The mortgage tax deduction and why it should go

    Yesterday, in a post about the President’s Commission on Fiscal Responsibility, I mentioned that co-chairs Alan Simpson and Erskine Bowles suggested, amid a long laundry list of federal programs to be cut, the elimination of the mortgage tax deduction. While I deduct my mortgage interest when calculating my taxes each year, just like everyone else who can do so, I’d never really given much thought to the longterm ramifications of the policy. Fortunately, though, a few folks in the MM.com audience have. Following are some of their comments:

    Brandon
    For what its worth, the mortgage tax deduction has been a key driver of urban sprawl and McMansionization for decades… doing away with it (in combination with an increased gas tax) could have some real positive long-term effects.

    Murph
    As Brandon points out, the mortgage interest deduction is a massive social engineering scheme, in the favored parlance of the right: it encourages people to buy (rather than rent) larger houses on larger lots further from the cities than they might otherwise choose if left to themselves. (For all you homeowners – remember when you were making the choice to rent or buy? I’m sure you remember the propaganda about how buying was the right choice due to the tax breaks, and how you should stretch yourself to buy a house for that reason even if you might otherwise not consider it.)

    The deduction both encourages consumption of larger homes, by promising a larger tax break for larger mortgages, as well as masking the true cost of these mortgages to the borrower. And, as we’ve seen demonstrated over the past few years, encouraging people to stretch themselves into homeownership – and stretch into the biggest houses they can afford – is hardly the path to wealth-creation that we’ve made it out to be.

    But there’s also the issue that the mortgage interest deduction is a somewhat regressive tax – it primarily benefits those on the upper income end of the scale. Wealthier taxpayers are in higher marginal tax brackets, so benefit more from deductions (especially if it bumps them down into a lower tax bracket), as well as typically owning larger and more expensive homes, and so having a larger chunk of interest they can claim. Look at the piece where they’re offering an option of “Maybe we don’t eliminate the deduction – but we just cap it to the first $500,000.” Is this really a blow to the middle class?

    Take away the name, and just look at a description of what we’re talking about: an expensive and regressive tax break that creates massive market distortion in the name of social engineering purposes with questionable benefits.
    In any other case, we’d be howling to end this sucker, with Speaker Pelosi leading the charge – but since we all benefit to some small degree (or want to save it so that, someday, we’ll make enough money that we can benefit), it’s a hot-button topic. As is, we’ll probably have to phase it out – since there are still plenty of folks out there who couldn’t really afford to buy the houses they bought, even losing the relatively small benefit of the mortgage interest deduction could put them over the edge if removed suddenly.

    I haven’t had a ton of time to think about the rest of the pieces of the chairmen’s proposal, but ending the mortgage interest deduction is a clear win.

    I know it’s probably unpopular to say so, but, now that I’ve thought about it for a little while, I’m inclined to agree. I don’t know that it would be wise to pull the rug out from under people all at once, but it seems to me that we could do something where the deduction was phased out over a period of time, like five years. As Murph points out, though, it’s unlikely that voters will go for it, as it’s a popular deduction, especially when there are other fish to fry, like the reestablishment of the estate tax and the repeal of the Bush tax cuts for the super-rich, but I think it’s worth adding to the list of things that, in a perfect world, we’d eliminate in favor of deductions designed to encourage conservation, education and investment in our communities. I know the repeal of the deduction would likely mean less money in your pocket, but I’m curious as to what you think.

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      28 Comments

      1. Posted November 14, 2010 at 10:57 pm | Permalink

        Sorry guys, off the top of my head I have to disagree. We get f’d in the A come tax time, being DINKs. (And since we be spayed and neutered up in here, there are no little TeacherPattis on the horizon, which is just as well). I would hate to think of how awful it would be if this went away. I can probably be convinced (there are really only two subjects I won’t budge on–no charter schools/homeschooling and yes to stem cells) but as a gut reaction, I’m saying no….

      2. Peter Larson
        Posted November 15, 2010 at 4:01 am | Permalink

        I never understood it anyway. Why should the government pay the interest on a home loan?

