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
I detect a theme at first Tuesday; social engineering in the form of removing tax credits (and eliminating Prop. 13, etc). Look – we are severely over taxed as a nation and more particularly here in California. We should never give up a tax credit no mater how small. Does the government willingly lower tax rates, percentages and/or net taxes? No they never do so we should never relinquish a tax credit.
Interesting article,I moved here from Australia many years ago ,am a a RE Broker , and having my eldest son return to aust. and purchase his first home in Sydney ( a higher price point area ),I was sitting on the fence taking in the process. He and his young family were able to purchase their home with the help of the Governments “First Time home Buyers Tax Credit ” which was a substantial amount of $8 or $10,000 thereabouts . I beleieve to stimulate this market the Obama govt.should bring back the ntax credit as it has a chain reaction that is all positive.but I digress- In Australia and indeed Britain they don’;t have the mortgage interest tax write off ,so as serious home buyers (in other words for wanting to own a home instead of looking at it as a cash account you can raid from time to time) they -my son included tend to put every extra dollar they have into Paying Off the home as quickly as possible .My son will have his 30 yr mortgage paid off in approx. 14 yrs,thus a huge savings on the interest. But they also don’t go out buying Jet Ski’s ,boats etc -you get the drift. Its my observation that a different mind set prevails in this country from the top to the middle class. The only people here that view a home as a home and keep it as long as they can are the lower more appreciative classes unless they lose their jobs .I have never been happier than when i have been invited to a house warming from one of these very appreciative clients to which their new HOME means everything -not just a piggybank. I don’t think doing away with the the interest deduction is a bad thing as long as its phased in incrementally,but i am a strong believer of First time Homeowner Tax credits ,Afterall we don’t need to have every bank repo out there, snapped up by investors who will rent it to anyone -thats when and where neighborhoods decline. I could write a book on the excesses of the last boom and the things i observed -maybe I will..and the worst ofenders were ….Guess ?..
nobody buys an airplane for the peanuts and nobody buys a house
for the interest deduction. my tax refunds are turned around and put back into improving
my property, providing jobs for local contractors, and improving the house and
to some extent the surrounding property. this is not trading long term debt for short
term ‘credit’ as you suggest. this is building a platform upon which to lead
a better life and environment. I am not rich, and I didn’t irresponsibly over leverage myself–
your two targets. the banks wreck the market and your solution is to tax
the public? nice.
“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.”
The FTHB credit has been doing just that. I have been getting calls from people who are marginally qualified and have little idea of how to manage credit or home ownership. Of course, we all have to learn sometimes, and those that are mature enough to pull it off at a young age stand to reap large rewards. In some areas the prices are so depressed that even an entry level buyer can afford a decent sized home, one that they could grow into as opposed to having to trade it in when the family grows a little bit. Those that do will likely be sitting pretty after the next wave of inflation crashes through. Owning real estate is a long term deal. Let’s remind people of that, and encourage them to buy fewer homes in their lifetimes. It’s healthier in the long run.
This is a discussion that should be much more mainstream. I agree generally with the position of the author, however, a few points that were not directly discussed: that the tax deduction simply doesn’t’ help the homebuyer have more disposable income or make homes more affordable, because the price of homes have simply adjusted higher to build the tax savings into an increased purchase price. The more affluent get a higher amount of tax deductions, but the unspoken beneficiary are the lenders / banks who collect interest and points on higher loan amounts with the federal tax payers footing the bill. Finally, the local county property tax revenues and the amount property owners have to pay are increased by the higher resulting sales prices (at least in California).
The tax rebate should be repealed in a manner that doesn’t produce instant shock to the system. This will prove difficult considering who are the real beneficiaries. However, this is a more complex topic for another post.
Thanks for your thoughts on the matter. The article does not, however, push the buyer’s credit. In fact, first tuesday has been fairly vocal about the ineffectiveness of the buyer’s credit for the same reasons which are outlined above in reference to the mortgage interest tax credit.
The article is one sided in its analysis. The reason why Britain changed their tax law was to raise tax revenue. While there are people who take nefarious advantage of the tax laws (Lenders and Borrowers) as pointed out in the article there is a very large majority of us who do not borrow on the basis to the tax deduction.
But the tax deduction does provide us with additional spending power – to be used in the rest of economy – in ways much more beneficial and efficient then the government. If government was less spendthrift (Federal and State) we would not need to have the deduction. When government workers stop getting long term unfunded benefits that reflect the remainder of the populations would we agree eliminating the deduction.
Your article pushed the use of the Buyer’s Credit thus making your article disingenuous.