Mortgage interest deductibility

Given the odd rumbling in Ottawa that the feds might make mortgage interest deductible from income tax, this article from the New York Times provides some interesting background on the origins of this deduction in the US, the impacts it has had, and the current state of play. The full article is rather lengthy; this excerpt captures some of the pertinent information for a Canadian audience:

Over the years, [mortgage interest deductibility] has become an American folk legend: the government invented the mortgage-interest deduction to help people buy their own homes, and the level of homeownership has risen ever since.

What part of the legend is true? Basically, none of it.

Economists don’t agree on much, but they do agree on this: the interest deduction doesn’t do a thing for homeownership rates. If you eliminated the deduction tomorrow, America would have the same number of homeowners, the same social networks, the same number of gardens.

The deduction might help some people (like me) to purchase bigger homes than they otherwise would. And it certainly helps people who are selling mansions to get a higher price. But it is hardly the democratic subsidy people think. In fact, it’s patently regressive.

More than 70 percent of tax filers don’t get any benefit from the deduction at all. O.K., many of them are renters. But even among homeowners, only about half claim the deduction. And for the 37 million individuals and couples who do, the rewards, at least on average, are surprisingly modest — just under $2,000 per return. (Figure it like this: the median home, as computed by the Bureau of the Census in 2003, is valued at $140,000. If you finance 80 percent of it with a 6 percent mortgage, your interest bill is $6,720 a year. A taxpayer in the 25 percent bracket would save one quarter, or $1,680.)

But cumulatively, the deduction is a big deal. This year, it is expected to cost the Treasury $76 billion. And the rewards are greatly skewed in favor of the moderately to the conspicuously rich. On a million-dollar mortgage (the people with those really need help, right?), the tax benefit is worth approximately $21,000 a year. And according to the Joint Committee on Taxation, a little over half of the benefit is taken by just 12 percent of taxpayers, or those with incomes of $100,000 or more.

This is a social policy? It’s hard to imagine that Congress would intentionally legislate such a rich-get-richer handout, but the origins of the deduction are so obscure that the myth about it persists. David Lereah, chief economist for the National Association of Realtors, explained the history of the deduction by observing matter-of-factly: “Homeownership is something this country desires. If you read the tax codes over the last 100 years, you’ll see the favoring of the housing sector and all the reasons Congress was giving for it.” Congress has indeed done plenty of things over the years to support homeownership, but the deduction wasn’t one of them. That mole in the Treasury Department who invented the deduction so I could buy a house — he never existed. In fact, as Steven Bourassa, of the University of Louisville, and William Grigsby, at the University of Pennsylvania, wrote in “Housing Policy Debate,” a Fannie Mae publication, the mortgage deduction “was largely accidental.”

… In 1913, … a new income tax was enacted … [and] interest was deductible. There is no evidence, however, that Congress thought much about this provision. It certainly wasn’t thinking of the interest deduction as a stepping-stone to middle-class homeownership, because the tax excluded the first $3,000 (or for married couples, $4,000) of income; less than 1 percent of the population earned more than that. The people paying taxes — Andrew Carnegie and such — did not need the deduction to afford their homes or their yachts.

There is another reason Congress could not have had homeownership in mind. The great majority of people who owned a home did not have a mortgage. The exceptions were farmers. But most folks bought their homes with cash; they had no mortgage interest to deduct.

When Congress made interest deductible, it was probably thinking of business interest. Just as today, the aim was to tax a business’s profits after expenses had been netted out, and interest was an expense like any other. … It was not until the 1920’s and the spread of the automobile that home mortgages outnumbered farm mortgages. In the 1930’s, the mortgage industry got a huge assist from the feds — not from the tax deduction, but from agencies like the Federal Housing Administration, which insured 30-year loans, and, over time, the newly created Federal National Mortgage Association, or Fannie Mae. …

By the time the G.I.’s returned from World War II, bursting with dreams of homeownership, the mortgage industry was ready for them. It wasn’t until after 1950 that the majority of homeowners had mortgages. And thanks to this ready financing, renters suddenly became owners. After hovering around 45 percent for the first half of the 20th century, the proportion of owner-occupied homes soared. By 1960, 62 percent of Americans owned their homes. (Today, the figure is only slightly higher: 69 percent.)

Of course, it was in those postwar years, when people were getting their first mortgages and also their first homes, that Americans discovered the joy of the interest deduction. Over time, it evolved into a birthright — almost like owning a home itself. Perhaps it was that confluence of trends that led people to suppose, as Daniel Gross did last year in the online journal Slate, that the U.S.’s “enviably high rate of homeownership” is a product of the deduction. But the existence of credit was a much greater catalyst than the longstanding ability to deduct it. Homeowners who genuflect to the deduction should probably be giving their thanks to mortgage bankers instead.

… [H]omeownership in the U.S. is about the same as it is in Canada, Australia and England, where interest isn’t deductible. … Research suggests that without the deduction, people would still buy the houses they do now; they would just cost a little less. In effect, the market would adjust downward to reflect some of the decrease in buyers’ purchasing power. Though no one knows, a plausible estimate is that prices at the upper end of the housing spectrum would fall by 10 to 15 percent. Prices of less expensive houses would probably rise a bit, because people who don’t get a break now would get the tax credit and thus could spend a little more.

One comment

  • There’s rumblings about this in Ottawa? Seriously? Gah. Would this be on top of the principal residence exemption? Double gah.

    Just what the inflated property market needs is a demand stimulus! So what you get is an even bigger windfall for owners at the expense of future buyers. Terrific. Why would there not be a similar deduction for rent? Conservative social engineering anyone?

    However, if home equity were treated as cap gains (ie no principal residence exemption) perhaps that’s fairer. Many folks have been making 10s of thousands of tax free dollars over the past few years in the form of windfall equity (unintentional rent seeking) — which money ultimately comes from the incomes of future buyers. Why not tax it?

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