      3. Mike Shecket
        Posted November 15, 2010 at 5:03 am | Permalink

        I disagree with TeacherPatti; as a TRONK I get totally P’d in the U while all my ZINOs get S’d in the G on the daily. Real talk.

      4. Taco Tom
        Posted November 15, 2010 at 7:19 am | Permalink

        Put me in the disagree column.
        Peter- Mortgage interest is an income deduction (not a tax credit.) The government is not “paying mortgage interest.” It lowers the amount of ones taxable income. In Michigan, renters actually receive a property tax credit calculated from the rent paid.
        Urban sprawl is fed by many things. Mortgage interest deduction, in my view is not one. Rather, the mortgage industry by overselling loans is more to blame here. In the 50′s, my parents were given a home loan with payments to not exceed a quarter of their income. Their bank held and serviced that mortgage for its full term. In the 70′s, I was told not to exceed a third of my income. After 5 years my loan was sold to another institution. Now, dual incomes are used in the calculation for amounts approaching one half of income. The mortgage is sold as fast as the paperwork can be processed. The originating institution has no accountability for the loan, which only leads to overselling to less qualified customers. Many folks were primed to default on their loans by being oversold. In a smaller house with lower payments, most would not have defaulted. The mortgage interest income deduction is one break (if not the only) the middle class taxpayer gets. Cap the deduction at a reasonable level, (say a $300,000 home) but don’t eliminate it.
        If you want to fight urban sprawl, start with gasoline tax. In my view, the proliferation of automobile use is the far larger culprit here. Tax gas guzzling vehicles, too.

      5. Peter Larson
        Posted November 15, 2010 at 8:12 am | Permalink

        Point taken. To be honest, I really don’t know the specifics of how it works, as I’ve never had a home loan.

      6. lorie thom
        Posted November 15, 2010 at 8:16 am | Permalink

        Put me in the agree column. And while we’re at it, go ahead a drop the kid deduction and all the rest of the tax loopholes, credits and social engineering stuff in the tax code. I know it sounds scary but really: 3 progressive tax brackets(4 counting no income tax), no loop holes – flat rates. OR…move to a value added tax on everything we buy/consume and end the game entirely.

        then if you want to,say, give incentives for solar panels – then give grants.

        less paperwork, less intrusive relationship with the government, reasonable revenue without the massive infrastructure…really, lets quit dinking around with it.

      7. Peter Larson
        Posted November 15, 2010 at 9:12 am | Permalink

        Not to belittle anyone, but I’ve often wondered why so many Americans have such a problem with the complexities of the tax code. It would seem to me, that the richest nation of the planet would require a complicated tax code.

        Malawi is the second poorest nation on the planet, and has an accordingly simple tax code. As it’s economy grows and diversifies, it is expected that the code will also grow in complexity (as it already is).

        For example, if I go to the hospital for a small cut, I would assume that the treatment would be quite simple. If I go for a brain tumor, I would assume that the treatment would include a litany of potential risks and benefits, and any options I would be presented would likely be tailored to my specific condition in order to maximize benefit, while minimizing risk. Any oversimplification of my brain treatment would put a large number of patients at incredible risk. Tax codes are no different. Complexity in economies requires a complex code.

        Really, I believe that most people shouting for a grand simplification of the tax code rarely itemize. In fact, I would wager that they often are able to take advantage of things like the EIC (as an example). An extremely rash simplification of the tax code, while nice to imagine for some, would have incredible consequences for all sectors of our economy.

        I feel that complexity scares the average American. One of the great consequences of the past ten years and the incredible availability of information, is that Americans finally realize exactly how complicated their country is, and it scares the shit out of them. I believe that this is largely what fuels the Tea Baggers.

        Enough rambling.

      8. Edward
        Posted November 15, 2010 at 9:36 am | Permalink

        Can someone explain to me why progressives are generally down on the idea of a flat tax on income? It seems to make sense. (Assuming all loopholes were removed.)

      9. lorie thom
        Posted November 15, 2010 at 9:49 am | Permalink

        @Edward, probably for a similar reason for a lack of flat pay rates per citizen.

