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Why We Should Scrap Mortgage Interest Deductions

AUG 19, 2014 2:58pm ET
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The mortgage interest tax deduction is often justified as promoting homeownership among the middle class and supporting industries that employ middle-class workers. The deduction also has broad public support: a recent survey found that six out of ten Americans oppose its elimination.

But such support is misplaced. Over 64% of the MID tax benefits go to tax filers earning more than $100,000, according to our new study released through the Mercatus Center at George Mason University. While the upper middle class does benefit from the deduction, the vast majority of the dollar benefits go to higher-income taxpayers. Little to no dollar benefits go to low-income households that purchase a home.

Our study examines the economic effects of the mortgage interest deduction in addition to assessing the tax break’s policy effectiveness. We argue that, considering the political hurdles that full repeal might create, policymakers should instead seek to replace the MID with a fixed $900 credit for all taxpayers with a mortgage.

The purported public policy role of housing-related tax deductions and credits is to increase homeownership. But as currently structured, the MID fails to significantly increase homeownership among its intended beneficiaries, and it encourages greater debt among homeowners. In short, the MID is generally giving a tax break to households that would likely purchase homes anyway and enabling high-income households to buy homes that are roughly 10–20% larger than those they would otherwise buy.

Of the 65.2% of tax filers claiming to make less than $50,000, a mere one in ten claims the mortgage interest deduction. One reason that low-income and many middle-income taxpayers are unlikely to use the MID is that the standard deduction is likely greater than any itemized expenses. Unless annual mortgage interest expenses, combined with any other expenses that are allowed as itemized tax deductions, are greater than the standard deduction, a taxpayer will not opt to itemize deductions. According to data from the Internal Revenue Service, it is only after reaching $100,000 in income that three-fourths of tax filers use the MID.

Other countries also demonstrate an inconclusive relationship between the MID and homeownership. In the case of the United Kingdom, which phased out the MID between 1975 and 2000, the homeownership rate rose from 53% in 1974 to 68% in 2001. While the increase in homeownership may or may not be a direct result of phasing out the MID in the UK, at a minimum, the phase out did not decrease homeownership.

Much of the justification for owner-occupied housing subsidies focuses on encouraging individuals who would not otherwise have sufficient savings to acquire home equity. Yet as Yale economist Robert Shiller points out, other foreign countries such as Switzerland have higher rates of household saving even without high homeownership rates.

The MID could likely be eliminated with minimal effects on low- and middle-income taxpayers. Only a full repeal of tax-favorable housing policies in exchange for lower marginal tax rates for all taxpayers will eliminate economic inefficiencies. Elimination of the MID in exchange for lower marginal rates and a higher standard deduction would represent a general improvement in the standard of living for almost all low- and middle-income taxpayers.

This hypothesis has already been proven by the The Tax Reform Act of 1986, which significantly reduced the value of the MID by reducing marginal tax rates and increasing the standard deduction. The lower tax rates significantly diminished the use of the MID by lower-income households, although the reduction in use was not quite as great for high-income households.

Eliminating the MID may slightly decrease the demand for housing among some low-income households that actually have sufficient mortgage interest to itemize. But this decrease seems relatively small, given that the MID is used so infrequently by low-income households. The bulk of the decrease in the demand for mortgage debt would come from households with large loans that exceed the loan limits of Fannie Mae and Freddie Mac.

A cleaner tax code would also move the housing industry away from its current tax-driven overvaluation. Revenue-neutral tax reform that eliminated the tax bias toward housing might encourage higher-income households to shift some housing investments to more socially productive investments, such as stocks or bonds.

If tax-favored housing must exist, it should, at a minimum, promote homeownership among low-income and middle-income households. A successful tax-favored housing policy would be designed to encourage households at the margin to purchase a home—that is, those homeowners who would like to own homes but would not do so without a federal subsidy. For example, offering a fixed, nonrefundable $900 credit to people who have a mortgage could increase homeownership among low- and middle-income households by as much as 5%, while only decreasing homeownership rates among high-income households by 1%.

By reforming the MID from a deduction to a credit, the purported policy goals of supporting homeownership would be more properly aligned with actual outcomes. A cleaner, simpler tax code brings more equality to investment opportunities and is a step toward greater tax fairness.

Jason J. Fichtner is a senior research fellow with the Mercatus Center at George Mason University. Jacob Feldman is a research analyst with the Mercatus Center. They are coauthors of a recent working paper published by the Mercatus Center on "Reforming the Mortgage Interest Deduction."

Comments (3)
I have been a homebuilder for over 60 years and have delivered about 30,000 residential units.
Interest rates are always an most asked question as are the tax benefits of owning a home. A major question asked is will the tax costs continue with the mortgage deduction. the reasoning is that it is a major part of the cash needed to own a home.
the serious home buyer is looking for a place to eventually pay the loan off and have a place to live in without increasing rent from an apartment and they want to buy the most house they can afford. Tax deductions are a major part of the purchase, it is nearly always considered as a part of the ongoing part of a home. Once it is bought is not thought of again until income tax preparation in most cases.
I wonder why there people making bogus studies to keep increasing costs for home owners? Do these people not care about people that happen to want to work hard and use their money to increase their ability to have a nicer home. Do they only want to get more money for government to continue to keep growing and increasing costs for everyone but government employees?
Yes, our country was founded on "Government By the People, Of the People and For the People" Why is this not being followed anymore?
Posted by Harry C | Wednesday, August 20 2014 at 2:06PM ET
These authors are focusing on a narrow, flawed premise -- that the only benefit of the mortgage interest deduction is for lower income earners to be able to afford a home. They are not expanding their view to take into consideration all of the jobs, wealth distribution, etc. that is a direct result of the fact that people own homes. Just because people who make more money are the ones that also tend to claim the mortgage interest deduction (if that wasn't self-evident anyway) the last thing this economy can afford is one more piece of the deflation puzzle (elimination of the mortgage interest deduction) to be put into place. The ripple effect of this would be huge if this were implemented. How many renters go to Home Depot to buy things to fix up their "homes"? The mortgage interest deduction helps maintain the QUALITY of homes, just go into any predominantly rented neighborhood in case you doubt that. Just because these authors claim that it isn't helping the lower income earner actually own a home doesn't mean that it isn't helping them -- many of them wouldn't have jobs if the MID went away.
Posted by Dave G | Wednesday, August 20 2014 at 3:56PM ET
Dave G.,right on the money. They have no clue. Just another Socialist view without understanding Capitalism and the major role Housing plays in the economy. Great response Dave. Thank you!!!
Posted by ROBERT R | Friday, August 22 2014 at 2:49PM ET
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