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Why We Need to Eliminate the Home Mortgage Interest Deduction

It's costly, and it might not really encourage homeownership


investorpoliticslettersAs Congress continues to consider comprehensive tax reform in the face of a long-term deficit problem, one of the most sacred cows of the tax code actually appears to be on the radar of would-be reformers.

The House Ways and Means Committee held hearings last month on how to wean homeowners off the federal mortgage subsidy known as the Home Mortgage Interest Deduction. This tax expenditure allows taxpayers to deduct up to $1 million of the interest they pay on their home mortgage, for both their primary and secondary homes. Homeowners also can deduct the interest on home equity loans of up to $100,000.

The HMID has been around for about 100 years and seems to be an intractable part of the American psyche. If you are a homeowner, you have likely done the math yourself and realized that, “because of the tax deduction,” you are better off owning than renting.

Before 1986, when Ronald Reagan signed major tax reform, all types of interest were deductible, including credit cards and car loans. His reform package eliminated tax subsidies for all consumer debt, save home mortgages. He argued, as politicians continue to do today, that the HMID is essential to encouraging home ownership, a building block of civilized society.

As politicians and pundits alike search for ways to make the tax code more efficient and fair, they should start with the HMID. President Obama has already proposed limiting deductions to 28%, and House Republicans also appear to be weakening on this entrenched subsidy.

Although this particular tax break is politically popular and backed by the powerful real estate, construction and mortgage lobbies, we need to phase it out. I can think of six reasons the Home Mortgage Interest Deduction should meet its end:

  1. It costs the federal government a lot of money. The HMID is worth about $100 billion per year. Budgeting is typically done over a 10-year horizon, so eliminating this particular deduction would shave about $1 trillion off the deficit over a decade — a fourth of what President Obama and House Speaker John Boehner have been aiming for in their budget negotiations.
  2. By encouraging homeowners to borrow more, the HMID artificially inflates real estate values. It drives prices up, particularly in high-income areas where taxpayers have the most to gain from claiming the deduction. While its defenders argue that it makes housing more affordable for the middle class, in reality it simply encourages the wealthy to take on more leverage. Eliminating it might actually make housing more affordable, not less, for middle-to-low-income families.
  3. The premise behind the deduction is that it encourages homeownership, but this relationship is likely spurious. Other countries do not have a tax subsidy for mortgage debt and experience as high or higher rates of homeownership than the United States. Furthermore, during the past 40 years, the rate of homeownership has basically stayed the same even as the value of the deduction has fluctuated significantly with inflation.
  4. Even if it does work, high rates of homeownership actually might be bad for employment. Preserving the HMID assumes that the government has a reasonable interest in promoting homeownership. However, recent research reveals that high rates of homeownership might depress local economies.
  5. It’s just not fair. Although the deduction costs all taxpayers $100 billion/year, only one-third of taxpayers actually benefit from it. Many homeowners do not have enough mortgage debt to itemize their deductions and thus do not benefit. Most of those that do benefit from the deduction are in the top 15% of taxpayers.
  6. It could cause history to repeat itself. By encouraging and subsidizing mortgage debt, the government is fueling some of the financial engineering that brought the economy to its knees in 2008. If as a country we had less mortgage debt, we also would have fewer mortgage-backed securities.

The opinions contained in this column are solely those of the writer.

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