Casey Mulligan’s weird defense of the mortgage-interest deduction

By Felix Salmon
June 15, 2011
this column from Casey Mulligan. Unfortunately, it makes no sense.

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It’s not easy to find an economist who thinks the mortgage interest tax deduction is a good idea, but the NYT has managed it, with this column from Casey Mulligan. Unfortunately, it makes no sense. Here, for instance, is the first paragraph, in full:

The home-mortgage interest deduction does not by itself significantly distort housing markets. Too much owner-occupied housing has been built because housing is excluded from sales and other taxes owed by businesses.

That’s the last we hear about sales tax: the argument isn’t fleshed out anywhere else. But apparently if you’re an economics professor at the University of Chicago, then this is all the argument that’s needed: houses aren’t subject to sales tax, therefore the mortgage-interest tax deduction doesn’t distort housing markets. It’s a non sequitur, and the bit about sales taxes isn’t even true. In New York City, for instance, real property transfer taxes, plus the “mansion tax” on properties over $1 million, plus the mortgage tax, can amount to 4.75% of the purchase price between them.

But never mind that, because soon we’re getting to the meat of Mulligan’s argument:

One person’s mortgage interest payment produces interest income for another person or a business. The lender may well owe taxes on the interest income.

More home-mortgage borrowing means more home-mortgage lending, and the latter means more interest income that can be taxed. In theory, home-mortgage borrowing could even add revenue to the Treasury if the lender is in a higher tax bracket than the borrower (or if the borrower is not itemizing her tax deductions).

This is quite possibly the silliest thing I’ve seen the Economix blog ever print. Confidential to Professor Mulligan: mortgages are made by banks, and the margins on mortgage lending are razor-thin: it’s simply impossible for the taxes on the profit a bank makes from a mortgage to exceed the amount of the tax deduction on that mortgage. Oh, and right now, most mortgage lending is done by the government, in one form or another. How much tax are Fannie and Freddie paying on the mortgages they write?

Mulligan’s not finished, though:

Landlords can also take out mortgages on their properties and deduct the interest payments from their taxable income (that benefit may, in turn, affect the rent they set). In that sense, the possibility of deducting mortgage-interest payments from income taxes does not by itself discourage renting rather owning.

It’s that “does not by itself” construction again! Which doesn’t make any more sense the second time it’s used. Of course the mortgage interest tax deduction discourages renting rather than owning, because it’s available only to owners rather than renters. And as any Chicago economist knows, rent is set by the market: landlords will look to maximize the amount of rental income they get on their properties, regardless of what their taxable income might be. Does Mulligan have any evidence that the deduction decreases rents? Of course not, because there is no such evidence.

Naturally, Mulligan completely ignores the host of excellent reasons why the deduction should be abolished, from the fact that it’s distributed incredibly unevenly, mainly going to rich people on the coasts, to the more salient fact, in these fiscally-conscious times, that it costs a whopping $100 billion a year. I can think of a lot of better uses for that kind of money — including simple deficit reduction — and few worse ones. Which is true no matter how many times someone comes up with a facile argument about how one man’s loan payment is another man’s income.


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If the bank makes almost no profit on the loans, it must be because they have to fund the mortgage loans and they pay interest to do this. The person they pay that interest to (bondholders, other banks, etc) may owe taxes on that interest income.

Posted by guanix | Report as abusive

Good points all, but of course repealing mortgage deductibility is a de facto increase in mortgage debt, something the country may not want to consider while so many homeowners are already under water.

Posted by RZ0 | Report as abusive

I understand phasing it out. It is a perverse incentive.

But I don’t understand why it would be good to engage in “deficit reduction” when the economy is tanking. Why take away a tax break for the middle class at this moment???

I wish you weren’t in thrall to the Peter Peterson Foundation. You just toss in these bromides about “debt reduction”.

Posted by petertemplar | Report as abusive

The mortgage interest tax break shouldn’t exist on a rational basis, but that also applies to 99% of the rest of the US tax code.

Unfortunately, the total capture of Congress by special interest groups as well as the complete polarization of our elected officals means that it is virtually impossible to discuss what a rational tax code would be without the resulting legislation immediately becoming perverted in conference.

At least there is a known structure to most of the tax code now, even though it is still massively labyrinthian. However, it has gotten so complex that I don’t believe anybody has a chance of predicting what the actual results of any changes would be after the various boomerang and ripple effects occur.

Posted by ErnieD | Report as abusive

You could easily replace the old Ben Stein watch with a Casey Mulligan watch. Today’s column is par for the course.

