A useful and interesting research paper showing that the US system of tax relief for interest on mortgages doesn't in fact achieve anything useful. In fact, in its second order effects it probably dissuades the marginal household from buying their own house. It therefore looks like one of those things that should be abolished in any attempt to sort out and clean up the US tax system. We could get rid of mortgage interest relief and then lower tax rates for all Americans for example, that sounds like a pretty good idea to me:
The mortgage interest deduction, a sacred cow in the U.S. tax code, does nothing to promote homeownership, according to an academic paper released Monday, a finding that undermines one of the core justifications for the tax break.
That is how it is normally justified too. We think it a good idea if people own their own homes. They will therefore have a capital stake in their neighbourhood, possibly leading to more communal investment in that area. They're also, once they've paid for the mortgage, building up a capital pot and we tend to think that the creation of that bourgeois society is a good idea. If it doesn't achieve higher home ownership then there's nothing really to be said in favour of it any more.
We present three main findings. First, the mortgage deduction has a precisely estimated zero effect on homeownership. This holds even in the very long run. Second, the mortgage deduction has a sizeable impact on housing demand at the intensive margin, inducing homeowners to buy larger and more expensive houses. Third, the largest effect of the mortgage deduction is on household financial decisions, inducing them to increase indebtedness. These findings suggest that the mortgage interest deduction distorts the behavior of homeowners at the intensive margin, but is ineffective at promoting homeownership at the extensive margin and any externalities that may be associated with it.
That is, it simply doesn't do any of the things we desire it to do and it has some negative effects as well. In fact, we can go further and point out another negative, that it generally increases the price of housing across the country. No, not by making people buy more houses, we've shown that it doesn't do that, but by making people buy more housing, each house being larger than they would be without the tax subsidy. Thus we really should get rid of it. But how?
Obviously the chances of big change here are small. But there is a way forward. My AEI colleague Alan Viard has proposed replacing the mortgage interest deduction with a 15 percent refundable credit, one available to all homeowners, including those who claim the standard deduction and those with no income tax liability. The credit would be limited to interest on $300,000 of mortgage debt (in 2013 dollars), with no tax relief for mortgages on second homes or on home-equity loans.
No, that's not in fact the way to do it. There's no point in replacing one tax break with another. Instead, we want to abolish the break. My suggestion would be to do exactly that. However, it's too large a cliff edge to jump off in one go, we need to do this in stages. A decade would be a long enough period of time. Reduce the value of the tax break by 10% (using straight line depreciation) each year for a decade. Currently the credit is worth 100% of mortgage interest--with some exceptions, sure--and so in year two it would be worth 90% of mortgage interest and so on until it was worth nothing. At the same time increase the personal allowance (the standard deduction perhaps in US speak) by the same amount as the revenue being brought in by the abolition of the credit. In that manner we change a tax break which benefits only homeowners into a lower rate of tax for all. I would note that my native Britain actually did this.
The mortgage interest deduction doesn't in fact encourage home ownership. Given that it doesn't do what we think it does we should abolish it.
