Saturday, November 10, 2012

Let's get rid of the mortgage interest tax deduction--for everyone

Yonah Freemark and Lawrence J. Vale have a great article in the New York Times questioning the wisdom of the mortgage interest tax deduction, and I wanted to discuss it a bit more. The mortgage interest tax deduction's effectiveness and value have been discussed at length over the years, but I think with Mitt Romney's proposal to limit deductions in exchange for lower tax rates we're a bit closer to actually taking a hard look at it and possibly even instituting something better.

There are a few things at the heart of this issue. First, we spend about $250 billion dollars a year on federal housing expenditures (in the form of both spending and "tax expenditures" - i.e., tax deductions that result in foregone revenue); however, although 1/3 of the country is renters, only about 1/4 of that $250 billion goes to renters, and most of it goes to the very poor in the form of Section 8 vouchers and public housing. People in the lower-middle class are left in the cold compared to both lower- and higher-income individuals and families. Given that renters tend to be less affluent on average, it seems perverse that they'd actually receive a smaller share of housing benefits.

Second, of the approximately $85 billion spent on the mortgage interest tax deduction each year, about $35 billion goes to families earning more than $200,000. A full 78 percent of expenses for the mortgage interest and property tax deductions in 2010 went to families earning more than $100,000, according to the congressional Joint Committee on Taxation. So even within the outsize share of money dedicated to supporting homeowners instead of renters, a very large portion of it is accruing to those with the least objective need. This information is explored in greater depth in this pdf from the nonpartisan Center on Budget and Policy Priorities.

From the Center on Budget and Policy Priorities.

If we look at where the spending is going, broken down by income brackets, we see that our hallowed middle class is getting almost nothing. Virtually all of the mortgage interest and property tax deductions are falling into the pockets of families that would be able to afford a home regardless, and have plenty of incentive to do so without any government meddling:

From the Center on Budget and Policy Priorities.

Lastly, it's very unclear whether we as a nation should be financially incentivizing homeownership over renting. Certainly there are many benefits to owning a home, but there are also many drawbacks. We tend to treat homeownership as an investment when in reality it's probably better understood as just another form of rental--instead of renting indefinitely, however, we pay (often) higher monthly costs in the form of mortgage payments. (Not a perfect model, but it helps us escape the trap of being primarily concerned about the appreciation or depreciation of the home.) In exchange, once the mortgage is paid off we are no longer required to pay rent, and we have an asset in the form of land and the home that sits on it, and that's pretty outstanding regardless of what their financial value happens to be. I can't understate how great a deal that is, but it's not without costs and risks.

Renters, in comparison, have much greater mobility (important for maximizing income by finding the ideal job) and a much easier time downgrading their residence in the face of a financial setback. They're also much less likely to overpay relative to the actual value of their apartment/home, a serious problem that's currently manifesting itself in the form of a "mortgage overhang" for many who purchased homes during the height of the most recent housing bubble and now owe much more than their home is worth. Lurking behind this whole discussion, of course, is the financial crash of four years ago which, among other things, exposed the weakness of a system that encourages families to pour the majority of their money into a home to the exclusion of other, safer investments.

I wholeheartedly recommend purchasing a home if you have a stable income, good credit, and don't plan on moving any time soon. In fact, right now is an unusually great time to buy a house, especially in certain regions of the country. The point though is that this a great time to purchase a house independent of the mortgage interest tax deduction. Just as a side note, I think it's also important to note that for many of the less expensive homes out there the mortgage interest tax deduction deduction doesn't even exceed the value of the standard deduction, so once again those with lower incomes fail to get much benefit from the program. This despite them needing the most help, and despite them probably being most likely to let perceived incentives convince them to take the leap and buy a home, even if it doesn't necessarily make sense for other reasons.

