GETTING OUT OF THE RED Buying houses with other people’s money

It’s time to eliminate the home mortgage interest deduction

For decades, the U.S. government has attempted to encourage home ownership through a tax provision called the home mortgage interest rate deduction (HMID). Formed in an era before politicians began christening each of their creations in Orwellian NewSpeak, the HMID does exactly what its moniker suggests: for those taxpayers who itemize, the HMID allows any interest payments on a home mortgage to be deducted from their taxable income.

The rationale for the HMID is a three-part argument: first, that homeowners provide benefits to a community that renters do not; second, that the HMID increases home ownership; and last, that the positive marginal effect of increasing home ownership outweighs the negative inframarginal effect of giving away money to home owners who would have bought homes anyway, with or without an interest rate deduction. The experience of the last quarter-century has busted or given reason to seriously doubt all three of these arguments.

In theory, home ownership raises the stake a person has in their community and can increase the civic participation of owners relative to renters. Empirically, however, there is no conclusive evidence that ownership has this causal effect. Controlling for demographics, there is little indication that home ownership increases voting, volunteering, or charity. Meanwhile, home ownership has significant negative effects, the foremost being that it reduces the flexibility of the labor market and makes economic downturns more persistent. By anchoring workers to a particular location, home ownership makes them less mobile — less able to leave low-wage areas and relocate to regions where labor is scarce.

Even if home ownership had positive effects for communities, the HMID fails to generate any benefits simply because the deduction has not raised the rate of home ownership in the United States. Over time, the value of the deduction has fluctuated, and yet the fraction of Americans owning homes has remained relatively constant, suggesting that the presence of the HMID has virtually no effect on the decision to rent instead of buy. International comparisons show the same thing: the trajectory of home ownership in countries with no interest deduction has been no worse than that in the United States.

It is no surprise that the HMID has failed to increase home ownership — after all, the deduction is available only to taxpayers who itemize (a group mostly consisting of high-income individuals who would own homes regardless of whether the U.S. government gave them the tax break or not). Roughly half of all dollars deducted using the HMID are from individuals making more than $90,000 per year — the distribution of tax avoidance is even more highly skewed toward the highest earners in society because their marginal tax rates are higher.

Rather than encouraging low-income individuals to buy instead of rent, the HMID has merely encouraged wealthy individuals to buy pricier homes than they normally would and pass on part of the cost to Uncle Sam. This is not just a giveaway to the wealthy — it’s a blatant misallocation of society’s resources, siphoning investment dollars from research, education, and factories into McMansions.

What makes the HMID even more unforgivable is the enormity of it all. If the HMID were repealed today, the federal government would take in an additional trillion dollars of revenue over the next ten years. Even a more gradual approach, like reducing the maximum deduction of the HMID to zero over the course of ten years, would save a whopping $400 billion.

Nor is the HMID the only housing giveaway that the U.S. government offers to homeowners. Besides the interest deduction, there are a host of other perks, the largest of which is the ability to exclude up to $250,000 ($500,000 for couples) of capital gains in home sales from the capital gains tax. If these handouts were cut at the same time as the HMID, revenue would increase by $1.4 trillion over the next decade.

Some cuts are hard to make. But the housing mortgage interest deduction is a no-brainer — with our budget situation, there’s no reason to maintain a distortionary tax giveaway to the upper class.

Action: End the home mortgage interest deduction. 10-year savings: $1 trillion.

Lucas over 11 years ago

You're exactly right. This one is obvious... and you didn't even have to explore the role the interest deduction had in increasing subprime mortgages--and hence foreclosures--which created both systemic risk to the economy and a negative "eyesore" externality.

Rolando over 11 years ago

This a bad idea as discretionary spending will evaporate for those in the middle class who would be most adversely affected by eliminating HMID. Simply givng the inefficient and wasteful federal government more funds to misappropriate will not solve the debt problem.

This is simply just another redistribution of wealth scheme that will harm an already fragile housing market and economy as a whole.

If the government wants to get serious about the deficit problem then entitlement reform and reducing the 'nanny state' must be the top priority.

Caroline over 11 years ago

There is an important factual error in this editorial which unfortunately undermines some of the argument. Taxpayers are allowed to deduct interest, on up to two personal homes, on up to $1.1 million of mortgage total - not "any interest payments", as stated in the column. So while I agree that the mortgage interest deduction is an enormous give-away to upper income people, the benefit does has a ceiling. This has been tax law since October 1987. See all the details, clearly with flowcharts, on the IRS website (irs.gov) in IRS Publication 936.

Freddie over 11 years ago

To classify HMID as a 'giveaway' is erroneous. It is not the government's money in the first place. The government 'takes away' from those who actually pay taxes and 'gives away' to those who do not. Please get it straight.

Further, to refute 'that homeowners provide benefits to a community that renters do not' is fallacious and boarderline absurd. Perhaps you have empirical evidence to prove crime is less and communities are more safe in apartment complexes and government run housing projects?

Anonymous over 11 years ago

The article actually does not mention all of the numerous distortions that exist in favor of ownership in the current tax code. Another one is that rental income is taxed, while people are not taxed on the implied rental value if they live in their own property.

Keith Yost over 11 years ago

To 1) Exactly right.

To 2) If that's your concern, then why not offset the end of the HMID with a tax cut to the middle class? I'd rather see the money go to debt repayment, but surely there's something you'd rather do with a trillion dollars than buy homes.

3) Very true. "Any interest payments" is too general a statement, indeed there is a cap. There are trade-offs between brevity and completeness, and that was one that I made poorly.

4) I think your first point is purely semantic, even if I am sympathetic to the "government doesn't actually make any money of its own" point of view. Rephann (2007) offers a decent peek into the nuances of the crime-home ownership relationship. I avoid claiming that there is no linkage, I'm simply trying to say that the linkages are not overwhelming, and that opposite, negative effects of home ownership exist.

5) I mention these other distortions in passing in the second to last paragraph. Again, there are trade-offs between brevity and completeness-- unlike 3's comment however, this is a trade-off I would make again.