Posted by 3oosion | Report as abusive

When you buy or sell a piece of property, someone pays for the documents to be recorded. In almost every jurisdiction, that includes some tax based on value, either of the deed or the mortgage. These can be huge. Who pays depends on local practice, so for example if the seller pays a deed tax, prices will tend to rise to cover that and vice versa. Sales taxes are totally in there.

An additional factor is that buying and selling in many jurisdictions resets the property value. This problem has actually become smaller because cash strapped places have reduced valuation cycles. In some places these were literally forever, meaning you paid at whatever value you bought, but many were 10 years and now the typical has moved toward 3. But when you buy, new or old, you create a value that the assessor picks up. In some places, that resets values for the next year and in others that goes into the next reval. It was very difficult, for example, to buy an older property in Cook County because the seller may have been paying at a decades old valuation and the moment your value hit the books your taxes would triple. So there are huge costs associated with transfers.

As for the rest, Mulligan says a lot of really dumb things.

Posted by jomiku | Report as abusive

Well it is pretty obvious politically how to start dealing with the mortgage interest deduction- immediately get rid of it for all new mortgages above the FHA limits and for all new second property mortgages. Then either gradually bring the top end down or refuse to index it so it doesn’t rise with inflation.

Posted by tuckerm | Report as abusive

While I agree with most of this post, I have trouble with the following:

“…mortgages are made by banks, and the margins on mortgage lending are razor-thin: it’s simply impossible for the taxes on the profit a bank makes from a mortgage to exceed the amount of the tax deduction on that mortgage.”

Banks borrow from the Fed at near zero per cent and loan the money to home buyers at about 5%. That’s not a razor-thin margin. And given the tax bracket of most home buyers, it’s likely that the taxes a bank should pay on that profit (I say “should” pay, because I’m not convinced they do) will exceed the lost tax revenue from the home owner.

Even if my claim is true, that shouldn’t be justification for keeping the mortgage interest deduction. It’s inflationary, as the lower effective monthly payment it enables allows sellers to raise prices.

Posted by KenG_CA | Report as abusive

Yes, the mortgage deduction lowers rents. The fact that they are set by the market isn’t relevant because the presence of it allows landlords to provide more housing for rent, equalizing adjusted returns between housing and other investments.

Real property is an investment. It is tax advantaged in many ways, but all debt is tax advantaged. If you eliminate the mortgage interest deduction, you should eliminate all interest deductions. It would be preferable to have a level playing field for all investments and to treat housing as an investment and that includes the interest deduction otherwise. The landlord’s deduction is worth about $500k. Keeping that but abolishing the mortgage interest deduction just invites more tax shell games.

Posted by MyLord | Report as abusive

“In New York City, for instance, real property transfer taxes, plus the “mansion tax” on properties over $1 million, plus the mortgage tax, can amount to 4.75% of the purchase price between them.”

Uh, Felix, the sales tax I pay on lunch at Minar on 46th is 8.75%. So even with the “mansion tax,” you’re talking a 46% reduction in the tax rate. (Also, mortgage interest is NOT deductible on that over-$1MM amount–but you know that, don’t you?)

Similarly (and arguably more directly comparable, since in theory it will be held as long as a mortgage purchase), anyone who buys a car from a dealer in NYC pays registration (“transfer tax”), licensing (“mortgage tax”), AND NYC sales tax.

So getting all hyper about that part of Mulligan’s argument doesn’t make sense.

Mulligan has said enough dumb things in his NYT columns that he could contend to be your New Ben Stein–I doubt he would win; the NYT has gathered some idiots around Krugman, Reinhardt, and a few other sane voices–but what you’re citing makes him sound sensible.

Posted by klhoughton | Report as abusive

klhoughton: But houses are traded a lot more than cars. What is the sales tax on a used car?

Posted by guanix | Report as abusive

Tax policy wonks would say that in a world of perfect information, a non-distorting income tax would permit deductibility of mortgage interest; but, the imputed rent of owner-occupied housing would be taxed, just as a landlord’s rental income is taxed.

Since imputed rent is hard to quantify (some countries like the Netherlands make an attempt), a second best option is to end the mortgage interest deduction. That makes the tax system less complex and more equitable.

Posted by AHooks | Report as abusive

Here’s a state-by-state list of transfer taxes: 2661

In most states, there is a tax, but it is much lower than the sales tax rate. In high-price areas, though, it can still amount to a fair bit of change.

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Posted by 8778503444 | Report as abusive

the mortgage write encourages home ownership but is also a safety valve for those who have not or are unable to provided for retirement. The safety net is the downsizing or sale of home that will likely release saved equity. If you think its wise to abolish the deduction consider that there will be no safefty net, that there are no pensions except for goverment workers. Then the tax payer will be picking up the tab-
bottom line its worth preserving this incentive

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