      10. Steph's Dad
        Posted November 15, 2010 at 9:54 am | Permalink

        It’s long been thought that home ownership brought societal stability. It’s a huge oversimplification but people who own homes are less likely to riot. They also spend more, driving the economy forward. The paradigm is shifting though. We can no longer afford the sprawl. I like the idea of rolling back the deduction over five to ten years so that people can adjust. Or I know it would be unfair but you could grandfather people in who already own homes.

      11. T Tarkov
        Posted November 15, 2010 at 10:11 am | Permalink

        Does anyone know when the deduction was first suggested and why? Was there a specific issue that it was addressing?

      12. ytown
        Posted November 15, 2010 at 10:24 am | Permalink

        Peter, you are talking about Malawi’s tax structure? Seriously? This shows how out of touch you are. How about we eliminate the Mortgage credit and start taxing trailer owners and renters.

      13. Glen S.
        Posted November 15, 2010 at 10:30 am | Permalink

        Here’s a thought: Why not keep the mortgage interest deduction for homes built, bought or renovated in existing higher-density urban areas (where, frequently, populations have dropped below the practical threshold necessary to support existing infrastructure) — while dropping it (or phasing it out) for any new construction or major expansion in exurban or rural areas?

        Much like “Renaissance Zones,” which attempted to use the tax code to promote commercial/industrial development in blighted urban areas, this could be way to promote residential investment/stabilization.

        It it were done right, I’m guessing the savings from not having to build new roads, utilities and schools, etc. in outlying areas would more than make up for any lost tax revenue.

      14. TeacherPatti
        Posted November 15, 2010 at 10:45 am | Permalink

        Steph’s Dad makes a good point about ownership and stability. This of course is not to say that renters are not stable but I see the difference in myself between when I was buying and renting. Not that I was out in the streets setting couches on fire like Bubba after the ’84 Tigers win, but I definitely didn’t care as much. I also didn’t get as involved in my community because I was just “staying” someplace instead of “living” there. Again, I am not knocking renters at all, but I do think there is validity in that viewpoint.

        And second what Glen S. suggested…that’s a good idea.

        PS: Gosh I hope this was clear enough for Mike up there. I’m really concerned now and will never again use those esoteric acronyms like those that stand for dual income no kids!

      15. lorie thom
        Posted November 15, 2010 at 6:31 pm | Permalink

        @Stephs Dad: I thought it was just the people buying NEW homes/construction. Renters and older home owners redecorate at about the same rate.

        @Glenn: I see your point but I believe that this would be better handled through a grant process. Really, I don’t think our tax code is the place for any kind of social engineering or “incentives for doing good” – it becomes a game rather than solid policy.

      16. Posted November 15, 2010 at 8:36 pm | Permalink

        Here’s a good piece from the NYTimes magazine (in 2006!) that addresses a lot of the questions and myths about the interest deduction. The big parts, though, can be summed up snappily in the pullquote from The Atlantic: “Who benefits? Rich, coastal homeowners who took on lots of debt. Who doesn’t? Renters, low-income families, and folks who made big downpayments.”

        @TeacherPatti – your first comment sounds like it doesn’t really have anything to do with housing or mortgage interest, but you’re just looking for *a* deduction? So a plan that eliminates the mortgage interest deduction, but also lowers the tax rate would have the same effect for you.

        @T Tarkov – from the NYTimes article above and Kenneth Jackson’s Crabgrass Frontier (1985), the interest deduction dates to the Underwood-Simmons Tariff Act of 1913, when it addressed *all* interest, and was meant to encourage borrowing for business and industrial expansion – at that time, only about the top 1% of earners paid income tax anyways, and most people didn’t own houses (and most homeowners didn’t have mortgages). It wasn’t until the 1940s and ’50s that larger, longer-term mortgages became prevalent enough, and rising incomes combined with the war debt meant that more people were subject to income tax, that the interest deduction began to apply significantly to home mortgages. Over time, other types of interest began to be removed from the deductible category – credit card interest, for example, was deductible until the ’70s. As Jackson points out, the modern effect of the deduction is flipped from the original intent: where it was meant to incentivize business investment, it now encourages upgrading to a bigger house (and mortgage) over small business investment, especially in times of high inflation.

