Debunking Mortgage Interest Deduction Benefit Myths

A few weeks ago, Minneapolis Fed President Narayana Kocherlakota argued that we should reduce the amount of mortgage interest that can be deducted from income tax receipts. He is just another in a long line of experts that are now speaking out against the mortgage interest deduction (MID), a line that included the President’s debt commission last year.

Yet, there remain stalwart defenders of the MID, mostly from groups that have a personal financial stake in the continuance of the federal subsidy for homeownership, such as the Mortgage Bankers Association and the National Association of Realtors (NAR).

About a year ago, NAR Chief Economist Lawrence Yun articulated a succinct encapsulation of the arguments in favor of keeping the MID. He says he has two arguments, though really there are four in his post. However, Dean Stansel, an economics professor at Florida Gulf Coast University, and I have spent the past six months studying the MID and believe there are some serious flaws in those arguments. So I will take them one at a time and debunk the myths that seem to support the need for the mortgage interest deduction. The numbers that follow are from our research and a forthcoming study by Reason.

1) Yun argues that two-thirds of those who claim the MID on their income tax statements are “middle-income” earners, and these households already pay 80 to 90 percent of the income tax, so why make them pay more?

It is not clear how Yun defined “middle-income” but the Census Bureau reports that the median household income for the U.S. in 2009 (the latest data on record) was $49,777. Looking at data from the IRS and Joint Committee on Taxation, we find that those making between $40,000 and $50,000 in 2009 only were 8.4% of those claiming the mortgage interest deduction on their taxes. Being generous, if we expanded the range to $40,000 to $75,000 the total of MID claims would only be 30.4%—which is one third, not two thirds. Even if you included everyone that claimed the MID up to $100,000 in annual pay, you’d only have 59.5% of those claiming the MID.

In contrast, those making $100,000 and above are 40.5% of those who claim the MID, and they paid about 75% of all income taxes in 2009. Yun’s argument may still exist, but it would be about ensuring those that make six figures a year don’t pay more in taxes. Even still, the issue of the MID is not about whether or not a particular subset of American society should or should not pay more taxes. The issue at hand is the distortion that the MID creates in artificially boosting demand for housing with subsidies and redirecting resources away from other parts of the economy.

2) Yun argues that the origin of the housing crisis wasn’t because of the MID, it was because of lax underwriting standards and bad credit ratings and irrational investing, and the MID “has brought remarkable stability to the housing market.”

I won’t spend a lot of time here since I wrote about this last year in our study on Rethinking Homeownership (see here). But I will say this, Yun can’t have it both ways. Either the MID props up prices, meaning they increase in value artificially—not due to real consumer demand—which in turn creates bubbles and contributes to the housing crisis… or the MID does not impact prices and therefore has little benefit to homeonwers.

Separately, it is worth pointing out who the MID is supposedly bringing stability to. We just looked at numbers showing that a plurality of those who take the MID are in high income brackets. Those making between $100,000 and $200,000 a year are 30.6% of MID claimants (the largest category) and those making above $200,000 are 9.9% of households claiming the MID. Those making $50,000 (roughly the median income) and below are just 18% of households that claim the MID. This is because you have to have itemized deductions on your income tax return, which only a quarter of taxpayers do, to directly benefit from the MID. In addition, you have to have a lot of interest on your mortgage, which typically only is the case for young, wealthy households.

3) Yun argues that homeownership has “positive social benefits, including lower juvenile delinquency rates and higher student achievement among children of home owners.”

There is no doubt that a lot of homeowners contribute to society in a positive way. But there is a danger of mixing up correlation and causation. Just because there is less crime where people own homes doesn’t mean that renters are necessarily more likely to be criminals. City centers and dense urban areas have higher land values and less single family dwellings (so more rental units), so if those areas have more crime the data will tend to correlate renting and crime. But that is not a cause. You could argue that dense population is a cause of crime, but that is a separate matter entirely.

Similarly, if those more likely to have the resources to be homeowners are more likely to be able to afford supplements to their children’s education or even good private schools, then there will be a correlation between homeownership and student achievement. But that doesn’t mean if you use public policy to get people into homes that their children will magically become better students.

But the argument is not just hypothetical. In a study published in the Journal of Urban Economics last year, researchers conducted an experiment between 1998 and 2003 in Tulsa, OK. The experiment picked two groups of low-income renters and offered one group matching funds of $2 for each $1 saved up for the purchase of a home. Their study compares the social benefits of the experimental group compared to the control group that did not get a subsidy. The experimental group did have a higher homeownership rate at the end of the study, however they did not exhibit any defined social benefits over the control group. In some cases, those that got a subsidy effected their neighborhood in a negative way, unlike those who were not offered a housing subsidy, but ended up becoming homeowners anyway.

Of course, there are a number of other studies backing Yun’s point that homeownership has positive social benefits. But in those studies the cause and effect are often confused and this should not be grounds for public policies to favor homeownership over renting like the mortgage interest deduction does. It is important to note that this study is not alone in debunking the claims about the positives of homeownership. See here, here, and here for some others.

4) Finally, Yun says getting rid of the MID would create “trillions of dollars in wealth destruction” and “a new uncertainty” for housing.

This argument is based in the belief that the MID increases the value of housing, and that creates wealth for homeowners. While I agree that the existence of the MID encouraged more people to buy homes, and that this increased demand contributed to pushing up prices in the housing bubble (and that is a good thing?) I disagree that getting rid of the MID would destroy wealth. Because those pushed up prices didn’t create any wealth in the first place.

I’ve written about this at length before so I’ll largely just link to it here, but in the short the myth of homeownership wealth creation rests on the view that houses have actually gained value over the past several decades. If you look at nominal prices, home values have risen by a large margin. But if you look at housing prices adjusted for inflation, they haven’t risen much more than 3% since World War II. Compare that to a 532% increase in the S&P 500 and a 932% increase in the Nasdaq since 1970.

At the end of the day, housing grows basically at the rate of inflation and not much more (and probably less without government subsidies). So it is a good store of value like a savings account, but not a wealth creation machine over time. It only creates wealth for investors who flip homes over a short period of time and profit from near-term increases in the prices of local real estate.

Also, it is unclear what exactly the “new uncertainty” would be that Yun is referring too, but there are some who claim that getting rid of the MID would hurt the housing recovery process because prices would decline. Ironically, that would be a good thing, since we need prices to hit their historical trend free from subsidies so that there will be certainty in the stability of growth in the housing market moving forward. As long as the government keeps a bubble inflated we run the risk of it popping and crashing down on us again.

In the spirit of fairness, if you would like to see NAR’s arguments in context, they have a lot of resources on it here.

*Bonus note: I didn’t want to pile on too hard with point number 3, but there is added evidence contradicting the idea that homeonwership necessarily equals positive gain for society. Consider all of those who were pushed into homeownership before they were financially ready to own (through cheap loans and low interest rates) that are now a part of the foreclosure society. Those families who have to move and then change schools negatively impact the education benefits the MID and homeownership are often argued to offer. There is also a case to be made with the housing collapse causing more divorces, separations, and marriage problems since financial problems are among the top reasons for divorce.