Felix Salmon

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.)

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.

26 comments so far | RSS Comments RSS

Sounds like a fascinating idea. I hope governments will look at this seriously.

Posted by Abulili | Report as abusive

Whoah, please provide some clarification on that 20% of HHs itemizing but 65% owning homes. Because you use these figures to support your premise that the deduction doesn’t help most. Something doesn’t smell right here…

I know this is just andecdotal (which is why I’d like to see more empirical), but as someone in Cincinnati, who bought a starter home ($100k-$200k) in my 20s, the mortgage interest deduction turned me into a itemizer. I mean, it wasn’t even close. Most others I know around these parts are in the same boat as me.

Please help me why I (and pretty much everyone I know, who are, again, are owners of modest home in modest markets) am experiencing such an exception to your stated empirical data.

Posted by glenngulia | Report as abusive

Good old M+M @ work. In the real world the present value of financial distress needs to be taken into account. This should cap the level of debt used. Hence the Static Trade Off Theory of capital structure.

V(L) = V(U) + T*D – PVdistress

Posted by david3 | Report as abusive

@glenn: I’m guessing that you are or were single, or filed as single. The standard deduction for singles last year was $5700; it’s not unreasonable to imagine that the interest deduction plus property taxes exceeded that. The married deduction was $11,400; that’s a bit harder to exceed for a modest house, especially in the low interest rate environment. However, it is very possible to exceed in a high cost of living area, such as NYC/NJ, Boston, SF, LA, and a few others. That’s why Felix is correct in positioning the mortgage deduction as largely (though not entirely) a tax break for the upper middle class and higher.

Posted by Curmudgeon | Report as abusive

I suppose if your interlocutor is tribal of the appropriate tribe, “this doesn’t do a very good job of subsidizing homeowners” might make sense. Since one of my big objections is that it subsidizes homeowners, this makes the abolition less compelling to me rather than more.

My bigger objection is that it subsidizes people who borrow the full cost of the house more than people who take a larger equity stake. I wonder whether that’s where the 20%/65% discrepancy comes from; my fiancee, with a $30,000 income, itemized deductions, largely due to a mortgage, but that’s with a mortgage of relatively recent vintage; if it were down to 60% LTV she’d be back under the standard deduction. Perhaps those 45% are middle-aged and older people who have paid down their mortgage?

Posted by dWj | Report as abusive

I should clarify that I don’t believe the best way to argue with me about tax provisions is likely to be the most effective way to argue with the general public, which I view as more “tribal” in the sense in which I used the term. It may well be that this piece of data makes most people less supportive of the mortgage interest exemption.

Also, I think that it’s a bit of a bullying move to label a tax increase as “fiscally conservative” on the grounds that it raises more revenue, when you know that “fiscal conservatism” as understood in this country tends to oppose taxes (while it, at its most coherent, opposes spending more). That may well be effective politics, too, though I would kind of bet against that.

Posted by dWj | Report as abusive

@glenn: I agree, I don’t understand the 20%/65% figures. A quick search of the IRS website shows 35% of taxpayers itemize (Tax Year 2007). Are there more recent numbers available that would account for the 20% shown in this post? Or is there a more detailed study that breaks down specifically the number of homeowners who itemize?

http://www.irs.gov/taxstats/article/0,,i d=102886,00.html

Posted by caramag1 | Report as abusive

Wow, so b/c mortgage interest deduction may “help” (based on conjecture) the higher value homes in NY and Cali it is worth abolishing? Now, wouldn’t the abolishment of this deduction absolutely destroy the “value” of those homes? Understood that encouraging people to reach for homes they may not be able to afford due to tax incentives isn’t a great idea but the cat is out of the bag here and the destruction of perceived value would be huge. Also think about the reduction in property taxes in this situation. Would they be greater than the increased tax collection on the income side?

Posted by wmaustin5 | Report as abusive


“wouldn’t the abolishment of this deduction absolutely destroy the “value” of those homes?”

Not unless a meaningful amount of house “value” (appropriate scare quotes) is derived from tax avoidance.

Posted by AEinCH | Report as abusive

Nice. When I bought my house, I did, as responsible folks should, a careful calculation of how much I could realistically afford. This calculation, obviously, took into account tax incentives. If you change the equation, I’ll lose my home – simple as that. It doesn’t matter that my LTV is 60%. it doesn’t matter that I have a 30 year 5% loan.

Without the mortgage tax write-off, I would lose my house.

I’m not alone. Everyone in my neighborhood stretched to move here. So far, we’ve been spared the foreclosure scourge, but a big shift in taxation policy would change that in a jiffy.

Posted by Bigmook | Report as abusive

Wow, another blatant attack on the middle class. Leave the one remaining “perk” middle-class homeowners have alone, please? Otherwise you’re going to send a lot of good people who have done what they were told to do out in the streets.

Or is that actually the plan?

Posted by lipreader | Report as abusive

@Bigmook: does this mean that renters and nonitemizers should subsize your house and the whatever gains you might realize?

Posted by xyz70 | Report as abusive

@Curmudgeon: I wouldn’t say that $11,400 is very difficult to exceed. In the first year of a 5.5% loan you exceed that amount at a little less than $210,000. At 20% LTV you’re looking at about a $260,000 house. According to census.gov, the median home price in the U.S. was $214,000 in March 2010. And obviously none of this is even taking into account any other deductions. Am I missing something?

