakota urged policymakers to consider lowering the mortgage interest these taxpayer’s could deduct and replace it with a tax credit that offsets part of the a buyer’s down payment. “Such a tax credit would encourage homeownership without simultaneously providing more incentives for households to accumulate more debt,” Kocherlakota said. Tim Rood, partner at financial advisory firm The Collingwood Group, disagreed with the claim. “I struggle with the argument that the solution to risks from heavily indebted consumers would be to raise the cost to service their debts,” Rood said. “The 1982 tax reform that phased out interest deductions on things like auto loans and credit cards certainly didn’t lead to a reduction in credit card usage or the size and frequency of car loans. Quite the contrary.” Kocherlakota did warn policymakers of the eventual timing of such a move, given the current economic conditions. In late March, Rep. Barney Frank (D-Mass.) told a House subcommittee the deduction “is going nowhere.” Kocherlakota said he wants lawmakers to weigh the benefits and the costs of the deduction, rather than the politics that will inevitably dominate the conversation. “I would also encourage policymakers in the tax arena to ask broader questions about the mortgage interest and corporate interest tax deductions,” Kocherlakota said. “What are the social benefits associated with these deductions? Can these social benefits be achieved using an approach that does not undercut the stability of the financial system?” Write to Jon Prior. Follow him on Twitter @JonAPrior.