Will President Obama wreck the U.S. economy?

This, in so many words, was the question my friend "Joe" posed me the other day. Joe was alluding to the President's plan to reform the U.S. health-care system, a mammoth, $634 billion endeavor comprised of three parts:

  • Requiring health insurers who currently participate in the "Medicare Advantage" program to submit competitive bids for the right to manage government benefits.
  • Pressuring Big Pharma to increase rebates on prescription drugs.
  • Capping income tax deductions for high-earners -- including those on mortgage interest.

Whether or not the plan comes to fruition, it's already accomplished one thing: Knocking 22% off the stock price of UnitedHealth (NYSE:UNH) and 20% from WellPoint (NYSE:WLP). Less directly, it may have given Merck (NYSE:MRK) an 18% haircut (and that was before today's news).

But it was Part Three of the President's plan that really got Joe's goat.

Look! Up in the sky! It's your taxes!
Joe, you see, is a homeowner. And the third part of the Grand Plan to Revamp the American Health-Care System includes capping income tax deductions for high-earners.

Individuals earning $200,000 or more can currently deduct interest paid on a home mortgage from their taxable income. Say you owe $200,000 on your home, and pay interest at 6%. That works out to $12,000 in income that would ordinarily be taxed at a 33% marginal rate (so $3,960) -- but isn't taxed under the current system.

Obama's plan would "cap" deductions at the 28% rate, while still allowing $3,360 to be deducted from tax owed. Although "your mileage may vary" by tax bracket, income level (the marginal rate for a single filer jumps to 35% at the $357,700 income level), or marital status, the net effect in this example would be: The taxpayer pays $600 more in tax.

This "tax increase" has Joe upset -- but not for the reason you might think.

What's bad for me is bad for the economy
Don't get me wrong. Joe isn't thrilled about the $600 tax hit. But his real objection is that this tax hike is "bad for the economy." His logic being that when you reduce the tax benefit of owning a home, you also reduce prospective purchasers' incentive to buy a home, and hence ... the home's value. So this is bad news for homeowners and homebuilders like Toll Brothers (NYSE:TOL), DR Horton (NYSE:DHI) and Pulte (NYSE:PHM) alike.

Sympathy for the devil
The logic's impeccable, but allow me to play devil's advocate for a moment -- because the fact is, I actually think Obama's come up with a pretty bright idea here.

You see, politicians today view the home mortgage deduction as the second "third rail" of electoral politics. Just like Social Security, politicos know that they touch this tax break at their peril. Yet ever since 1984, when President Ronald Reagan caved to the National Association of Realtors and retained the mortgage interest deduction (even as he ended deductions for interest on other forms of consumer debt), Adam Smith free market-eers have argued that a clean sweep is needed. Why?

Would you like that McMansion supersized?
Because the mortgage interest deduction encourages profligate spending. I remember my Realtor's wise words clearly, from back when I bought my own first house in 2001: "Buy as much house as you can. The more house you buy, the bigger your tax break."

Macroeconomically speaking, though, this argument makes no sense. Excessive money sunk into a house is, by definition, money not being put to productive use elsewhere in the economy. It's money not deposited at a bank, not re-lent to finance spending by consumers. Funds not invested in growing businesses, starving them of capital they could use to buy equipment from other businesses, hire workers, and so on. Money tied up in buying "as much house as you can" is, in essence, money tied down for the sole purpose of capturing a tax break.

Baby steps
But what about the cost? In the example given above, $200,000 salary-earners can expect to pay about $600 a year in higher taxes. Do I like the class warfare angle of capping the deduction only for the rich? Of course not. But when you get right down to it, a 0.3% tax hike isn't too high a price to pay to capture the economic gains of eliminating an eminently silly tax policy.

As for the rest of taxpaying America, mark my words: This is not the end of the mortgage interest deduction rollback. It's just the first step. By starting with a "soak the rich" tax increase, the President has donned the political equivalent of "insulated gloves" that will enable him to first shift, then remove this political third rail.

In my Foolish opinion, that's a good thing.

Fool contributor Rich Smith owns shares of UnitedHealth Group. Still. The Motley Fool has a disclosure policy.

WellPoint is also a current Motley Fool Inside Value recommendation. UnitedHealth Group is a recommendation of both Motley Fool Inside Value and Motley Fool Stock Advisor. The Fool owns shares of UnitedHealth Group.