Posted by spectre855 | Report as abusive

@xyz70: Do you think removing the subsidy is worth causing people to lose their homes? Would renters and nonitemizers see that big of a gain? I don’t think so and this change wouldn’t affect me. I’m not even close to the standard deduction.

Posted by spectre855 | Report as abusive

Go ahead, phase out the mortgage and business interest deductions. Even though I own (or at least pay the mortgages on) properties in the SF Bay area, this tax break just makes no sense. Yes, the mortgage deduction is built in to the value of a property, so it doesn’t make it any more affordable, it just artificially inflates the price. If it were phased out then increasing income and inflation over time would lessen the blow, and besides, one person’s price decline is another’s better affordability. If home ownership is deemed a public good then offer a once in a lifetime grant to get first-timers in the door.

Posted by IanAndEgg | Report as abusive

@Curmudgeon: For the record, my wife and I live in the Midwest in a house that cost $197k in 2006, with a 7% interest rate. Our area does not have a high cost of living, either. Like glenngulia, the mortgage interest deduction turned us into itemizers.

Posted by GreatMidwest | Report as abusive

“Not unless a meaningful amount of house “value” (appropriate scare quotes) is derived from tax avoidance.”

That’s just it, as of now a meaningful amount of value for a large number of homeowners is derived from income tax avoidance. People can afford those houses with the tax deduction and most certainly can’t w/o it. As some other commenters pointed out it doesn’t take much in the way of interest expense to have a benefit here to the homeowner. I think a change like this would cause the value of a large number of homes around the NYC region to absolutely crater.

Posted by wmaustin5 | Report as abusive

And as a follow up, I bring up the value point as a way to look at property taxes not the sale benefit to the homeowner. A neighborhood starts decreasing in (assesed)value and the property taxes collected head down as well. Do these decreases in property taxes colleced balance out the deductions homeowners took on their income taxes? Maybe, but as a homeowner I would think you’d be mouch more concerned about the services your municipality provides to you on a day to day basis than the federal gov’t.

Posted by wmaustin5 | Report as abusive

A $250,000 loan at 5.5% interest results in $13,500 in interest in year one. That’s above the standard deduction for married filing jointly and we haven’t even gotten to things like kids, education, property taxes, and charitable donations. It’s a bit more than expensive homes in New York and California that care.

Posted by MitchW | Report as abusive

You could reduce the mortgage interest deduction without hammering the middle class in one of two ways:

(1) Convert it to a 15% tax credit (thus those in the 25% tax bracket would still pay 10% tax on their mortgage interest).

(2) Remove the deduction from the Alternative Minimum Tax.

The former “solution” would reduce the complexity of tax filing, the latter would increase it. Bets on which Congress would prefer?

Posted by TFF | Report as abusive

Nobody with a million-dollar mortgage deserves a subsidy from the U.S. Treasury.

Edward Glaeser has argued against the mortgage-interest expense deduction:

http://economix.blogs.nytimes.com/2009/0 2/24/killing-or-maiming-a-sacred-cow-hom e-mortgage-deductions/

And so has Roger Lowenstein:

http://www.nytimes.com/2006/03/05/magazi ne/305deduction.1.html

Posted by dedalus | Report as abusive

” People can afford those houses with the tax deduction and most certainly can’t w/o it.”

You seem to be saying that house prices are high because the tax subsidy, and without the subsidy no one would be able to afford these very high prices. Am I alone in finding this a bit peculiar?

Posted by AEinCH | Report as abusive

“I think a change like this would cause the value of a large number of homes around the NYC region to absolutely crater.”

Which is value-neutral to society, since for every home seller there’s a buyer. Maybe this will benefit the huge universe of renters currently unable or unwilling to buy into the perpetual-tax-avoidance machine.

Posted by AEinCH | Report as abusive

Just curious why Vancouver BC seems to me to be significantly more expensive than Seattle and yet the Canadians don’t have the mortgage-interest deduction.

The areas are roughly similar with substantial constraints in entitlements and topography.

So what gives?

Posted by dsucher | Report as abusive

Only 20% of households itemizing seems surprisingly low given the high homeownership rate. As several commenters above have noted, it doesn’t take a huge mortgage to hit the itemizing threshold. The actual threshold would be even lower for most after adding in property taxes and state income taxes.

I don’t know what year Felix’s statistics are from, but there are several factors that make it plausible, especially if the numbers are recent:

1. Mortgage interest payments decline over the life of the loan. My neighbors who have owned their houses for 15 years have lower loan balances than me becuase they took out smaller mortgages to begin with and they have paid down a hefty portion of the original balance.

2. Nearly 50% of households paid no federal income tax in 2009. A portion of these are homeowners (given the 65% homeownership rate), and many of them probably don’t need the mortgage deduction to reduce their tax bill to 0.

3. As far as I know, you only get the interest deduction if you pay your mortgage. With high delinquency rates in 2009, there could be a large number of homeowners not taking the deduction who would qualify if they were current on their mortgages.

To those commenters complaining that they bought their houses expecting the deduction and removing it would cause undue burden on them: no doubt that is why Felix suggests phasing the deduction out over time. This doesn’t eliminate the pain, but there is always pain on the part of those adapted to current policy when tax policies are changed. The article Felix linked does a reasonable job of explaining why the deduction isn’t good policy.

Posted by amichael | Report as abusive

Here’s another question though it may be a stupid one as I know very little about tax law: If the mortgage interest deduction were to be removed, would this affect the standard deduction? If so, the 20% number would be moot.

Posted by spectre855 | Report as abusive

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