Mortgage Interest Deduction on the Chopping Block?
A panel ranging from liberals to libertarians suggests turning the mortgage interest deduction, a sacred cow of the U.S. tax code, into hamburger.
There was a rare sight in debt-ceiling-obsessed Washington on Thursday afternoon at the Urban Institute: Liberals and libertarians were agreeing on a controversial and politically ugly policy proposal.
The home mortgage interest deduction, a sacred cow of the tax code that allows homeowners to write off a chunk of their monthly mortgage payments, must be wound down. Economists with the libertarian Reason Foundation, the progressive Center for American Progress, and the Urban-Brookings Tax Policy Center all concluded as much.
Even a quick glance at the numbers reveals that this tax benefit doesn’t achieve what we’ve come to think of as its primary goal — encouraging homeownership among people who otherwise would be perpetual renters or could never leave home. Its status as an inefficient deduction (or expensive government spending program, depending on how you look at it) has made this break a target of policy wonks getting serious about cutting the deficit.
This consensus among economists, though, doesn’t mean there’s political consensus to get rid of the mortgage interest deduction — far from it. And if the United States did decide to reform or eliminate the deduction, there are a lot of conflicting ideas on how to do it.
The deduction is deeply entrenched in society and beloved by the home-owning public. Among all of the advantages to individuals embedded in the tax code, this one packs the biggest punch — in 2008, it spared $470 billion in income from federal taxes, making it far and away the largest single goodie available to people who itemize their tax deductions.
The revenue the U.S. Treasury therefore doesn’t collect is proportionately large. Seth Hanlon, director of fiscal policy at the Center for American Progress, cited projections by the Treasury Department that the deduction will reduce government income by almost $100 billion this year. “That’s about twice the size of the budget request for the Department of Housing and Urban Development. In a sense, it’s twice as big as all of our other housing programs combined.”
The deduction also taps into some less-than-empirical claims about the importance of homeownership to the American Dream, to the type of society where there’s less violence, better public schools, greater civic participation and stronger communities.
“If you have a society of a solid majority of owners, one has to think about whether that leads to more stable social outcomes,” said Lawrence Yun, chief economist for the National Association of Realtors, who was the lone dissenter on the Urban Institute panel that brought together the liberals and libertarians. “FDR mentioned that ‘a nation of homeowners is unconquerable.’We have to think maybe there is something more than numbers to a homeownership society. Reagan said he would not touch the mortgage interest deduction because it symbolized the American Dream.”
This argument didn’t do much to sway the economists on hand Thursday. And perhaps it will start to lose its salience among the public in a new economy where homeownership is viewed as much as a shackle against job mobility as a sign of financial stability. Even if the mortgage interest deduction did help create homeowners where they otherwise wouldn’t exist, for the first time many people are starting to wonder if homeownership in and of itself is such a worthy end.
The housing bubble certainly illustrated that it is decidedly not a good idea — for individual families and society as a whole — to push people into their own houses who barely have the wherewithal to be renters.
And if eliminating the deduction did in fact cause housing prices across the country to fall by as much as 15 percent — a claim espoused by defenders of the deduction and disputed by economists — would that necessarily be a bad thing? Many large cities are currently struggling with a shortage of affordable housing. And, as pre-burst-bubble home prices had gone up without comparable gains in wages, housing has been eating up a greater and increasingly unsustainable share of many family budgets.
The wide popularity of the deduction doesn’t match its impact. According to an analysis published Thursday by the Reason Foundation, the deduction was used on but a quarter of all tax returns filed in 2009.
Only 5.5 percent of people making between $20,000 and $30,000 a year used the deduction in 2009. It saved them next to nothing. Among filers making between $40,000 and $50,000 — the middle-income individuals a government homeownership program might want to target — the deduction saved them just $114 on average.
It was, however, used on 73 percent of returns filed by those making more than $200,000 a year — the families who likely don’t need a hand from Uncle Sam to become homeowners. On average, homeowners in that top income bracket saved $2,221 on their tax bill.
“How much is the home mortgage deduction really doing for homeownership?” asked Eric Toder, co-director of the Tax Policy Center. “If you really wanted to help homeownership, you wouldn’t be giving deep subsidies to high-income people who’d most likely be owning anyway.”
The U.S. probably also wouldn’t be giving deductions to people for second homes — including summer homes and boats that can double as housing.
If we did achieve a broader coalition around the idea — whether because the deduction is simply expensive, or because it mostly benefits people who don’t need it, or because we don’t believe the government should be encouraging homeownership at all — exactly what to do about it will be contentious. This is where the economists diverge.
Dean Stansel, one of the authors of the Reason study, advocates a “revenue-neutral” approach where the government takes the savings from eliminating the deduction and uses it to lower everyone’s tax rates. He calculates that we’d be able to cut everyone’s rates by 8 percent (note: That’s not 8 percentage points!). The Center for American Progress, on the other hand, supports slowly transitioning the deduction into one that does more to benefit people who actually live on the margins of putative homeownership.
Both ideas sound politically unrealistic right now.
“But given the size of the fiscal problems we face, I don’t think it’s possible to do anything to address them without doing something that’s politically unrealistic,” Toder said. “Just saying ‘this is politically unrealistic,’ in today’s context, is not enough to push it off the table.”