At first blush, the mortgage interest income tax deduction seems like a great thing. You get to deduct your mortgage interest from your income. This saves you money and encourages homeownership nationwide (believed to produce positive externalities such as crime reduction, community, etc.).
But beneath the surface, the mortgage tax deduction disproportionately benefits the wealthy and creates perverse incentives and market distortions that are plainly bad for America. I deal with these issues one by one:
(1) Good for the rich: since the US tax code allows the deduction of mortgage interest directly from your income, those that benefit the most are those with the most income. The very poor cannot afford to buy a home, so they do not benefit at all. Poor homeowners benefit very little because they do not pay much in income taxes. But the wealthy receive huge tax breaks from the interest on their jumbo McMansion mortgages.
(2) Perverse incentives: because of the huge mortgage interest tax break, high income earners are then encouraged (and subsidized) to buy ever more expensive mansions and borrow even more money through ever larger jumbo mortgages.
(3) Market distortions: by subsidizing the purchasing of homes and the taking on of mortgage debt, the mortgage tax deduction has increased the demand for homes (expensive homes, in particular) and reduced the effective rate of borrowing again homes. While the housing price bubble and over-leveraging of American was not caused by the mortgage interest tax deduction, certainly the previously (and still) inflated values of homes and over-borrowing of the US consumer cannot be disaggregated from this pernicious deduction.
What to Do Next
The rational policy choice would be to eliminate the mortgage tax deduction. The federal government can still encourage homeownership (distinguished from mansion-buying) by instituting a Housing Tax Credit. The credit could be cost-neutral and take the average cost per family of the current deduction, and give that amount out as a tax credit to any family or individual who wishes to purchase a home. A standard credit would make sure that regardless of a family’s income they would receive the same nominal incentive. This would provide more incentive for poor people to buy a home (the credit would likely be worth more to them than the current deduction) and waste less taxpayer money on subsidizing the mansions of the wealthy. Moreover, such a policy could potentially spur homeownership among lower-income families which could help us dig our way out of the housing crisis. Let’s hope the next president has the foresight to do something about this.Powered by Sidelines