        @Steph’s Dad & TeacherPatti 2.0 – the “homeownership -> stability” issue is one we might debate, but don’t have to. The abovementioned sources – and adding in the Wall Street Journal from earlier this week all note that the deduction has a minimal effect, in actually boosting the homeownership rate – that most of the people who can actually benefit from it (people who make enough money and have enough deductions to itemize) would already own a home. While the deduction might encourage some people on the margin to buy a home where they might not otherwise, the primary effect is to encourage people already buying homes to buy bigger homes and take out bigger mortgages.

        @Taco Tom – I agree that charging more for gas would be a great way to reduce sprawl (as well as bring the price of driving closer to its actual cost), but that doesn’t mean eliminating the mortgage interest deduction is a bad idea. Just because it isn’t the only subsidy for sprawl doesn’t mean it isn’t contributing, and, as mentioned, there are plenty of other reasons not to like it.

      17. Posted November 15, 2010 at 9:47 pm | Permalink

        BTW, please don’t mistake my support for removing the mortgage interest deduction for an overall endorsement of the Commission chairs’ proposal. I can’t say that I’ve spent enough time looking at it to have a well-reasoned opinion on the whole.

        It’s just that the mortgage interest deduction has been so clearly bad policy for so long (note that I threw in the 5-year-old and 25-year-old sources in addition to the ones from this week), that I had to respond to Mark’s original callout of it.

        (Gut instinct on the overall proposal: the left is arguing that the balance of spending cuts and tax increases needs to be adjusted, while the right is arguing that the deficit needs to be addressed by spending cuts alone. If both were arguing about the mix, then I could assume the proposal was somewhere in the middle. Since the left is arguing for 40% of what they want, and the right is arguing for 100% of what they want, I’ll assume the proposal is probably starting skewed to the right.)

      18. Christine M.
        Posted November 16, 2010 at 1:11 pm | Permalink

        What the hell is and Ass Hook? Nevermind, I don’t want to know. This festival does sound really hilarious. Reminds me of the time I went to see “Sex and Zen” in Baltimore with my friend’s husband. That was weird.

      19. Posted November 16, 2010 at 2:15 pm | Permalink

        Either there’s some fantastic cross-thread comment drift going on, or else the federal deficit proposal has some pretty wild stuff in it.

        Christine, please tell me you’re talking about the deficit proposal?

      20. TeacherPatti
        Posted November 16, 2010 at 3:47 pm | Permalink

        Ha ha, I think that was supposed to go in the HUMP column :) Although including Ass Hook in the tax code might make it more readable???

      21. Kim
        Posted November 16, 2010 at 4:00 pm | Permalink

        I say we start referring to taxes as “ass hooks” from now on, at least here at MarkMaynard.com.

      22. Posted November 16, 2010 at 8:04 pm | Permalink

        Second what Kim said.

      23. Robert
        Posted November 17, 2010 at 4:04 pm | Permalink

        I saw a Tea Partier sign which read “Ass-Hooked Enough Already?”

        I didn’t understand it until just now.

      24. Posted November 17, 2010 at 6:45 pm | Permalink

        Tears tears of laughter. Though next time I get mad at my husband (or Mark Maynard) I am going to call him an ass hook.

      25. Posted November 17, 2010 at 9:04 pm | Permalink

        “Did you hear that City Council passed a 5% ass hook on festivals last night?”

      26. TeacherPatti
        Posted November 18, 2010 at 9:59 am | Permalink

        We need Cafe Press tshirts!

      27. ytown
        Posted November 18, 2010 at 1:05 pm | Permalink

        If you get rid of the mortgage deduction, then you’ll just have more rentals and less stability. Basically, all of Ypsi would look like it does around campus. Whoops, too late.

      28. PSL
        Posted September 20, 2011 at 4:14 am | Permalink

        If Obama were serious about shared sacrifice and the strategic future of our country, he’d do this as well.

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