More than half of the $85 billion in deductions is going to people who require no additional incentive to buy a home, and on the other end of the income spectrum we're encouraging some people to buy that probably aren't ready financially; can we think of no better way to spend this money? To start with, with $85 billion we could just mail a $300 check to every person the country, or $400 to every adult. Maybe some would decide to put that toward purchasing a home or paying down a mortgage, but others wouldn't, and that's fine. They'd be free to make their choice, and no one would be missing out simply because they didn't want to be pressured into buying a house before they were ready, or ownership just didn't appeal to them. Or, since we're presently in an age of austerity, that money could just be redirected toward paying down our deficit. Better still, we could send out checks for the next few years until our economy has fully recovered from the recession, then start using it to reduce our deficit. There are most definitely much more creative and probably much stimulative and efficient uses than these examples.

Another important issue at stake is the fact that most residences available for purchase tend to be in the suburbs (especially now, with millions of foreclosures in the newer developments), whereas there are far more rentals available in more densely-populated cities. If people are being encouraged to purchase homes they're necessarily being encouraged to leave city centers for the more expensive, less efficient suburbs. This is bad for the cities themselves, but it's bad for the United States as well: as more people are forced to live in the suburbs we're forced to build (and maintain) more roads to support them, more utility infrastructure to far-flung regions, more public servants serving fewer people per capita. Local and state government is at least as culpable in this case, as they're generally responsible for the oppressive zoning codes that prevent significant development in already-populated regions. This also drives up rental prices, leaving less money for people to spend on, or invest in, more important things. So while we're inefficiently spending many billions of dollars via our housing policy, it's costing us billions more on the back end in the form of high rents, excessive infrastructure costs, more pollution, and longer commute times.

I'd also like to preemptively respond to a likely criticism of this idea: the claim that reducing tax expenditures  is the same as a tax increase, because the government is basically giving you back your own money. This is false. The fact is that when you take out a loan from a bank they will charge you interest as a hedge against the possibility of you defaulting, and to ensure that they're actually making money on the deal. Nowhere in this contract is the federal government's blessing required, and if you've determined that the benefits of taking out a loan for a home outweigh the drawbacks (and the bank agrees to offer you a loan), that should be the end of the story. It really should be as simple as that.

Government doesn't allow you to write off the exorbitant interest of a payday loan because it doesn't want to encourage that activity; likewise, it shouldn't tip the scales in favor of homeownership by allowing you to write off mortgage interest. The case for maximizing homeownership is tenuous at best, and in its current form the mortgage interest deduction isn't even an efficient means of pursuing that dubious goal. We can do better, and we should.

4 comments:

  1. In the old days (sigh), you COULD write off the exorbitant interest of the payday loan. You could deduct ANY interest you paid. I remember collecting credit card statements for the deductible interest.

    The mortgage interest deduction is a leftover from that period.

    I actually think there's a good argument for going back to full deductibility of interest.

    Why in the name of hell should someone with a $20K salary who's paying $10K a year on student loans have to pay the same tax rate as someone with a $20K salary and no student loans?

    Of course, the whole issue of interest would be a lot less serious if we had federal usury laws -- make it illegal to charge interest rates more than federal funds + 4%, perhaps.

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  2. I don't think writing off all interest is a good idea, and I'm glad that's gone. I understand there's a social justice issue involved with the burden that payday loans place on lower income people (I've gotten a few myself in the past), but I don't like the idea of so blatantly endorsing poor financial choices. Sometimes a payday loan or some credit card debt are a necessity, but we keep it a necessity and not a regularity by imposing some kind of penalty. People should avoid credit card interest just like they should avoid payday loans; even though mortgage interest deductions are unnecessary to encourage people to purchase homes, there's at least a benefit to owning a home.

    And I think you're overstating the issue of student loan debt. For one, not many people who are employed after college are making $20k, and those that are have options for income-based repayment, at least for federal loans (which account for most out there).

    I'm with you on usury laws though, within reason at least. It's a tough issue though, because I had very poor credit until recently and without exorbitant interest-rate credit cards available on the market I'd have struggled to get anything that could help me improve my credit. It just meant I had to make sure I didn't actually accrue interest. I'm absolutely sure there are abuses with interest rates in many cases, but it's also true that high rates are required when you deal with people with poor credit because you're more likely to not get your money back, on average.

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  3. Thanks again! You are so right that habits are learned and enforced by social behaiours and so the right social support can be invaluable when changing habits!

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