11 Why the home mortgage interest deduction may not be good for us

The home mortgage interest deduction is probably the single most sacred provision in the Internal Revenue Code. I remember when, in 1986, Congress flirted briefly with the idea of repealing it. The secretaries at my law firm – normally an apolitical bunch – marched through the halls yelling revolutionary slogans. Congress backed down the next day.

So I’m taking a bit of a risk suggesting that the home mortgage interest deduction and other tax subsidies for home ownership may be a bad idea.

First, an important but nonobvious point. Economists agree that home buyers do not actually receive any net financial benefit from such subsidies. In the long run, home buyers would be just as well off financially if the subsidies were eliminated.

What!! How could this possibly be true?

Because home ownership is tax-advantaged, economists tell us that buyers are forced to pay more for homes than they otherwise would. Indeed, tax subsidies should cause housing prices to rise to the point where the new home buyer gets no net subsidy at all. Economists say that such subsidies are “internalized” in housing prices.

As a practical matter, what this means is that if tax subsidies for home ownership were eliminated, we’d all pay less for our housing – substantially less. More affordable homes. Lower home mortgages. Fewer financial eggs in a single basket. Less risk of financial catastrophe, either individual or nation-wide.

This, in turn, would mean that the cost of living in cities like Los Angeles, where I live, would be closer to the cost of living in Des Moines. Businesses would not have to pay so much to attract employees to southern California. Families that wanted to sell a home in one town and buy in another would find it cheaper, easier and less risky to do so.

There’s more.

Tax subsidies for home ownership (about $190 billion each year) drain capital from other sectors of the economy – probably substantially more than the amount of the subsidies themselves. Less capital for manufacturing, innovation, education – you name it. There is no such thing as a free lunch. More single-family dwellings necessarily mean less of everything else. Those who care about underinvestment in education, infrastructure and the like should therefore also care about tax-stimulated overinvestment in owner-occupied housing.

Importantly, such subsidies also drain capital out of the rental housing market. This means fewer apartments at higher rents, creating a double whammy for low-income Americans. The home mortgage interest deduction nominally benefits high-bracket taxpayers the most. It doesn’t benefit low-income taxpayers at all. And by draining capital from the rental housing market, it increases housing costs for those who have the hardest time getting by.

Tax subsidies for home ownership thus have a reverse Robin Hood effect, taking money from the poor and giving it to the better-off. But this extra money doesn’t actually help the better-off. They need it to pay the higher prices the market – having internalized those subsidies – demands for their homes. And then they’re locked in – stuck in expensive homes with expensive mortgages whenever the housing market craters, as it does at least once a decade.

But that’s not all.

The fact that our tax system is biased in favor of single-family dwellings and against apartments means that newer cities like Los Angeles and Houston, built largely since the income tax was enacted in the early 20th century, tend to be very spread out. This means that it takes forever to get anywhere. Because population densities are lower, mass transit is less viable. Families must typically own and drive at least two cars. (In Los Angeles, we even drive to the grocery store. This is not true in most European cities.) Commuting to work by bus or subway is the exception. Traffic jams are the norm, even with eight-lane freeways. Rush hour never ends.

And this means dirty air. It is no coincidence that Los Angeles and Houston, the largest American cities built since the income tax was enacted, have the worst air pollution – nitrogen oxides, carbon monoxide, carbon dioxide, particulates, ozone. Over 500,000 Americans die each year from cardiopulmonary problems. In effect, we’re breathing our own tax deductions. (Happily, we’re allowed to deduct the resulting medical expenses.)

Pollution is not the only resulting health problem. The fact that we drive everywhere means we get less exercise than we would in a higher-density city. We’re fatter and less fit. We no longer get our beta endorphins from ordinary living; we have to buy them at the gym. When we can’t, we seek happiness in less healthy ways. Our kids are increasingly obese. We drive forever to take them to soccer and then fret about air quality when they wheeze.

In the process, our carbon footprint grows ever larger. Today’s Los Angeles contributes far more to global warming than it would if it were more compactly designed. So we mandate costly additives to our gasoline to reduce pollution and propose tax incentives for alternative energy and higher gas taxes to persuade people to stop driving.

I am, of course, exaggerating – to some extent. Our ills have multiple causes. They are not all the result of Section 163(h)(2)(D) of the Internal Revenue Code.

But tax provisions intended to enable every American to own a separate home on a separate lot with a lawn and a garage and a swing in the front yard are not costless.

At the very least, we should think carefully about what the American Dream really is. If we’re not clear about what we really want, we’re unlikely to get it.

Comments

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Thanks for taking the time to explain mortgage interest deductions, it's certainly an area where people need to learn a lot more than they do now.

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great! thanks for sharing this info)
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[Bryce Mason]

All the interest deduction has served to do is (1) provide a boon to banks who can capitalize on the misunderstood belief that it's wise to spend a dollar (on interest) to save a quarter (on taxes), (2) provide the National Association of Realtors a marketing channel, and (3) serve to shift wealth to those who owned property prior to the law being implemented.

For the government caring so much about housing affordability, all their policies and rhetoric appear to be aimed squarely at propping house prices up at all costs. Any tax break on the mortgage interest deduction has now already been built into the sales price of the home.

Why should a mid-western farmer subsidize a California beach homeowner?

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