I'm receiving a lot of e-mail supporting the closure of the tax exemption that is currently granted to banks on the interest earned on first mortgage investments. This deduction, which has been in place since the early 1980's, means that banks don't currently pay Business and Occupations (B&O) taxes on the interest or investment earnings made from the interest from residential first mortgages.

The Supplemental Operating Budget proposed by the House of Representatives proposes to cap this deduction at $100 million, so that each bank would be taxed only on the excess over that amount – i.e., if the bank earns $150 million in interest, it would pay tax on the additional $50 million. It is estimated that the cap on the deduction would garner around $59 million.

The House's proposal would also clarify that the first mortgage deduction applies only to interest earned on first home mortgage loans and first home mortgage-backed securities. A recent State Supreme Court ruling expanded the existing deduction to apply to other streams of business revenue, such as fees charged for servicing loans sold on secondary markets. The House estimates that this clarification alone would save the state about $8.5 million in the current fiscal biennium.

The Senate did not include the closure of this tax deduction or the clarification of the deduction in its budget proposal. I and several of my progressive colleagues firmly support closing this loophole, but we were unable to muster a majority of our 31 Democratic colleagues to support it. We're now in our 3rd day of a "special session" called by the Governor to make our final budget decisions. (For more information about the special session, you can read my blog post here: http://blog.senatedemocrats.wa.gov/kline/blog-no-rest-for-the-weary/) The first mortgage tax loophole is still part of the negotiations between the House and Senate, and I hope to see it included in the legislature's final budget.

This loophole primarily benefits large banks that aren't based in Washington. Since the collapse of Washington Mutual, there are no longer any big banks headquartered in Washington. However, our state Department of Revenue estimates that there are three community banks headquartered in Washington that make over $100 million in first mortgage interest earnings each year. We may raise the cap to $110 million in order to accommodate them.

The original intent of the B&O deduction was to make home mortgages more affordable and available. Bank managers and staff have lobbied hard against closing this tax loophole. I met with representatives from several community banks in our district, as well as representatives from out-of-state banks. They claim that this deduction gives an incentive to banks to provide first mortgages to buyers of residential properties, and that closure of the loophole would mean that banks would loan less money to potential buyers. This argument is somewhat compelling, because in this hazardous economy we all want banks to assist people to buy homes. The banks also claim that losing this deduction would mean the loss of some jobs in the banking industry. Community banks and those big out of state banks employ a lot of folks in our community, and of course we don't want even more people to lose their jobs.

In my estimation, banks haven't provided the evidence to back up their claims that there would be significant job loss, or that there is a connection between this deduction and the availability of home mortgages. There haven't been any objective studies done on the consequences of this tax deduction, so there is no proof that it's meeting its intended goal of making first mortgages available and affordable. The fact that banks profit from providing affordable mortgages may well be enough incentive for them to do so.

Still, many of my colleagues in the Senate have been persuaded that this tax deduction is worth keeping. They don't want to prevent people from obtaining mortgages. It's not that they want to support big Wall Street banks, but they want to support the businesses in their communities that provide jobs to their constituents.

As I said, this is still part of our budget negotiations. I'll do my best to get the closure of this loophole included in the final budget, and there's a good chance we'll succeed.