An Indefensible Tax Deduction
If and when the U.S. Congress ever gets around to giving serious attention to comprehensive tax reform, it ought to reconsider the deduction for mortgage interest. A new study suggests this quirk of the tax code makes even less sense than previously thought.
The U.S. isn't alone in allowing some kind of tax deduction for mortgage interest -- many countries do, though the American version is unusually generous. And the stated reason for this preferential treatment is the same everywhere: It promotes homeownership, which in turn is believed to encourage people to take a bigger stake in their community.
The new research, the first of its kind, shows that the deduction doesn't do that. Examining Denmark's reform of the mortgage-interest deduction in the 1980s, the study shows that a sharp cut in the preference for top-rate taxpayers (with smaller changes for other taxpayers) had a "precisely estimated zero effect" on homeownership, even in the very long run. The deduction encouraged people to live in bigger houses and borrow more, but that's all.
Up to now, the question has presented a trade-off -- more homeownership on the one hand against the admitted drawbacks of the deduction on the other. Those drawbacks are already numerous: For a start, the deduction is very regressive, as it is worth more to high-rate taxpayers than low-rate taxpayers. It also shifts tax from owners to renters, and from owners of expensive properties to owners of modestly priced properties.
In addition, it can worsen financial instability by encouraging overborrowing. Recall that the recession of 2008, cause of untold harm to millions of households, started in the U.S. housing market. In hindsight, perhaps a generous taxpayer subsidy to over-extended borrowers is ill-advised. In all, then, there'd be a solid case for limiting and preferably abolishing the mortgage-interest deduction even if it did what it was supposed to. But it doesn't.
Needless to say, there'll be political resistance to removing this tax break -- as there would be for any other multi-billion-dollar subsidy of dubious value. Yet it can be done: Denmark did it, and so did Britain, where the idea was initially seen as impossible. Maybe the U.S. can follow suit -- especially now that it's clear that this defect of the tax system no longer has a leg to stand on.
--Editors: Clive Crook, Michael Newman.
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