Another Way to Fix the Mortgage Interest Deduction

Money and BankingOne of the biggest welfare programs in America is the mortgage interest deduction. People who are wealthy enough to purchase a house are given thousands of dollars every year to pay for that house. Of course, almost no one sees it as welfare because — like most welfare for the more affluent — it is designed to be invisible. We can’t have upper income people think they are getting welfare; that would be rude! So when I talk to people about the issue, they have a hard time seeing the reality of it. So let me provide a simple example.

Imagine you are I live next door to each other. We have identical lives: household size, income, the whole deal. But there is one difference: I own my home and you rent. As a result of this, I pay substantially less in taxes than you do. We both make $100,000 per year. My federal income tax bill is $20,000 and yours is $23,000. We have the same income and expenses. We should both be paying $23,000. So effectively, the government is sending me a check for $3,000. The mechanism by which this happens — giving me some of my tax money back as opposed decoupling it from the tax system — doesn’t matter in the least.

A couple of business professors, Stephen Cecchetti and Kermit Schoenholtz, wrote a paper, Why the Mortgage Interest Tax Deduction Should Disappear, but Won’t. They noted that economists don’t like the mortgage interest deduction. The main problem from an economic standpoint is that it distorts the natural flow of capital. By the government making home purchases cheaper, capital that would normally go to other parts of the economy gets diverted. But even more than that, the mortgage interest deduction increases inequality. Yet we are stuck with it for a number of reasons.

The biggest reason is that roughly 50 million households currently have mortgages and they are not keen to lose out on their welfare checks, even though they probably don’t think of them that way. But in addition to this, there are lots of people who feed on this: real estate agents, bankers, and home builders. And even more, getting rid of the mortgage interest deduction would cause house prices to fall — hurting every homeowner in the nation. According to Cecchetti and Schoenholtz, it would represent a loss of $4.1 trillion — comparable to the cost of the bursting of the housing bubble: $6.4 trillion.

But Cecchetti and Schoenholtz have a good idea for making the mortgage interest deduction less of a problem. They suggested putting a maximum mortgage value that one could deduct at $400,000. They noted that currently, 90% of US homes are worth less than $500,000. This would have the effect of reducing some of the bad economic signals with the deduction by not subsidizing vanity homes. But it would also make the deduction less inequality expanding by not allowing the government to subsidize more and more the richer the home buyer. The Center for Budget and Policy Priorities also has an idea for making the system better, Fixing the Unfair Mortgage Interest Deduction.

The point of all this is that something can be done to make the mortgage interest deduction more fair and less disruptive in the economy. But I doubt we are going to see much. Eventually, the government may see that there is a bunch of money to be had. We’ll see if that leads to improved policy. For me, I would just appreciate recipient of the mortgage interest deduction understanding that they are getting welfare.

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About Frank Moraes

Frank Moraes is a freelance writer and editor online and in print. He is educated as a scientist with a PhD in Atmospheric Physics. He has worked in climate science, remote sensing, throughout the computer industry, and as a college physics instructor. Find out more at About Frank Moraes.

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