Reuters Money
Time to end the mortgage interest tax deduction
Alan Mallach is a senior fellow at the Center for Community Progress and a visiting scholar at the Federal Reserve Bank of Philadelphia. The opinions expressed here are his own.
This is part of an ongoing series on tax reform ideas. Where do you stand? Vote below and come back regularly to be a part of the national debate.
If someone proposed a tax “reform” designed to push house prices up and encourage buyers to borrow to the limit of their ability at taxpayers’ expense, it is unlikely that they would get much support. Yet that is precisely what the home mortgage interest deduction does.
The research evidence is in. No matter what real estate agents say, there is no evidence it encourages home ownership overall. When it comes to home ownership rates in developed countries, the United States is roughly in the middle of the pack, about the same as Australia and Canada, which don’t have a similar deduction. Italy abolished its deduction in 1992, and still has a much higher home ownership rate than the U.S.
The deduction does two things. First, by changing the relationship between the sticker price of the house and the actual carrying cost, it pushes prices upward and encourages people to buy bigger, more expensive houses. Second, it encourages them to borrow more instead of putting more of their savings into home buying, because in essence they get a federally-financed rebate on every dollar they borrow.
It is one of the most regressive parts of the tax code, since it affects all house prices, including the price of houses bought by lower-income home buyers, who rarely itemize and get little benefit from the deduction. One study found that barely 10 percent of homeowners earning less than $30,000 take the deduction, but they pay higher prices for their homes to benefit more well-off homeowners. On top if this, it is projected to add $120 billion to the federal deficit next year.
The mortgage interest tax deduction distorts the American economy; penalizes the nation’s lower income home buyers; and, moreover, costs the U.S. an amount equal to the total discretionary spending of the departments of Agriculture, Education and Housing & Urban Development.
Do you need a bigger house – or just want one?
Jake Engle has some sobering news for bright-eyed families eager to ditch their tiny houses for sprawling four-bedroom homes in the suburbs: you might be sorry.
As a financial planner at Wealth Planning & Management in Portland, Oregon, Engle has a unique perspective on the financial blunders people make in the name of having a family, particularly when it comes to the idea of owning a home.
“We’re sold this fiction that bigger is better and that two or three people need a 3,000-square-foot home,” he says. “And that’s deceptive. Banks will let you ruin your life by letting you get a house you can’t afford.”
It’s not that experts have anything against happy homeowners. The problem is what happens when the desire for a “McMansion” eclipses other financial goals, like saving for college, putting aside money for retirement or even having enough cash to pay for emergency expenses. Thousands of Americans found that out the hard way when the housing bubble burst, setting off a wave of foreclosures and underwater mortgages.
But the quest for the American dream lives on.
“Once you start having kids, that emotional level of wanting your own place rises exponentially,” says Mark Berg, president of Timothy Financial Counsel in Wheaton, Illinois. “It’s a hugely emotional decision.”
As a father of three, Berg understands the allure of a bigger home, but he tries to get clients thinking about their time horizon. Families with growing teenagers often feel the biggest push to move into a bigger home, but they should be realistic about how much longer they’ll be tripping over gym bags and skateboards – chances are, it will only be a few years until the kids move on to college and parents will be left alone in a five-bedroom house.
We went the keep it small route, and I think you over-simplify the benefit.
We knew we were making a major financial statement (in 1980) when we decided to stay in our 1300 sq ft shack, but we made sure that the money that didn’t go to a higher mortgage, went to increased savings.
Both kids went to a good university and graduated with no loans, and grades good enough to get in the grad program they wanted. Both got to do a semester abroad in a country they were interested in. Both still have their heads clearly above water even in a tough job market, and, yes, we subsidize to make that happen.
When the Subaru head-gasket went on our daughter’s at the same time our son burned though yet another clutch, we simply fixed it, cash. Both are taking advantage of tax deferred IRAs, even with no spare money, because we fund it – a cheap and easy way of doing early estate transfer, and they get a very needed tax refund.
When the market went to heck in ’08 and early ’09, we all treated it as a buying opportunity. The eldest is now in the market for her own small house. We’ll do 10% down out of the credit union reserve account, and maybe push off the African wildlife trip a year.
Neither my wife and I ever had salaries more than 100K per year, but we’ve not had to worry about money in a very long time; the last time I know for sure was no more recent than 1994, when my employer at the time did a mass layoff. I simply took a lower paying job for a while, and we eventually recovered and in time did even better than pre-layoff. Max impact – maybe a couple of weeks of little sleep.
What is all that worth?
Don’t hold your breath on home appreciation
You may see two full moons in a month before home prices start rising again across the U.S. The rip tide of a huge home inventory, increasing foreclosures, unemployment and more bank woes continue to roil the housing market in most regions.
