Time to end the mortgage interest tax deduction

February 8, 2011

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.

A house for sale has a "Reduced Price" sign in front of it in Dearborn, Michigan, March 27, 2009.  REUTERS/Rebecca Cook 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.

Why then do real estate and development interests fight so hard to keep it? A clue can be found in John Cassidy’s book How Markets Fail, where he writes about walking into a Wall Street watering hole the night after Black Monday, the day in 1987 that the Dow lost over 500 points. “I rushed downtown,” he wrote, “expecting to find some Wall Street types crying into their glasses … to my surprise, Harry’s was packed, and there was a carnival atmosphere.”

As the young reporter learned, it didn’t matter if the Dow went up or down; they all worked on commission. The entire real estate, development and finance industries all work on commission, or profit on sale, which amounts to the same thing. The higher prices go and the bigger the mortgage, the more money they make. In the final analysis, the mortgage interest tax deduction is a giant taxpayer subsidy to the real estate and finance industries.

The strength of the opposition to the mortgage interest tax deduction from those industries will make it hard to kill, but it is worth a serious effort. While adjusting to a world without the deduction could be painful for many homeowners, that problem can be solved. A rational plan would not make home owners go cold turkey; the deduction could be gradually phased out, perhaps for the highest income homeowners first.

For homeowners in financial difficulty, the deduction could even stay in place until their financial circumstances changed, or they sold their house. The real problem is getting the American people to realize that they have been sold a bill of goods by the real estate, development and financial industries.

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If the mortgage interest deduction is removed, you will find a massive exodus out of home ownership which would make the current glut of homes on the market swell to unimaginable levels.

Millions of people whose mortgages are underwater know that walking away from their mortgage is the prudent thing to do. Every month, they elect to make yet another payment on a property that will probably never in their lifetime appreciate back to the price they paid it.

The Mortgage Bankers Association did a short sale on their national headquarters building in Washington, DC right after the market collapsed. It’s the smart thing to do.

It would not be wise to remove one of the few reasons people with underwater mortgages have for continuing to make payments.

If you need 120 billion bucks, go after Wall Street for it. For them, it’s chump change bonus money.

Posted by breezinthru | Report as abusive

Why is it that every time we need to look for money it has to come out of the middle class? Getting rid of this deduction will add at least $5000 to my tax bill (my husband and I fall right in the middle of the middle class). I have no problem paying taxes, taxes like Social security, which I will never see, but I am tired of putting the blame of the nations fiscal mess on people like me. It’s time for the wealthy to act like patriots and pay up. They got us into this mess, it’s time they helped pay for it.

Posted by BB1978 | Report as abusive

I think it should be eliminated, but phased as to not penalize current middle-class mortgage holders. If the deduction increases home prices, it is already hurting any middle class person looking to buy a home now — they may think ‘deduction’ but they would be paying a higher price (and since they will have a higher mortgage they are also paying more total interest to banks.) Not a good deal as far as I can tell.

As for a ‘massive exodus’ out of home ownership — I don’t see why his would happen. Buying a home is buying a lifestyle and a place to live. If it’s just buying a tax deduction, it’s a lousy reason to do it.

Posted by PaulGK | Report as abusive

Imagine putting 50K down on a 250K house, imagine the payments on a 200K mortgage. Now let the values of your house fall to 170K.

You could rent a nice house for $600/month less than you are currently paying to own one. Your 50K is gone, vanished into thin air. You can’t sell the place now, probably not even when you retire.

Even if someone was fool enough to give you 195K for your 170K house, you’d have to pay the $5000 real estate commission out of your own pocket.

Now take away the mortgage interest deduction. Still feel like making payments on the place?

Posted by breezinthru | Report as abusive

Mortgage interest deduction, or a national health care program? In many of the countries mentioned above, most of them fund national health care coverage. It seems to me that you can get one or the other, but not both. In the USA, we get the MID, but not health care. In Canada, they get health care, but no MID. It’s hard to compare these scenarios when the table is set so differently for entitlements.

Posted by vineyards | Report as abusive

PaulGK has it right. It should be eliminated, but in a phased way so that the economy and the housing industry aren’t penalized too harshly.

What most people don’t realize is that no more than half of homeowners get to take the deduction at all since only one third of all taxpayers itemize.

Posted by aterhune | Report as abusive

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I will be one of those who immediately stops making payments on my (underwater) mortgage if I lose the tax break.. My only attachment, like others in my situation, is sentimental..and that feeling is quickly vapourized if I lose my $45K/year tax deduction on my house..If this incentive is lost, then it is best to just rent, and save up money until you can buy things for cash.
As the market will immediately tank another 30-40%, you can save the money in about 10 years. Houses will be immediately viewed as well as rapidly depreciating assets like cars, only the land underneath them will continue to have value.

Typical of bankers/economists, they never think through their actions on real people..

Posted by cadence46 | Report as abusive

This is just plain stupid. If the concept is so great for the economy then we should take away the use of depreciation on corporate assets. The housing market is in trouble because of all the bad mortgages that were given to people to finance homes they did not belong in. This is one example of affirmative action that blew up in the face of the government. The banks are at fault also, their lending and business practices require a investigation.

Posted by keepeyeongovt | Report as abusive

I agree that the US government must stop putting more and more of the tax burden on the middle class. This would be a huge tax increase for families who are already struggling. Just the fact that Obama is suggesting this shows how out of touch this man can be.

The government keeps savings rates low (now less than 1 percent in most places) and manipulates inflation numbers to show no inflation when any idiot knows that the cost of everything middle class buys has increased exponentially recently….but no increase in SS or pensions. Saving a lot of money on the backs of those who can least afford it…older and less sophisticated people who want to put money in savings rather than the stock market…because they can’t afford to lose their meager life savings.

Our government is disgusting and they think they’re so clever but soon they will find out that they’re not. We could easily end up with an Egyptian type revolution (probably not as peaceful though) if our government keeps pushing the envelope.

We need to educate the middle class about how the US Government is treating them. They may find that they are being treated as poorly as the Egyptians. Who cares about whether the press has freedom? We already have MSM who report according to their political leanings rather than the truth. What do we have to lose?

Posted by lezah2 | Report as abusive

If you want to find out information about our economy, inflation, etc., look outside the US. Our news media does not provide accurate information….why? They’re big businesses who get big benefits from the federal government tax code. Be careful how you rely on their information. I have to give kudos to Reuters for even bringing up this subject.

http://www.telegraph.co.uk/journalists/r ichard-blackden/8317035/Americas-inflati on-alarm-is-growing-ever-louder.html

Posted by lezah2 | Report as abusive

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.

Posted by RynoM | Report as abusive

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