Economists Argue Over Mortgage Interest Deductibility

by devteam June 23rd, 2011 | Share

 (Editor’s Note:  This is the second in a series of articlesrnsummarizing material in the latest edition of “Evidence Matters” the new digestrnof housing research first published in February by the Department of Housingrnand Urban Development (HUD).  The currentrnissue is devoted to rental housing as it was discussed at the Next GenerationrnHousing Policy Conference held in October 2010.) </p

The Next Generation conferencernfeatured three presentations on the topic of the future of the mortgagerninterest tax deduction (MID).  This feature of the tax code allowsrnhomeowners to deduct interest paid on one or more mortgages on up to two homesrnand its elimination is suggested in current attempts to reduce the budgetrndeficit.  It is, in fact, the only taxrnincrease to have come under wide discussion. The three economists who madernpresentations were:</p<ul

  • Edward Glaeser, Ph.D., Fred and EleanorrnGlimp Professor of Economics at Harvard University.</li
  • Todd Sinai, Ph.D., AssociaternProfessor of Real Estate and Business and Public Policy at the University ofrnPennsylvania’s Wharton School, Visiting Scholar at the Federal Reserve Bank ofrnPhiladelphia and Faculty Research Fellow at the National Bureau of EconomicrnResearch.</li
  • David Crowe, Ph.D., Chief Economistrnand Senior Vice President at the National Association of Home Builders (NAHB).</li</ul

    Two of the three speakers arguedrnforcibly for curtailing the deduction although their reasons differed. rnOnly Crowe, speaking for an industry group which benefits from home ownership,rnfavored its continuation.  </p

    Glaeser called the deduction a regressivernone that artificially distorts behavior, including pushing people towardrnsingle-family detached houses, while at the same time being poorly designed tornactually promote homeownership. He maintained that the government should not bernencouraging people to use leverage to gamble on “the vicissitudes of thernhousing market,” particularly in the wake of a housing crisis.   </p

    The deduction, he said, alsornencourages people to buy bigger homes and he believes that Americans alreadyrnlive in homes that are too big for their budgets or for the environment.  Homeownership is generally equated withrnsingle-family structures so, by encouraging ownership rather than rentals therngovernment is pushing people away from multifamily dwellings and thus fromrnurban areas where they are more common. rn”We should not be bribing people to leave our economically productivernurban cores,” he said.</p

    Homeownership, Glaeser said, hasrnoften been pushed as a path to middle-class prosperity, but in the wake of thernhousing boom he calls this “dubious.”  Itrnis also credited with other desirable social outcomes but the deduction isrnactually poorly designed to encourage homeownership because it disproportionatelyrnbenefits the wealthy who are likely to own anyway.  Glaeser quoted research from James Poterbarnand Sinai that the MID is ten times more beneficial to upper income individualsrnthan the family earning $40,000 to $75,000 and stated that many poorerrnhouseholds “on the margin between owning and renting do not even itemize.”</p

    Reform is needed but with the marketrnstill in distress eliminating the deduction all at once would be toornextreme.  He suggested reducing the upperrnlimit from $1 million to $300,000 over the next seven years.  “Eventually, policymakers could replace therndeduction with a straight owner’s credit that provided some incentive forrnownership (if absolutely necessary) but did not encourage extra borrowing orrnlarger homes.”</p

    Sinai opted for referring to the MIDrnas a subsidy rather than a deduction and says it is only one component of therntotal tax subsidy for owner-occupied housing. “In an undistorted tax code,rntaxpayers would be allowed to deduct their expenses (mortgage interest) whenrnthey pay tax on their income (rent). Because the United States does not taxrnestimated rental income for owner-occupiers, the interest deduction should notrnbe allowed.” This constitutes a subsidy. “However, the tax code also does notrnpermit many actions that could offset the effects of untaxed rental income,rnsuch as taxing the estimated return to equity invested in owner-occupiedrnhouses.”</p

    The deduction costs an estimatedrn$93.8 billion in each year which constitutes nearly 9 percent of the 2011rnbudget deficit as projected by the Congressional Budget Office.  However, Sinai said that his and Poterba’srnresearch concluded that in 2004 the total tax subsidy for owner-occupiedrnhousing was $330 billion. The MID is just a subsidy that uses mortgage debt tornfinance home purchases. Curtailing it leaves behind a host of subsidies, thernmost important being a subsidy for using equity to buy a house.  “Many positive aspects of homeownershiprnexist, but the inappropriate use of mortgage debt negated nearly all of them inrnthe latest downturn.”</p

    Eliminating MID would not eliminaternthe tax subsidy for owner-occupied housing. High-income households might substituternequity finance for debt, allowing them to retain their housing subsidy. Olderrnhomeowners with little mortgage debt and low-income households that do notrnitemize do not benefit from MID, so curtailing it would have the biggest impactrnon middle-class families and would discourage wealthy households from usingrnleverage. “Is a partial reduction in the housing subsidy worth theserndistortions to household capital allocation and progressivity? Because therngovernment can change other parts of the tax code to restore progressivity, thernanswer is likely yes.”</p

    The solution depends onrnimplementation; reducing MID requires corresponding reductions in the incomerntax burden and any changes must be phased in to mitigate an adverse impact onrnhome prices. </p

    Crowe outlined what he called thernfundamental role of homeownership in American society including improvedrneducational outcomes, better health, reduced crime, and in the long run,rnhomeownership a path to wealth accumulation. rnThe net worth of the average homeowner, he said, is more than 45 timesrnthat of the average renter.</p

    Homeownership for most is impossiblernwithout debt financing and the MID provides parity with the tax treatment ofrninterest expense associated with other forms of debt-financed investment,rnincluding financial assets and rental housing and lowers the effective interestrnrate making homeownership accessible to more households.  “The MID is well justified as housing policyrngiven the documented positive externalities associated with homeownership.”</p

    Crowe said that among the misleadingrnor incorrect information used to attack the MID is that few homeowners actuallyrnbenefit because they do not itemize on their tax returns.  In fact, Crowe said, 86 percent of allrnmortgage interest paid over the past decade was claimed as an itemizedrndeduction. </p

    He also argued that it is notrnregressive, citing a Congressional committee which estimated that about 70rnpercent of the benefits from MID go to households earning less than $200,000rnand figures NAHB that show middle-class households earn the largest benefits asrna share of income. That these benefits are greatest during the early years of arnmortgage when most of a monthly payment is interest provides significant helprnto younger homebuyers when their household budgets are the tightest and wealthrnaccumulation is beginning. </p

    Another NAHB analysis indicates thatrnfamilies with children collect larger tax benefits so, rather than causingrnhomebuyers to buy a larger home, the MID helps growing households finance the largerrnhome they need. </p

    Crow disputed that the MID played arnrole in the recent housing crisis as it has been part of the tax code sincern1913 and widely used by the middle class since the 1940s, with no evidence ofrnhaving created a housing bubble.  If thernMID were responsible for recent problems, “you would expect a positivernrelationship between the use of the MID and foreclosures, but none exists.”</p

    “Given the macroeconomic damage thatrnweakening the MID would cause,” Crowe said, “the MID must retain its place as arncornerstone of U.S. housing policy.”

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  • About the Author


    Steven A Feinberg (@CPAsteve) of Appletree Business Services LLC, is a PASBA member accountant located in Londonderry, New Hampshire.

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