Should we get rid of the mortgage interest tax deduction on personal residences?
Proponents of eliminating the personal deductions for homeownership suggest the deduction is just fuel for overheating mortgage markets. The tax deduction, which allows homeowners to deduct interest on mortgages of up to $1.1 million, causes homebuyers to stretch their incomes and borrow to the max to purchase property. Despite its attractiveness to populist politicians who pander to constituents by pushing homeownership as part of the fabled “American Dream,” the tax itself actually favors individuals with higher incomes who take out bigger loans, rather than individuals with lower incomes — the very targets of the public policy push towards homeownership.
By encouraging individuals to borrow and pay interest rather than save (the bigger the loan, the greater the deduction), the tax credit for equity loans and refinancing sets a bad precedent for borrowing long-term to buy short-term goods and services. This extensive borrowing amplifies financial shocks such as illness, job loss or the death of the family’s breadwinner, when they occur.
Those presently in favor of the tax deduction point out that making housing less financially attractive is a dangerous idea with the housing market still looking for its crutches. Without the itemized tax deduction, they argue, the purchasing power of potential homebuyers drops, and just at a time when the market needs highly-motivated buyers the most.
However, evidence from other developed countries suggests that eliminating tax subsidies for personal housing can be done. Britain successfully phased out its mortgage interest tax deduction over a 12-year period. This did not cause Britain’s housing market to deteriorate (indeed, Britain was subject — as were many other advanced industrial nations — to the same overheated housing conditions as America during the Millennium Boom). Proponents of doing away with the mortgage interest deduction on this side of the Atlantic hope that doing so, in tandem with staunch regulation of all types of lenders, will bring a return to stable homeownership in this country.
first tuesday take: Despite the initial public outcry, phasing out the mortgage interest tax deduction would be entirely feasible and practical in the United States. The wealthy will do most of the out-crying since they are the primary beneficiaries of the tax subsidy.
In the 2000s, the government policy set by the administration at the time deliberately began to force-feed homeownership to tenants in an effort to kick the homeownership rate up to 70% throughout the country. Mortgage lenders and Wall Street bankers were given free rein to peddle easy financing. (Fannie Mae was actually given working instructions to inject two trillion dollars into the mortgage market to tease borrowers out of the woodwork.) Part of that dangling carrot was the marketing of the tax deduction. The collective push eventually inflated the homeownership rate to over 69%.
Prior to the homeownership push, the rate was doing fine at a steady 64% of homeownership experienced nationally throughout the 1980s and 1990s — a natural equilibrium between those Americans deciding to become homeowners or remain long-life tenants. There is no reason to believe that this homeownership equilibrium would be disturbed by a return to homeownership without an interest tax deduction.
In fact, the homeownership push and the ensuing easy-credit policies probably did more harm than good. The first-time home-buying population (those aged 25-34) will not be a driving force in the real estate market until 2014 or 2015. What the push for homeownership in the 2000s did was raid the chicken coop (apartments) and pluck all the hens before they were ready to lay eggs: the prospective homeowners of 2014 or 2015 were prematurely placed into homes with promises of property, security and riches, and were promptly punished for it in the ensuing bubble implosion. Thus, not only are those homeowners unable to hold on to their homes now, they will not likely be back in the future to drive housing as they ought to have, if they’d been left alone to do so. [For more information on the population of the homebuyers, see the February 2010 Market Chart, First-time homebuyers and new housing.]
The other dilemma of the mortgage interest tax deduction is the same as that of the existing housing tax credits: tenants who are short-term thinkers grab hold of these secondary (and often ephemeral) tax credits and make them the primary reasoning behind their financial decision. This behavior is especially damaging when real estate — the single biggest life-long purchase most individuals ever make — is involved. Real estate is a long-term investment, and should be undertaken with long-term goals and financing in mind. Careful analysis of the costs and benefits of homeownership must be completed before considering homeownership, with tax benefits of ownership as a factor — but not the primary (much less the only) factor — in making the decisions of how much house to purchase and how much money to borrow. [For discussion of this cost benefit analysis see the first tuesday Recommended Legislation Page.]
Homeownership is not for everyone. Pushing tenant-minded, short-term thinkers into long-term homeownership is a recipe for disaster; witness the recent housing bust. Getting rid of the mortgage interest tax deduction will certainly adjust the purchasing power of those looking to get into the housing market, but it will also, as a one-time shock, necessarily adjust the prices sellers may ask for their property (after the initial stickiness has worn off). Removing the mortgage interest deduction would eventually induce a return to real estate market fundamentals — real estate purchased by those who are willing to undertake the costs of homeownership for the sake of providing a permanent nest for their family, without the distortion of using it to avoid taxes or turn a profit. [For more information about the sticky price phenomenon, see the December 2009 first tuesday article, The flat line recovery: a side-effect of sticky housing prices.]
As gatekeepers, real estate brokers and agents have a lot to mull over these dog days before going into the recovery.
Re: “The Case for Ending the Mortgage Deduction” from the New York Times