Mortgage interest tax deductions (MIDs) do not promote homeownership or benefit homeowners, according to a recent study by Danish economists.
An analysis of Denmark’s MID found its primary effects strayed far from the goal of promoting growth in the homeownership rate.
Rather, the analysis came to three main conclusions:
- the MID has no effect on the homeownership rate;
- the MID induces buyers to purchase higher priced homes and obtain larger mortgages; and
- the MID’s largest effect on homeowners is to influence their household financial decisions by encouraging them to increase indebtedness.
To give context to the comparison, Denmark’s tax system is divided into three income brackets. The Danish MID was reformed in the 1980s to significantly limit the deduction for those in the top bracket, slightly reduce it for the middle bracket and increase it for those in the bottom bracket, providing lower income homeowners more tax benefits. In the U.S., the MID is applied similarly to all income tiers (subject to income phase-outs).
However, even with Denmark’s more progressive MID, the study found the difference had no effect on the homeownership rate between the income groups.
Further, the true beneficiaries of the MID are home builders, lenders, real estate agents and mortgage brokers who profit from increased home prices — not homeowners.
Alternatively, the study found other types of tax policies do promote homeownership, such as providing low-income homebuyers with subsidized savings accounts for home purchases.
The MID’s severe shortcomings
In the U.S., the MID provides an itemized income tax deduction for interest paid on a mortgage that:
- funds the purchase price or improvements for a primary or second residence; and
- is secured by the owner’s primary or second home. [Internal Revenue Code §163(h)]
However, claiming the MID requires a homeowner’s total deductions and income to be high enough to benefit from itemizing — a tax filing method most often used by high-income homeowners with more assets and expenditures.
Thus, the size of the MID subsidy directly correlates to the amount of the mortgage, the home’s value and the owner’s supporting income. The wealthier the homeowner, the bigger the tax savings.
For some perspective, consider that only 12% of tax filers with an adjusted gross income (AGI) of less than $50,000 itemize their deductions and benefit from the MID, while 94% of those with an AGI of $200,000 do, according to the Internal Revenue Service (IRS) and U.S. Census Bureau.
In practice, this means the MID:
- is claimed by a relatively small portion of homeowners — just 20%, according to the Urban Brookings Tax Policy Center; and
- disproportionately benefits the top income earners.
So, the majority of homebuyers do not benefit from the MID at all. In fact, the purported “savings” afforded by the MID are actually paid up front through inflated home prices. This results in the MID primarily functioning as a tool to increase profits for:
- builders through increased property prices;
- lenders through larger mortgages; and
- real estate brokers through increased broker’s fees.
Theoretically, the homeowner may recoup their losses over the course of several years by claiming the MID. However, as this is conditioned on having the income and financial wherewithal to itemize — and knowing most do not claim the MID — the chances of the homeowner using the MID for this purpose are slim.
It is true, then, that many do benefit from the MID. However, it is not the homebuyer — the very participant the MID is intended to serve.
The future of the MID
While discussion surrounding the current administration’s proposed tax reform plan involves the negotiation of many itemized deductions, the MID has been identified as one that will be preserved.
The choice to maintain the MID is to be expected: it has long been passionately supported by many, making its repeal a near impossible feat.
What is more politically probable and necessary is a reform of the MID to redirect benefits from the wealthy to mid- and low-income homeowners — the intended beneficiaries. For example, the MID’s maximum deduction amount could be reduced to an amount closer to the average priced home for the homeowner’s area. Or, homeowners may be permitted a standard tax credit for homeownership not tied to their mortgage amount.
Yet, no change of any sort appears to be in sight. Until the MID is amended, expect low- and mid-income homebuyers to continue losing out on these tax benefits, while home prices remain bloated and other participants in the industry profit.