Wednesday, March 27, 2013

It is time to pull the plug on the mortgage interest deduction

As I was driving back from a meeting today I listened to a guy on the radio who said taking a 30 year mortgage in this rate environment makes no sense, especially if you do not itemize.   That accounts for about 70% of all taxpayers.   His argument is simple, a 30 year mortgage begins to pay more principal than interest in the eleventh year - thus for taxpayers who do not itemize the benefit of taking a long mortgage adds costs over the life of the loan and provides zero benefits, except a slightly smaller monthly payment.

The cost of the mortgage interest deduction is one of the most expensive provisions in the tax code.  Estimates come close to $100 billion in subsidy and that applies to some percentage of the remaining 30% of taxpayers that itemize.

When I was writing my dissertation I found that, at least at the time, there seemed to be two facts.   First, the evidence about whether the provision actually increased homeownership in the countries where it was in place, was uneven at best. From my view, the deduction was downright ineffective in encouraging home ownership.  Second, the distribution of benefits was not heavily skewed to upper income taxpayers.   (In essence the elasticity of demand for housing was not perfect - as incomes rise the price of one's housing to not rise in a parallel fashion.) In recent years, a lot of the discussion about this tax provision has been to cap the amount of interest that can be deducted.  Celia Chen, an analyst at Moody's argues that the deduction “hasn’t helped to expand homeownership, but it’s helped to support purchases of larger homes.”  The National Association of Realtors, despite the evidence, argues that the deduction should be preserved.  For example  “Our members believe tinkering with the mortgage interest deduction at the high end will trickle down,” said Lawrence Yun, chief economist of the National Association of Realtors.   They would be even more vociferous if current proposals were to eliminate the deduction entirely.

Since I wrote my dissertation (almost three decades ago) the number of non-itemizers has increased significantly.  Thus, a decreasing percentage of families avail themselves of the deduction.   Eliminating the deduction might also encourage home buyers to take out shorter mortgages.

For both policy provisions and for simplifying the tax code, eliminating the deduction entirely would seem to be timely and appropriate.

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