Paul L. Caron

Wednesday, August 7, 2013

Bartlett: The Sacrosanct Mortgage Interest Deduction

New York Times:  The Sacrosanct Mortgage Interest Deduction, by Bruce Bartlett:

When people talk about “sacred cows” in the tax code, the deduction for mortgage interest is usually at the top of the list. But it is just one of many tax expenditures benefiting homeowners. Other important ones include the deduction for property taxes and low taxes on the gains from sales of primary residences.

Contrary to popular belief, the mortgage interest deduction wasn’t adopted to encourage home ownership. The original income tax enacted in 1913 allowed a deduction for all interest on the theory that it was largely business-oriented. According to Dennis Ventry of the University of California, Davis, School of Law, only a third of homeowners carried a mortgage in 1910. ...

It is likely that if mortgage interest had never been deductible the home ownership rate would be similar to what it is today. Indeed, it might even be higher, according to research by the economists Matthew Chambers, Carlos Garriga and Donald E. Schlagenhauf. They contend that without deductibility tax rates could have been lower, which would have raised after-tax incomes, making it easier to afford a home.

There is further evidence from foreign countries. According to a recent paper by the economists Steven C. Bourassa, Donald R. Haurin, Patric H. Henderschott and Martin Hoesli, there is little evidence that mortgage interest deductibility has any impact on home ownership rates one way or another. As the table from their paper shows, many countries without deductibility have higher home ownership rates than we do, and some with deductibility have lower rates.


The principal constraint on any reform is that the mortgage interest deduction is very popular, according to every poll on the subject. ... The main argument for reforming the mortgage interest deduction is simple math – it is the second largest tax expenditure, reducing federal revenues by more than $100 billion. It will be harder to reduce tax rates if the deduction is declared off limits.

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Dear Tedd: Sell now, collect profit, wait for bottom.
I get a sense of "LA - 2006"
And as for Vox Clams...
If not for the (much) higher marginal tax rate imposed on "the rich" a.k.a the above-average income middle class, there would be little advantage to deductions. Don't blame the fever, blame the virus.

Posted by: aVet | Aug 9, 2013 9:23:56 AM

"1. Canada's housing market is crashing as we speak. Lack of mortgage deduction did not protect them."

Go right on believing that if it makes you feel better. My house in Canada is worth 20 percent more now than when I bought it in 2008. How's yours doing?

Posted by: Tedd | Aug 8, 2013 11:02:41 PM

The mortgage interest deduction is one of the most unfair aspects of the current tax code, and that is saying something. It benefits only those wealthy enough to have more deuctions than the "standard" deduction, and it disproportionately benefits those with larger mortgages - that is, more expensive houses. Talk about welfare for "the rich" (well, not necessarily the rich, but those with relatively expensive houses). Get rid of it, along with all the other deductions, save maybe the charitable deduction (someone would need to honestly study what might happen to services for the poor if the charitable deduction - already only 50% - were wiped out).

Posted by: Vox Clams | Aug 8, 2013 8:42:25 PM

Perhaps it would have been better if the mortgage deduction had never existed, but that is an academic point. It exists, and so the question is what effect would its elimination have on the economy and, in particular, housing prices and construction employment, in the short, medium, and long terms. Has there ever been a solid economic study of the impact on the economy if the mortgage deduction were to be eliminated? For example, would housing prices actually go down? What effect would it have on mobility? What effect would that have on the financial institutions and markets? In the current economy, might not another significant hit to housing prices, just as they are climbing again, send the country back into recession? Can these risks be mitigated through a "phase out"? And, if so, over what time period?

I don't pretend to know the answers, but in these discussions I frequently see analyses like the one above that lament what might have been and glib 'sacred cow' comments about how a lack of political courage is the only reason it continues to exist, but I rarely see thoughtful analysis of the economic risks of eliminating the mortgage deduction. It seems to me that especially given the current economic and political situations, the law of unintended consequences should chasten all of us before advocating for such a substantial change in our tax code.

Posted by: Jim | Aug 8, 2013 3:15:44 PM

1. Canada's housing market is crashing as we speak. Lack of mortgage deduction did not protect them.
2. This wouldn't be an issue if not for the insanely progressive income tax rates that clobber middle class families for up to 50% on the margin. Mortgage deductions (and 401k/IRA deductions) benefit most those at the highest marginal tax rates, but then those are the folks getting hammered the worst as well.
3. Apparently "all you monies are belong to us" is the government's accounting principle. Deductions or not, I pay more than a reasonable amount for the support of the federal government.

Posted by: aVet | Aug 8, 2013 3:04:29 PM

@Blnkless: "Just wondering why you don't point out how regressive the deduction is. It mostly benefits well off younger adults buying homes in expensive coastal markets, since they'll have the highest marginal tax rates and the largest mortgages. ... "

Who cares who it benefits? In calculating a capital gain, taxpayers deduct their basis from the amount realized. This deduction also benefits more affluent taxpayers disproportionally. Are we supposed to reject subtraction of basis as well, on the grounds that it's "regressive"?

