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Bill Roper's Journal
That Mortgage Interest Deduction 
13th-Apr-2011 09:25 am
I keep hearing people say that the mortgage interest deduction subsidizes home owners. While that's no doubt true in one sense, it seems to me that it simply levels the playing field between home owners and renters.

If the Joe Corporation buys a house for rental purposes and takes out a loan to finance the purchase, JoeCorp gets to deduct the interest. If the interest is deductible on a rental property, why shouldn't it be deductible when you're buying your home?

In my heretical moments, I think that all consumer interest should be deductible. There's an economic stimulus that would hit a lot of people who need it the most.

The place where home owners clearly do receive a tax subsidy is with the capital gains exclusion on the sale of a home. Of course, some of those gains aren't real (especially now) -- they're simply inflationary gains over 30 years. You can also make a strong argument that all taxes on capital gains index the underlying asset to inflation.

But that's yet another discussion.
Comments 
13th-Apr-2011 02:50 pm (UTC) - Don't you remember?
Unsecured consumer debt did used to be deductable. Now it's only deductable if it's secured by your home loan. I think this had the effect of making people (with a choice) move other debts to home equity loans. To some degree this may have been responsible for the housing bubble.

--Robin (who considers the property in California a "tiger by the tail" situation)
13th-Apr-2011 04:05 pm (UTC) - Re: Don't you remember?
I was pretty sure that it used to be deductible and a bit of research says that changed in 1986.
13th-Apr-2011 04:57 pm (UTC) - Re: Don't you remember?

Mad Magazine once ran an article on a proposed TV show called "Tax Time, USA." It included a song which I remember in part:

You can deduct your doctor bills,
And the cost of all those pills,
And your auto license fees,
And your gifts to charities,
(Mumble),
Interest on your mortgage loan.

I don't recall the exact year, but it was probably from the late sixties or early seventies. Two out of five remain.

14th-Apr-2011 02:31 pm (UTC) - Re: Don't you remember?
I was pretty sure that it used to be deductible and a bit of research says that changed in 1986.

Yet another thing NOT to thank Regan for.
13th-Apr-2011 03:02 pm (UTC)
I don't think that credit card interest ought to be deductable. Maybe this is just reflexive moralizing on my part but I don't think going into debt for discretionary purposes is the sort of thing that ought to be encouraged.

Now frequently a *car* is necessary to be able to go to work (owing to mistakes in infrastructure that we will be a long time correcting if ever) so I could see a certain portion of car loan interest (that portion that would have been necessary for buying an inexpensive car) being deductible.

Regarding the inflation issue, I think the entire income tax system ought to be indexed for inflation, standard deduction and exemptions, tax percentage breakpoints, AMT and all. That would solve that problem for good instead of requiring periodic wrangling over rearrangements.

While I'm dreaming we could raise the tax on the highest income levels back to Clinton levels or even Reagan levels.

That would remove the thin excuse for destroying poor women's access to birth control by targeting Planned Parenthood.
13th-Apr-2011 03:20 pm (UTC)
One of the reasons an income tax is inherently bad is that it necessarily distorts the economy. What's "income"? Is interest which merely keeps up with inflation income? If you sell things, what part is income and what part cost of production? Is the time you put in a cost of production?

That's assuming we had a simple, flat tax. In practice, people want somebody else to be taxed, resulting in a horrendously complicated and arbitrary tax code. Different rates apply to different levels of income. Expenses that seem equivalent are treated differently.

I don't know anything about the tax treatment of rental property, so I can't address that. It seems logical that a house should be treated as a capital asset and so be subject to depreciation. I own my home free and clear (aside from a hefty condo fee) but can't depreciate it, and I have no mortgage interest to deduct. Is this fair? The term "fairness" just doesn't have any meaning in the tax system.
13th-Apr-2011 07:42 pm (UTC)
While it's true that JoeCorp can deduct the interest, Ron Renter has to pony up a profit to JoeCorp. That might be a wash against the mortgage interest bringing the advantage back to the home buyer.

Ron pays (Joe's) Principle + Interest + Profit
HB pays Principle + Interest.

If there was no mortgage interest deduction, the home buyer would be:
HB pays Principle + Interest + Tax.

If Tax is a similar number to Profit, then not having a deduction is the more level field.
13th-Apr-2011 07:57 pm (UTC)
Your equations don't balance -- obviously, the home builders and sellers make a profit, which HB pays. All else being equal, the "home builder" profit corresponds to a capital expense incurred by a rental property owner, and the "home seller" profit corresponds to the market profit made by renting out property.

In the long term, the two always balance: if they fall out of balance, the price of one option will rise relative to that of the other, causing people to shift to the less expensive option, causing prices to shift in response to the new demand patterns.



Edited at 2011-04-13 08:02 pm (UTC)
13th-Apr-2011 09:04 pm (UTC)
Sure the home builder made a profit, but since both home buyer and JoeCorp were buying, they both paid that profit to the builder and it's a wash.

