How to attack the mortgage-interest tax deduction

By Felix Salmon
May 18, 2010
Barbara Kiviat is right that (a) it makes perfect sense to abolish the mortgage-interest tax deduction, and that (b) it's not going to happen any time soon. But rather than get defeatist about this, I think the answer is to take Paul Volcker's advice and embark on an ambitious root-and-branch overhaul of the way that debt is treated everywhere in the tax code. Remember that the overall tax rate on equity finance is 36.1%, while the tax rate on debt finance is negative 6.4%. No wonder American businesses, just like American homeowners, are overleveraged! (Frankly, it's a wonder to me that American companies aren't more leveraged than they are, given how attractive the tax treatment of debt is: maybe this is just a function of how easy it is to avoid taxes in less dangerous ways.)

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Barbara Kiviat is right that (a) it makes perfect sense to abolish the mortgage-interest tax deduction, and that (b) it’s not going to happen any time soon. But rather than get defeatist about this, I think the answer is to take Paul Volcker’s advice and embark on an ambitious root-and-branch overhaul of the way that debt is treated everywhere in the tax code. Remember that the overall tax rate on equity finance is 36.1%, while the tax rate on debt finance is negative 6.4%. No wonder American businesses, just like American homeowners, are overleveraged! (Frankly, it’s a wonder to me that American companies aren’t more leveraged than they are, given how attractive the tax treatment of debt is: maybe this is just a function of how easy it is to avoid taxes in less dangerous ways.)

Maybe the thing to do is to phase this in gently: start by allowing the tax-deductibility of only say 90% of interest payments, and then bring that number slowly down to zero over time. And of course include mortgage-interest payments in the overall bill. Fiscal conservatives would love it, since it would raise billions of new dollars, while at the same time reducing overall systemic risk — which is always highly correlated with overall systemic leverage. Let’s give it a go!

As for the mortgage-interest deduction specifically, the best way I’ve found to explain that it makes sense to abolish it is to point out that only 20% of American households itemize their deductions on their tax returns, while about 65% of American households own their own homes. This clearly isn’t something which helps most homeowners: it basically just helps homeowners in very expensive houses in New York and California.

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