Rethinking Home Mortgage Deductions

Harvard economics Professor Edward Glaeser, in The New York Times this week, asks us to rethink the home mortgage deduction in the tax code, and it certainly sounds like a […]

Harvard economics Professor Edward Glaeser, in The New York Times this week, asks us to rethink the home mortgage deduction in the tax code, and it certainly sounds like a good idea.

In hard economic times, we all need a good reason to buy, particularly if what we’re looking to buy only improves our lifestyle, and not completely and utterly essential to our survival. It’s why Rooflines typically questions consumer incentives provided by the people doing the selling, whether they are government incentives to purchase a house, to utterly backwards, half-baked, halfwitted incentives to purchase an automobile. (I’m looking at you, Chrysler, for offering in spring 2008 a customer incentive for some cars in its fleet: if you buy, you get locked in to $2.99/gallon gas for the next three years! Hmmm…now while we all know the era of cheap gas has, or will soon come to an end, gas ain’t that expensive anymore). And now Chrysler, along with General Motors, has asked Congress this week for an additional $20 billion in aid while they simultaneously cut 50,000 jobs on top of the $17 billion they had previously requested and thousands of layoffs. GM also posted a $9.6-billion loss in the fourth quarter.

But we live in a global economy where purchase power and buying things is so vital to economic health, so it’s a double-edged sword, really, when consumers, finally paying down credit card debt and holding on to their money for the proverbial rainy day (did anyone spend last year’s rebate check?), damages the economy.

I recall the epic Wall Street Journal headline that could have been lifted directly from The Onion back in January:

Hard-Hit Families Finally Start Saving, Aggravating Nation’s Economic Woes

Why do we walk this fine line of fiscal responsibility? Why do we sell fiscal responsibility as a key virtue, but then tsk tsk consumers when they’re not spending enough? I know I’m asking economic Meaning of Life questions here, so I don’t expect answers, though I should.

Edward Glaeser calls for the gradual reduction of the upper limit of the deduction to loans of up to $300,000 and then “refunding the tax revenues in a more productive manner.” Currently, the tax code allows for homeowners to deduct the interest on loans used to buy, build, or improve a home for mortgage principle of up to $ 1 million.

So, for our latest installment of “Live Within Your Means,” here’s Prof. Glaeser’s list of why the home mortgage interest deduction is “in need of a good stockyard”:

  • 1: Subsidizing interest payments encourages people to leverage themselves to the hilt to bet on housing markets. The size of the tax benefit is proportional to your debt. The deduction essentially encourages us to make leveraged bets on the swings of the housing market. That leverage means that housing price swings can easily wipe people out. We are currently experiencing the consequences of subsidizing gambles on housing.
  • 2: The deduction pushes up prices in places where the supply of new homes is constrained, as it is in many coastal markets. Economics 101 teaches us that if we subsidize demand where supply is inelastic then the only effect is to make prices go up. Housing supply is pretty constrained in places like New York City because of land-use restrictions and lack of land. In these places, the deduction doesn’t make housing more affordable. It just transfers money from buyers to sellers, and that makes little sense.
  • 3: The deduction is wildly regressive. The tax savings for households earning more than $250,000 is 10 times the tax savings for households earning between $40,000 and $75,000 a year, according to recent research by James Poterba and Todd Sinai.

If there ever was a case for small-government egalitarianism, then this is it. Eliminating the home mortgage deduction and replacing it with an across-the-board tax cut would equalize after-tax incomes without a single new government program.

  • 4: The deduction encourages people to buy larger, single-family detached homes, and that increases carbon emissions and pushes people out of cities. The deduction encourages people to buy more expensive homes, which are generally bigger homes.

Bigger homes use more energy. The deduction is therefore implicitly urging Americans to run higher electricity bills and spend more on home heating. If global warming is a serious problem, then the government should be encouraging us to live in smaller, not bigger, dwellings.

  • 5: The home mortgage interest deduction is poorly designed to encourage homeownership, which is, after all, the alleged desideratum. Much of the interest deduction’s benefits go to richer Americans who are likely to own homes in any case.

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