You seem to be making the builder and the seller into two different things. They aren't really. In both cases they're simply the previous owner. It doesn't matter if there was one owner (the builder), or twenty. When the building is purchased by Joe, or HB, all previous liens, profits, interest, etc have to be closed out. They affect the selling price, but I assumed we were considering the two units to be basically similar, including the selling price.

The second part, not so much. It brings in a lot of other factors. For a simple example, it's probably not possible for a mere mortal to buy a home in Manhattan. Another one is that home purchase requires a larger up-front piece of change (or should, the recent muck up shows what happens when it doesn't). And deciding to purchase means a commitment to stay in one place. But you can add factors to no end. I was trying to stay to Bill's simple example and keep the variables to the ones he mentioned.
23rd-Apr-2011 04:54 pm (UTC)
I see your point. The deduction of mortgage interest for landlords clearly makes sense as a business expense, so why shouldn't homeowners have the same advantage?

On the other hand, why should the government subsidize home ownership? The deduction for mortgage interest on owner-occupied homes will cost the federal government about $104.5 billion in 2011. This tax break is regressive, primarily benefiting wealthier taxpayers. (The other day my barber and I were talking about politics. He asked me if I believe in redistribution of income. I should have said "No, I don't. I think the government should stop giving ever more money to the already wealthy.")

Subsidizing home ownership distorts the economy. Rational consumers choose which goods to consume based on utility and cost. Subsidizing home ownership, or any other good, encourages consumers to buy more of that good, for which they receive less utility than from other goods produced with the same economic effort. This effect is particularly dramatic for vacation homes, as a homeowner can only enjoy one home at a time.

Subsidizing home mortgage interest encourages more debt than is healthy either for borrowers or the economy. I think the burden of excess debt is the main reason the economy is operating below capacity and unemployment is so high. People are afraid to spend money because their mortgages are under water. Financial corporations are afraid to spend money because their loans have gone bad.

See Suzanne Mettler, "Reconstituting the Submerged State: The Challenges of Social Policy Reform in the Obama Era".
26th-Apr-2011 05:13 pm (UTC)
I'm commenting again, even though I expect at most one other person will ever read this, in order to clarify my own thoughts.

I left out the most important reason why the government subsidizes home ownership: to make it possible for more people to own their own homes, which most of the voting public wants, and which arguably benefits society by encouraging stable neighborhoods.

I left out another disadvantage of subsidies for home ownership: it creates increased demand for homes, thereby driving their prices up. (Most of the time. Not so much at present.) I left this one out because I thought there was some double counting involved: to the extent that home prices rise, the economic distortion I mentioned in my previous post diminishes. But on the other hand, as home prices rise, homes become harder for people to afford, which is the exact opposite of the intended effect of the subsidies.

I think the moral of the story is that public policy is hard. Any one argument, no matter how logical, is insufficient. Whether the home mortgage interest deduction, enacted in 1913 as part of the brand new income tax, was a good idea or not depends on all the advantages and disadvantages you and I have mentioned, and on how they have interacted over time.
26th-Apr-2011 08:42 pm (UTC)
Well, we'll see. I have another post that I'm planning to make on the subject. :)

I think that the home mortgage deduction simply levels the playing field between buyers and renters, all other things being equal. (They aren't. Most of them still tilt in favor of the renter -- only the capital gains exclusion on the sale of the house and the step up in basis of inherited assets benefit the buyer.)

I'll describe this in more detail later, but take two identical houses. BillCo buys one and rents it to Joe. JoeCo buys the other and rents it to Bill. Absent the mortgage interest deduction (assuming that both buyers took out a 90% mortgage on the property), renting to your neighbor turns out to be substantially tax-advantaged over buying your own place.

Edited at 2011-04-26 08:43 pm (UTC)
27th-Apr-2011 06:15 am (UTC) - We're both right
Yes, you are completely correct. But so am I. I don't think this is like a proof of a mathematical theorem, where one correct argument suffices. The mortgage interest deduction has numerous advantages and disadvantages, all of which must be weighed and balanced.

Suppose there were no mortgage interest deduction, and the federal government had an additional $104.5 billion to spend. (More or less, because the existence of this deduction affects the price of homes.) Would the highest use of this money be to give it to homeowners?
27th-Apr-2011 02:59 pm (UTC) - Re: We're both right
I think you're making the mistake of applying static analysis to the tax code. If you eliminated the mortgage interest deduction, you wouldn't gain anything like the full value of it, because you would convert home owners to home renters.
28th-Apr-2011 12:22 am (UTC) - Re: We're both right
Yes. That is one reason I said "more or less".

Again, we're both right.
14th-Jul-2011 08:47 pm (UTC) - An interesting post about the home mortgage interest deduction
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