November 20, 2017

Get Rid of Big Housing's Big Break

Matthew D. Mitchell

Senior Research Fellow

Tad DeHaven

Research Analyst
Summary

The mortgage interest tax deduction only benefits the housing lobby, and it's time Congress nixed it.

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One is about as likely to find the Loch Ness Monster as to find someone who thinks that the federal tax code isn't a complicated, counterproductive mess. It's also hard to find an economist who thinks that one of the costlier complicators – the mortgage interest tax deduction – is worth keeping.

Yet, despite all the talk in the past year about "draining the swamp" in Washington and the need for serious tax reform, it's looking like this creature from the Beltway lagoon will survive in one form or another.

Motivated in part by a need to find revenue offsets for its broader tax cut proposal, the House has proposed to reduce the amount of mortgage debt taxpayers may deduct interest on from $1.1 million to $500,000; the Senate version would slightly reduce it to $1 million. But even these modest reforms have raised the ire of Big Housing.

Indeed, even if both chambers had proposed to leave the mortgage interest deduction alone, this powerful lobby would still be upset that Congressional Republicans intend to raise the standard deduction: Doing so would cause fewer taxpayers to itemize, which means fewer people would claim the deduction.

When President Donald Trump laid out his principles for tax reform in August, he called for "getting rid of the loopholes and complexity that primarily benefit the wealthiest Americans and special interests." Getting rid of the mortgage interest tax deduction would do precisely that: It benefits wealthier Americans and the housing lobby at the expense of the majority of taxpayers, who receive no benefit and yet are forced to cover the deduction's approximately $70 billion annual revenue loss to the federal government.

Furthermore, as our Mercatus Center colleagues recently noted, even the benefit for wealthier taxpayers is illusory "because the tax gains to homeowners are largely offset by increases in home prices."

That leaves the powerful housing lobby – represented most prominently by the National Association of Realtors and National Association of Homebuilders – as the real beneficiary. Big Housing has spun a heartwarming fairy tale that the mortgage interest tax deduction fosters homeownership and the virtuous American values that come with it. There's just one problem: It doesn't.

But don't take our word for it. According to Harvard economists Edward Glaeser and Jesse Shapiro, "the home mortgage interest deduction is really not a pro-homeownership policy in any meaningful sense." In July, a study from economists Jonathan Gruber, Amalie Jensen and Henrik Kleven concluded that the deduction "has a precisely estimated zero effect on homeownership, even in the very long run." And as many others have observed, countries that do not offer a tax break on mortgage interest have similar – and even higher – rates of homeownership. Indeed, there is no historic correlation between U.S. homeownership rates and the subsidy value of the mortgage interest deduction.

So why, then, has Big Housing fought so hard to keep the mortgage interest deduction? The answer is that although the deduction doesn't affect home ownership, it does incentivize people to purchase more expensive homes. That translates into more money for realtors and home builders. And because the deduction is taken against the interest payment and not the down payment, it encourages home buyers to put more of the purchase on credit.

So in reality, the deduction encourages home-borrowship, not homeownership. Did we mention that the Mortgage Bankers Association is also a prominent defender of the mortgage interest deduction?

Big Housing knows there's blood in the water, and the mortgage interest deduction is running out of defenders. But as the tax reform process moves along, the deduction could end up getting replaced with a tax credit – allowing those who do not itemize to obtain a tax break against their mortgage payments and expanding the preference to more taxpayers. With more people getting the tax preference it will be harder to eliminate it, even if those who think they benefit from it don't actually do so.

But the bottom line is that the federal government has no business using the tax code to play favorites with economic activity. The goal should be to lower rates and eliminate all targeted tax breaks in the process. A simpler, less punitive tax code that didn't play political favorites would be a boon to the broader economy. And it would dent the armor of a privileged commercial interest that has been cashing in at the public's expense for far too long. Otherwise, Congress will have let this monster swim away.