Time to Write Off the Mortgage Interest Deduction

Congress should take the bold step President Obama didn't on housing subsidies

The President's budget proposal for 2012 landed with a thud at the doorstep of Congress this week. The spending package actually assumes an increase in deficit spending over the next five-years from the current Congressional Budget Office estimate, and has virtually no substantive adjustments to the nation's tax code. This is confusing since there are number of good, bipartisan ideas floating around that the President or an ambitious Congress could adopt to start the process of real fiscal reform. Eliminating the mortgage interest deduction is one of them.  

The Office of Management and Budget has calculated that the MID will cost $104.5 billion in foregone tax revenue in 2011. With a projected budget deficit of over $1 trillion, keeping this this would hardly seem like sound fiscal policy.

When it comes to an issue that progressives, conservatives, and libertarians can agree upon, getting rid of the MID-which allows people to deduct the interest on their mortgage from their tax bill-is low hanging fruit. Or at least, it should be.

Yet, if you ask anyone on Capitol Hill, they'll tell you the MID is a third rail that no one—neither fiscally conservative Republicans or social goal of homeownership-supporting Democrats—wants to touch. The President's proposed budget didn't address the issue at all, despite the White House's own debt commission explicitly suggesting MID reform.

Ignoring MID is ironic because it is very fiscally irresponsible and doesn't help the progressive goal of expanding affordable homeownership.

To start, progressives should favor eliminating the mortgage interest deduction because it has only been shown to increases homeownership rates in high-income areas, and even then not for low-income households. In larger urbancenters, like New York and Los Angeles, it often mixes with strict zoning regulations to drive up prices, making houses unaffordable for people in lower income brackets.

Although the MID has been show to increase homeownership rates slightly—3.6 percent to 5 percent according to a 2010 study from the Spatial Economic Research Centre—those gains have only come for for moderate- or high-income households. And in locals with tight zoning regulations, the MID has been shown to decrease homeownership likelihood by 3.4 percent to 3.7 percent.

In the end, households that cannot afford to buy a home and seniors who have paid off their mortgages don't get any benefit from the deduction, so it ends up being little more than a tax break for young rich people. If the MID was supposed to promote the progressive goal of increasing homeownership and affordable housing, it's been a total failure.

Conservatives shouldn't be happy about it either. From the fiscally conscious perspective, reducing people's tax liabilities is a good thing, since people should be able to use their money as they see fit, instead of it being redistributed by the government. The MID, however, isn't about the government taking less income-it's about giving money back to homeowners to reduce their net tax liability. This nuance is important for conservatives to understand.

Having the government only take 10 percent of your income instead of 30 percent is a tax cut. Having Uncle Sam take 30 percent, but then cutting the tax bill down based on the interest that's being paid by a specific type of American, is not a real tax cut. And it's not fiscally conservative.

The government certainly does not have a right to all our money, but arbitrarily finding ways to deduct tax liability is just another way of redistributing wealth-especially since this tax deduction favors owners over renters. This favoritism also overincentivizes housing investment over other capital ventures, misaligning resources in the economy. In fact, the MID represents a housing subsidy like that provided by Fannie Mae and Freddie Mac, which distorts the housing market and causes inflated prices that lead to booms and busts. Thus, the MID is a failure from a conservative perspective as well.

So why do we have it again?

When the income tax was first introduced, all interest was tax deductible, since it was generally incurred by businesses purchasing capital equipment that would be used to increase the company's income.

By the 1980s, this was no longer the case and a significant amount of debt was held by consumers. At the time, the Reagan administration embarked on a plan to eliminate a majority of the loopholes from the tax code, thereby allowing the marginal tax rate to be significantly lowered.

Since a majority of the interest being deducted was no longer related to the purchase of income-producing assets, the MID was scheduled to be put on the chopping block with the rest of the loopholes. That is, until the politicians realized that eliminating the largest tax deduction would piss off a lot of voters. And so, the entire rational for keeping the MID was politically motivated. And political considerations have maintained the policy ever since, even though it's been a massive failure in terms of both social and fiscal outcomes. Who wants to be seen as the policymaker who made housing more expensive?

But, progressives should be upset because the MID is a de facto tax break for rich people and has failed to increase home ownership rates. And conservatives should be angry that the government is subsidizing housing and creating an incentive structure that favors homeowners over renters, which ends up distorting the free market.

There are legitimate concerns about what the best way to go about eliminating the MID would be, including whether or not other changes in the tax code should be made to avoid having real costs for taxpayers rise. But before having that conversation, Congress needs to develop a commitment to taking on and getting rid of the MID.  

There is wide agreement that something needs to be done to get America's finances in line. Eliminating the mortgage interest deduction is a good first step that both sides should be able to agree on.

Anthony Randazzo is Director of Economic Research






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