The only factor in judging an exemption or deduction should be whether the exemption or deduction makes sense, not who it will benefit.

Posted by: No-no-no | Aug 8, 2013 11:30:07 AM

it may be that we would have higher rates of ownership without the deduction but we have a chicken/egg situation in that you have to lower that tax rates at the same time you eliminate the deduction, but I do not see that happening.

Posted by: Rich | Aug 8, 2013 10:47:59 AM

The only way to lower taxes is to lower the cost of government. How we get to the bottom line on our individual 1040's is a shell game, won by some, lost by others. The mortgage business has long advanced the reasoning that a larger loan and greater leverage were beneificial because of the tax deductability. The last crisis was caused by many high loan-to-value loans because it seemed unfair to some that all people couldn't share in this "vital and important" benefit.
It is ironic that the same economic slowdown hit Canada to the north, too, but they virtually missed the housing crisis part of the crash. Canadians have no reason to leverage their real estate like we do. They had plenty of equity and were not upside down when values flucuated. For this reason I would like to see the mortgage interest deduction disappear. The reason to get a mortage is to obtain a home. And the reason to own a home is to gain equity in it. Other reasons like a tax deduction work against that by allowing owners to rationalize over-leveraging their properties.

Posted by: DBix | Aug 8, 2013 10:43:38 AM

> You explain that ALL of the tax code madness is going away. You have a tax rate, and you pay it. It will be lower than you pay now, and most people will see no net difference. You explain to them that this gets some of the lobbyists and special interests out of DC,

And then you get to explain why this time will be different, because they've heard it all before, both wrt taxes and immigration. (Coincidentally, both in the 80s.)

Politicians don't have credibility on these issues, so any plan that requires them to use their credibility is fatally flawed.

Posted by: Andy Freeman | Aug 8, 2013 10:23:13 AM

Only in a Bizarro, alternate universe is a deduction considered a tax expenditure.

Posted by: Mark Well | Aug 8, 2013 10:01:32 AM

Just wondering why you don't point out how regressive the deduction is. It mostly benefits well off younger adults buying homes in expensive coastal markets, since they'll have the highest marginal tax rates and the largest mortgages. I think many people are under the impression that the mortgage deduction gives working families a leg up, but it's really not true. A family of four making 70K a year gets next to nothing from the deduction.

Posted by: BInkless | Aug 8, 2013 9:56:51 AM

Like Nathan above, I support a gradual reduction of the deduction (and I say this as a homeowner who takes full advange of the deduction). I agree that non-primary residences should not be included in the deduction.

Is there a way to limit the deduction only to conforming loans? I think "conforming" is the term for non-jumbo loans.

The reason why I went with our loan officer and bank was because he gave me these words of wisdom when I bought my first house: "Don't base your mortgage on what you get back in tax refunds. That's like spending a dollar to get back a dime."

Posted by: Jacknut | Aug 8, 2013 9:40:33 AM

Taxpayers are liable for capital gain tax when they sell (with a generous exclusion, certainly). In calculating the gain they should be able to deduct necessary costs of ownership, no? This would include all interest paid (not limited to $1 million or $1.1 million), property taxes (not limited by AMT), and homeowner's insurance. It's certainly an advantage to be able to deduct year by year versus waiting until the home is sold, but the basic principle of deductibiliity should not be in question.

Yes, there's an exemption for the first 250,000/500,000 of gain. But this itself is a "tax expenditure" and is duly counted as such in the usual lists, so treating the entire value of the mortgage interest deduction as a tax 'expenditure" involves a fair amount of double-counting.

Posted by: No-no-no | Aug 8, 2013 9:28:56 AM

The tax code is the politician's power base, they will never reform it.

Posted by: Nan231 | Aug 8, 2013 9:22:07 AM

As a Canadian, I years ago used to think that the mortgage interest tax deduction was something the U.S. did better than us. At one time, it was proposed here, too, but the government fell on the budget it was to be enacted in, and it has never made a comeback. I'm now inclined to think that I was wrong, before, and that we are better off for never having had it. It's one of several structural differences between Canada and the U.S. that have made our housing market less volatile, mostly to our benefit.

Posted by: Tedd | Aug 8, 2013 9:02:54 AM

After our accountant did 2011 taxes and we had filed our taxes, I asked him to take out mortgage deduction as though we rented. It had almost no effect on our tax bill. Realtors hate this when I tell them.

Posted by: Jim | Aug 8, 2013 8:49:17 AM

What about making changes to this in a more moderate step rather than a complete abolishment? For example, two tweaks that might be palatable to the general public:

1) What would be the savings from eliminating mortgage interest deduction for houses that are not owner-occupied > 9 months of the year? That would still give a benefit for those who have just one mortgage, on the house they're in. Investment/vacation homes wouldn't count for a deduction.

2) Cap the amount of interest deduction to what the current jumbo loan would be. Most people would still get a deduction, but multi-million houses would pay more. If this is NOT indexed for inflation (or even deflates slowly), this would help slowly wind down the amount of the mortgage interest deduction over time.

