Two months ago, the Center for Budget and Policy Priorities (CBPP) released an amazing report, Mortgage Interest Deduction Is Ripe for Reform. It argues that the mortgage interest deduction is a bad way to encourage home ownership. Now, this is the kind of talk that normally makes home owners freak out. And with good reason! Although we can trust CBPP, it usually seems that whenever the government “reforms” the tax code it means that middle class people end up paying more.
The idea is a good one, however. And it could, if we the people hold our elected officials accountable, work out really well. Currently, the mortgage interest deduction is a $70 billion per year program. That’s quite a lot of money. It is more, for example, than the amount of money raised in new taxes from the Fiscal Cliff deal. Of course, no one is talking about getting rid of this homeowners’ subsidy, so we aren’t talking about saving all of the $70 billion, but there is still a lot that we could save.
There is something that most people don’t have a good grasp of: tax deductions are no different than welfare programs. There is no difference between allowing some people preferential tax rates and just handing them checks. Sure: homeowners think this deduction is God given, but it is anything but. It is a policy choice. In other countries, it is done differently. France doesn’t allow interest to be deducted at all. The Netherlands allows all interest to be deducted, but property values are added to taxable income. And in India, they limit the amount of interest.
What most surprised me is how non-egalitarian the mortgage interest deduction is. A shocking 77% of it goes to homeowners with more than $100,000 in income per year. So effectively, we are subsidizing the wealthy to buy very expensive houses. As I reported earlier today, Fred Thompson’s primary residence was worth over $3 million. And good for him! I just don’t think that it is a government interest to subsidize his rich lifestyle. This graph provides a good overview of homeowner needs and where we actually put resources:
CPBB suggests replacing the mortgage interest deduction with a mortgage interest credit. It would be better focused on the needs of homeowners. What’s more, it would actually help more people to buy homes than the current system because it would be better focused on the middle classes rather than the upper class. But since it would be helping just as many or more homeowners, the change would not hurt the construction industry. (It might hurt contractors who focus on very high end homes, but even that is not certain.)
Our tax system is a mess. It is extremely unfair in most ways. The marginal rates are just the tip of the iceberg. Reforming the mortgage interest deduction would be an excellent change in the right direct. I recommend going over and reading the whole CBPP summary proposal. There is a lot more than I’ve mentioned here.