If you think you’ll see a profit from selling your home or hope to get a home-equity loan based on recent appreciation, you may have to wait a while — maybe a few years.
A host of demons continue to bedevil the U.S. home market. The worst of these gremlins is unemployment. Home sales and prices are directly linked to the number of people working. A jobless rate around 10 percent doesn’t spur home sales.
Nobody is in a hurry to buy homes. According to a recent report by Ned Davis Research, housing prices may not begin to appreciate until the jobless rate goes to 7 percent or lower.
Once the jobless rate gets to about 6 percent, the firm estimates that home prices may begin to rise roughly 2 percent annually or track the historical level of inflation.
“Yes, there is a light at the end of the dark housing tunnel,” writes Joseph Kalish, the report’s author, “but it will take at least two years and possibly more to get there.”
Complicating any housing rebound scenario is the fact that there are millions of unsold homes on the market and more are being acquired and resold by banks through foreclosures.
What is it about the magic number 2? Every time a wannabe expert makes a prediction about the economy or the housing market(or the wars in Iraq and Afghanistan for that matter) they always say that things may start improving in two years. Isn’t that what they said in 2008? I don’t buy it. This downturn has very different smell to it than those I’ve lived through in the past. China is becoming prickly and assertive and won’t budge on its currency, so forget about an export driven job surge. And if the addlebrained GOP and the Tea Partiers get their way things may actually be a lot worse in 2012 than they are now.
Dump the mortgage deduction to revive U.S. housing
Some sacred cows need to be sacrificed in order for a country to prosper again. Let’s start with the deduction for mortgage interest on U.S. tax forms.
Killing the mortgage deduction wouldn’t be heresy for the American dream; it would allow more people to buy homes. The money saved by eliminating this break could actually boost homeownership, reduce payroll taxes or pare the budget deficit.
This sounds wildly counter-intuitive in light of the dismal home sales reported on Tuesday — the worst in 15 years. With the expiration of the $8,000 first-time homebuyer tax credit, buyers retreated to caves and thousands of more foreclosures came on the market.
I know the industry doesn’t want to hear this, but removing the interest break would lower prices — and ultimately sell more homes — if the deduction is transformed into a dollar-for-dollar credit that anyone can use.
The mortgage interest write-off may have over-stimulated the housing market during the bubble years. If you could write off interest on a higher-priced home, why wouldn’t you? This financial steroid also led to price inflation and led overstretched homeowners into more dodgy loans where they were exposed to bond-market risk.
As it stands now, the write-off subsidizes the affluent at the expense of everyone else, particularly renters. Residents of states with the highest mortgage values understandably took the most deductions. Maryland homeowners, for example, had the highest percentage of residents taking the write-off — about 38 percent — according to a National Association of Realtors, a Washington-based trade group.
Not surprisingly, the highest actual dollar amount of deductions were reaped where real estate prices are highest. California was the top state for loan interest write-offs with an average $18,876 deduction (of returns that claimed the break). Hawaii followed with roughly $17,000.
For those confused about why prices would decline the reasoning is presumably that people are prepared to pay more (ie too much) for something when they get a tax deduction (and therefore recover part of the cost). Common sense is often out the window (I have had tax clients who throw thousands away leasing sports cars because they ‘get a deduction’ without realizing that even net of tax deductions they are still throwing away money unnecessarily). More importantly though, a fundamental tax principle is that it should be fair and equitable, which is corrupted if only ‘homeowners’ get a certain deduction. It seems that in the US this principle is not part of the strategy however. Two taxpayers who earn a similar income should pay the same tax. In South Africa for eg this has resulted in a huge simplification of the income tax act, removing complex provisions revolving around marital status, number of dependants and personal circumstances, as well as ‘special interest group’ style provisions. The goal is not to address ‘social’ aims in tax legislation but rather separately (for example welfare structures). I suspect the US loves the incredibly complex status quo with state to state differences and special interest groups and resulting ‘loopholes’ which is wonderful for keeping poilticians and lawyers employed and not useful for facilitating commerce nor reducing tax administration costs.
This deduction is redistribution of income, plain and simple. The only middle class it benefits are those who already own; it does not benefit those middle class folks who do not own, and may never own. The latter are busy subsidizing those of us who do.
This deduction is also part of what has turned out to be a house of cards; an unsustainable practice that eventually bubbled and burst.I agree that phasing it out would be the right way to do it because slower change is less disruptive than fast, and catastrophic disruption is to be avoided.
An underlying theme in opposition to this proposed measure is the sense that what we are receiving we are entitled to. The thing is, every beneficiary of a subsidy feels the same way. It is hard to imagine that millions of renters will insist on continuing to subsidize us.