Both of these proposals would generally protect current homeowners who are investing in a reasonable property to live in, but phases out for the more wealthy.

Posted by: Nathan | Aug 8, 2013 8:45:38 AM

I take full advantage of the mortgage interest deduction for two homes; both my primary residence and a rental that I keep. Even I think this is a dumb deduction and it should be done away with.
Hardly anyone I know has a tax calculator out when they are shopping for a home. If we dropped the deduction, those that were concerned would either drop out of the buyer's market or bid at a lower price, which would have an overall net effect of some downward pressure on home prices. Why is this a bad thing? Sure, it would hurt those of us that own for a little while, but at the end of the day the people most hurt by a drop in home prices are the realtors and the National Association of Realtors (NAR) is one of the biggest lobbies behind keeping this deduction.
The only worthwhile argument for keeping this thing as some have mentioned above is that it is VERY unlikely that the government would give any of this increased revenue back through lower tax rates in other places.
At the end of the day, I'm just tired of having the government with their fingers on the scales of the free market. For Heaven's sake, just leave the market along and let things settle where they are going to settle.

Posted by: Gilbert_Sundevil | Aug 8, 2013 8:33:47 AM

All other very valid arguments aside, please explain "tax expenditure". Private property, money for example, does not belong to the federals and it is not an expense to them that some or all remains in private hands.
Fort Sumter.

Posted by: Dan Patterson | Aug 8, 2013 8:31:36 AM

The statement in the article:
"They contend that without deductibility, tax rates could have been lower"
makes this entire premise false.

Posted by: Diggs | Aug 8, 2013 8:20:40 AM

Why do proposals for tax reform seem to always focus on consumer deductions: mortgage interest, property taxes, real estate sales taxes? It seems that all the proposals are directed solely at homeowners or private citizens. Nothing ever mentioned about corporate tax structures and the myriad of tax loopholes and exclusions applicable to businesses. Not one word about that aspect of this subject in this post. Curious that.

Posted by: John Griffin | Aug 8, 2013 7:42:55 AM

The problem with zero-ing out the mortgage interest deduction to increase revenues and thereby "theoretically" lower tax rates across the board is that even after the housing melt-down, a home is likely the first and for most largest investment for the middle-middle and lower-middle class. Because their investments aren't as diversified as upper-middle class and wealthy persons and because their income relative to the economy as a whole is much more limited and, therefore, less resistant to expenditure shock, getting rid of this deduction inordinately affects those families. Couple this with wealth transfers to big banks through the fed and corollary rising inflation and federal debt servicing, on top of welfare et. al. transfers to the poor and middle class incomes and savings are stretched to their limits. Many see this deduction as the one benefit they themselves get from participating in the economy and to take it away would lead to a lot of resentment directed at the politicians.

Politically, I think that the only viable way to get rid of the mortgage interest deduction is as part of a complete restructuring of the tax-code (something akin to a flat tax) where ALL deductions are done away with.

Posted by: Smack | Aug 8, 2013 7:36:55 AM

Of course, cutting the exemption won't result in reduced overall rates, it'll simply result in more money available for wasting by the Feds.

WWI is over, we should be rid of the income tax and go back to funding the government by the means originally intended by the Founders.

Posted by: Dr. Kenneth Noisewater | Aug 8, 2013 7:24:38 AM

Both Singapore and Italy have a high incidence of adult children living with their parents. My guess is this is also true for Greece, Portugal, and Spain. I do not see any indication in the link where home ownership is defined. How is adult living at home rent free handled in the reporting of each countries home ownership rates?

Posted by: James | Aug 8, 2013 6:35:54 AM

Which is why it can't be done in a vacuum. You need to approach the American people with a plan that is a radical departure from the current lunacy. You explain that ALL of the tax code madness is going away. You have a tax rate, and you pay it. It will be lower than you pay now, and most people will see no net difference. You explain to them that this gets some of the lobbyists and special interests out of DC, and helps prevents bubbles and economic instability caused by distortions in the marketplace. This is what the GOP should be talking to the country about, not some quixotic attempt to defund Obamacare with 1 house of congress.

Posted by: Mark Buehner | Aug 8, 2013 6:34:46 AM

" It will be harder to reduce tax rates if the deduction is declared off limits."

More to the point, tax rates are quite unlikely to be reduced even if the mortgage interest deduction goes away. And the public knows it.

Posted by: Stacy | Aug 8, 2013 6:27:58 AM

Where do you get your news? The President and Senate Majority Leader have said unequivocally that tax reform must produce new revenues and lots of it.

In practical terms, if we eliminate "tax expenditures" we will just get higher taxes, and no other benefits.

Posted by: SongDog | Aug 8, 2013 6:06:49 AM

Perhaps I am in a unique position, but it the mortgage interest deduction goes away, so does the interest revenue currently going to whomever holds my mortgage - I'll just pay the remainder off and be done with it.

Posted by: Hogarth Kramer | Aug 8, 2013 6:03:58 AM

It's easy to say get rid of it if you have your home paid for and used the tax break!

Posted by: Tea | Aug 8, 2013 6:03:25 AM