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Economics8 myths about the mortgage deduction
One of the most sacred cows in the U.S. real estate market is the mortgage interest deduction available to taxpayers who itemize deductions on their federal income tax returns. This tax provision is traditionally viewed as one of the key elements favoring housing as an investment in the virtually impenetrable U.S. tax code. Yet, there is much misunderstanding associated with this tax provision:
Myth #1: The deductibility of mortgage interest is relatively recent in origin. Actually, this provision is one of the oldest ideas in American income taxation. Begun with the permanent U.S. income tax law in about 1917, it has been left untouched in all subsequent tax reforms. It is a manifestation of America’s love affair with owner-occupied housing.
Myth #2: The current system treats all borrowers the same. Actually, the higher one’s income, the more valuable the tax deduction is. Not only are renters completely discriminated against by this provision, but higher-income borrowers are able to value the deduction higher in terms of tax savings than are lower-income borrowers. A new study by the Joint Committee on Taxation reported that half of the borrowers who claimed the mortgage deduction had incomes over $100,000 and 32 percent of the tax benefit went to households with incomes over $200,000. And you thought this was a fair tax code?
Myth #3: The current system, by providing tax deductions for borrowers, makes housing a good investment. There is no doubt that the mortgage deduction favors home ownership but which homeowners benefit: current or future households? Since 1917, it is reasonable to expect prices to have been bid up to reflect this transfer payment from government to borrowers/owners. In fact, the major beneficiaries of the deductibility rules were property owners before and during the time when the new tax code was passed. Future buyers are only able to acquire property with the premium incorporated into market prices.
Myth #4: The current system helps young homeowners via the mortgage deduction. Since the premium built into house prices is more valuable the higher one’s income and tax bracket, young purchasers with low or moderate incomes are likely to pay an expensive premium relative to the value of their stream of deductions. In effect, low- and moderate-income borrowers may get a poor deal since house price levels are often determined by higher-income borrowers.
Myth #5: The deduction of mortgage interest is a worldwide phenomenon. Some countries provide some “mortgage interest tax relief” as it is called in the U.K. However, there is a cap or limit on the size of the deduction: in the U.K., only the first 5000 pounds are deductible. In Canada, there is no deduction at all. Guess what? Canadian house prices have always been a lot cheaper compared with their U.S. equivalents. They have also been less volatile.
Myth #6: Deducting mortgage interest is a stabilizing force in housing markets. Up until recently, this was typically argued by many commentators. But after the recent turmoil in housing markets, critics are beginning to acknowledge that this tax break might lead to greater volatility in house prices. This is due to the distortion associated with inducing investments via tax incentives.
Myth #7: OK, yet the mortgage interest deduction is the largest tax break available to households. Well, it is the largest of many studied by the Joint Commission on Taxation (estimated to cost the U.S. Treasury $573 billion from 2009 through 2013). However, there is another policy which results in even a larger avoidance of tax consequences: the imputed rent of homeowners (i.e., the value of housing services homeowners consume) completely avoids the U.S. tax code. Rental income of property owners is taxed; imputed rent of homeowners is not. With about 65 percent of the U.S. population in home ownership, even in 2010, this total is a massive amount of revenue which escapes taxation quite legally.
Myth #8: New proposals in Congress will limit or eliminate the mortgage deduction. Don’t bet on it; current proposals are silent about touching this deduction. It is not going to happen.
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Austin Jaffe, Ph.D. is PAR's Consulting Economist from the Smeal College of Business at Penn State University. |
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Jim,
I agree completely with all of your points.
Re: Last one about getting re-elected, it is a time honored tradition to “hand out” goodies by pols even if it does not make good economic (or other) sense!
I believe that home ownership is a benefit in and of itself. I think that the tax code partiality to home ownership (i.e., deductible mortgage interest) reflects itself in higher home prices. I don’t think we should have had a tax credit of $8,000 or $6,500 for buyers who signed agreements before April 30 – I think that housing prices should reflect the value of the house, not the tax benefits.
Then again, I’m not in Congress seeking re=election!
Sandy,
I believe you are missing a few points I tried to make. The myth is that the tax code treats everyone equally. Clearly, renters do not benefit from the mortgage deduction (i.e., choosing to rent means you give up the transfer payment, choosing to buy and borrow enables you to get the deduction). This is not exactly treating everyone equally. Also, since high income borrowers pay income taxes at a higher rate, the mortgage deduction is worth more the higher one’s income. Consider two individuals who both borrowed the same amount, the borrower with the higher marginal tax rate would pay less money after the tax deduction because the savings is the tax rate times the amount of interest paid. Thus, the tax deduction is worth more the higher one’s rate. More importantly, first-time buyers who are low-to-moderate income borrowers probably lose in the deal since the built in deduction is likely to be determined by the average tax payer (who is probably in a higher tax bracket than the low or moderate tax payer). So the system is deceiving to say the least.
Austin
Myth #2 seems incorrect. Mortgage interest deductions are for those with a mortgage (private home ownership), not renters. Higher incomes should have nothing to do with the mortgage interest, it’s probably the higher cost of their mortgage because of the purchase of a higher priced home. Am I missing something?
As always, a thoughtful post from Dr. Jaffe–with some great information. On the heels of the tax credit frenzy in April, I (for one) would like to see REALTORS(R) stress some of the other benefits of home ownership–stability, the freedom to do as you want with the property, the ability to lock in a payment for a long period (in other words, a fixed rate mortgage payment could stay low long after comparable rent payments have risen);….things like this. I think there are plenty of great reasons to own a home that have nothing to do with taxes or tax credits. I think that everytime I visit my garden, for example!