Friday, February 11, 2011

Ventry on the Mortgage Interest Deduction as a "Social Program"

A must-read of the day: Bruce Bartlett (via James Kwak) on what we get from "social programs" versus what we pay.  Among "social programs," they count the home mortgage interest deduction, although Kwak rightly acknowledges that "you could get into an argument about whether it’s really a social program.'"

At 12:21 pm, in a mood of idle mischief, I fired the link, inviting comment from my colleague Dennis Ventry, whom I knew to cherish firm views on the topic.  At  1:34 pm, my Blackberry began to smoke.  Blowing away the brimstone, I read:

Of course it's a social program. A poorly targeted, inefficient, and inequitable social program, but a social program nonetheless.

If the policy goal is to increase rates of homeownership (a dubious goal in its own right--rather, than, say, increasing the rates of shelter--but one we'll take as a given here), switching from a deduction to a credit would immediately increase the number of homeowners, as would-be marginal buyers (rather than those who'd own a home with or without the deduction/credit) make the tenure decision to own versus rent. Indeed, economists (i.e., except, perhaps, those working for the National Association of Realtors or the National Association of Home Builders) have found that it does not raise rates of homeownership (just ownership of bigger, more expensive homes).

The deduction's inefficiencies are legendary and numerous: distorts cost of housing relative to other investments; contributes to overinvestment in the asset class and misallocation of capital stock; artificially raises housing prices; raises unemployment (by decreasing labor mobility); destabilizes the national economy; encourages overconsumption of bigger, costlier homes; and encourages precariously high loan-to-value (LTV) ratios.

Finally, with respect to its inequities, the deduction disproportionately favors high-income TPs; distributes benefits unevenly across different regions of the country; and discriminates against minorities & low-income households. Moreover, it is the classic upside-down subsidy in that it provides 10x the tax savings for households with income exceeding $250K compared to households between $40K-$75K; provides no benefit to 65% of TPs claiming the standard deduction; provides no benefit to almost one-half all homeowners; no benefit to one-quarter of mortgaged homeowners; no benefit to renters; no benefit to low-income households; and only minimal benefits to middle-income and elderly households.
 Okay, any questions?  


they call me trouble said...

Good points all. But it seems to me there is one piece left to address. Someone made the point that the effectiveness of a tax break tends to diminish over time. As the break gets figured out, the cost of buying it (here buying a home to get mortgage interest deductions) increases. The point was that the break greatly benefits those who owned the property before the break became available. Later entrants to the market just buy into equilibrium.

The corollary is what happens when the break goes away. Now I'm not a homeowner, and I would love to see the market really tank to take into account the loss of the mortgage interest deduction (and take away the deduction for state property tax, and the elimination of capital gains rates, and the exclusion for gain on the sale of a principal residence), but I doubt many homeowner voters would be too happy about it.

Also, it seems to me that what I am buying is the break. At the end of the day, market equilibrium would drive the conclusion that my after tax cost without a break should be the same as my after tax cost with the break. Is it that clear that getting rid of the break really matter? Is the social cost for getting rid of the break worth correcting the cost for having the darn thing in the first place?

My guess is it is not clear. Still, I reckon I could make a killing on buying houses in the intervening period while the market was trying to re-sort itself.

Ken Houghton said...

True, taxpayers claiming the standard deduction get no credit for Mort Int. Nor do they get credit for Charitable contributions.

The claim that it provides no benefit to renters is, at best, disingenuous: in a demand-driven (e.g., current) market, renters are able to rent properties at below the "sticker" price of Mort&Prop Tax&Maint Costs precisely because of the tax advantage. Properties that are rented for between their gross and net carrying costs by definition pass some of that tax gain on to the renters, while leaving said renters immune to any downside risk in the value of the property.

If you want to talk about a bad piece of tax deduction, the IRA is a much stronger candidate than Mortgage Interest: it's more illiquid, and downside exposure is much more of an issue due to the "miracle of compound interest" effect.

If my house is slightly underwater. I still have a place to live--nice countercyclical insurance. If my IRA goes underwater, it is likely to do so procyclically; that is, at the same time I most need to borrow those funds.

Strangely, those who attach the Mort Int deduction are perfectly happy to yell "equity premium" and glorify IRAs.