Should We Dump the Home Mortgage Interest Deduction?

By :: May 27th, 2010

Do we want to use the tax code to subsidize home ownership? And, if we do, is the mortgage interest deduction the best way to do it? A new paper by my Tax Policy Center colleagues Eric Toder and Katherine Lim, along with Urban Institute researchers Margery Turner and Liza Getsinger, asks these provocative questions, and comes up with some surprising answers.

To even ask seems almost un-American—almost like suggesting we replace barbeque at the Memorial Day picnic with, oh, tofu. But a close look suggests there is much less to the hallowed deduction than meets the eye. Thus, we’d miss it much less than we think.

In 2012, the deduction will reduce federal revenues by $131 billion. In contrast, the entire budget for the Department of Housing and Urban Development is just $48 billion. The conventional wisdom says these tax breaks are important because A) they increase home ownership and B) homeowners are more engaged in their communities than renters.

It turns out that neither of these assumptions is necessarily true. For instance, for a half century--until the recent real estate boom and bust--home ownership rates in the U.S. have barely budged even though the value of the deduction has fluctuated widely. Similarly, there is no clear connection between home ownership and the availability of mortgage deductions in other countries.

The exact relationship between home ownership and other social benefits is just as uncertain. We know home owners are more connected to their communities than renters. But is that because they own a house, or is it merely that the same types of people who are engaged in their communities are also prone to home ownership? We don’t really know.

We do know, however, that the deduction is not a very efficient way to encourage home ownership. Most benefits go to high-income households that would probably buy a house with or without the deduction. Since non-itemizers get no benefit from the deduction, it is not surprising that most of the subsidy goes to upper-bracket taxpayers.

So is there a better way? The paper looks at a half-dozen alternatives, from eliminating the mortgage subsidy entirely to capping its value or turning it into a credit. Not surprisingly, each design has its own set of winners and losers.

To take one example: If the goal is to encourage homeownership among people who otherwise would not buy, what if we replaced the deduction with a credit? Remember that credits are usually a better deal for middle-income households. Simple example: A 20 percent credit on $1,000 of interest is worth $200 no matter what your tax bracket or whether you itemize. But a $1,000 deduction is worth $350 to someone in the 35 percent bracket but only $100 to an itemizer in the 10 percent bracket, and nothing to someone who takes the standard deduction ).

The paper looks at four different credits, each of which provides the same total subsidy amount as the current deduction. For instance, replacing the deduction with a non-refundable credit equal to 20 percent of interest payments would raise average after-tax incomes for households in the lowest 80 percent of the income distribution, with middle-income households getting the biggest average benefit. However, on average those in the top 20 percent would do less well with the credit than with today’s deduction. A non-refundable 100% credit capped at about $2,000 would benefit middle-income households even more but raise taxes more for people in the top 20 percent.   
Sadly, the study also explains why the deduction is likely to stay right where it is. The big winners under the current system are upper-middle-class suburbanites who disproportionately own homes, itemize deductions, and spend a relatively large share of their income on mortgage interest. And nobody wants to get them mad, either by cutting their housing subsidies or feeding them tofu.  


  1. Anonymous  ::  11:38 pm on May 27th, 2010:

    Of course we should can the home mortgage interest deduction. And I say this as a homeowner with a combined state/federal tax marginal tax rate of around 45% (in other words, I benefit heavily from this deduction).
    The government *should not* be in the business of declaring which lifestyle choices are to be favored by the populace. The home mortgage interest deduction is granted but one of many of these. But it's an important and expensive one, and one that distorts the decisions we make.

  2. Anonymous  ::  4:45 am on May 28th, 2010:

    Congress is not going to kick the real estate market when it's down. However once the Fed starts printing money to roll over government bonds, real estate prices will soar, even though interest rates will also increase. That will be the right time to repeal the mortgage interest deduction.

  3. Anonymous  ::  8:48 am on May 28th, 2010:

    The most common type of home loan is a fixed rate mortgage. This is a loan that carries a fixed rate for a set period of time, otherwise known as the term of the loan.
    mortgage information

  4. Anonymous  ::  11:33 am on May 28th, 2010:

    The home building and real estate lobbies are among the most powerful in D.C. Because they are the main beneficiaries of the mortgage interest deduction, this alone will almost assure that something like this never comes up for serious consideration.
    A few years back, a reputable study (I forget the source) posited that the only verifiable changes in home ownership attributable to the interest deduction as the ever larger size (average square footage) and higher prices of new homes. Given rising energy costs and stagnant wages, this would seem to be deadweight loss to the economy.
    Robert Fuller,
    Hopewell, NJ

  5. Anonymous  ::  12:32 pm on May 28th, 2010:

    The mortgage deduction doesn't work for an even simpler reason:
    The market for housing has already included the value of the deduction in the price of houses. Since people use the mortgage deduction to buy “more house” then they could otherwise afford, demand increases for “more house” and therefore the price of houses is forced up by the greater demand. (Basic Econ 101, supply and demand).
    The housing market has accounted for that since the mortgage interest deduction was “invented.”
    Getting rid of it would be hard, since it would tend to deflate home prices for a while.

  6. Anonymous  ::  1:01 pm on May 28th, 2010:

    What an intriguing idea…you know what? You first…let's make it voluntary. Because if it's such an important idea, it should be organic, not one of those cop out rejoinders that we need to 'share the pain' in some sort of ethereal karmic equity. So, any think tank thinker (and I know you're rich afnd have houses) that wants to abolish the mortgage interest deduction should go do a little math and file a few 1040Xs to volunteer that share of the cash that the government gave back for the MID…just bite down on the 'envy reflex' when I keep mine.

  7. Anonymous  ::  1:43 pm on May 28th, 2010:

    Two quick thoughts:
    — Home buying decisions are based rarely on economic calculations. It's very much an emotional purchase. I think that explains why the interest deduction hasn't impacted home ownership rates.
    — I'm happy to see the deduction disappear, but I think we should have a corresponding effort to bring down the transaction costs of buying and selling a home. Some argue we need to encourage renting because it keeps people mobile in a world where moving for the best job opportunity has become commonplace. I don't disagree but that doesn't mean we should give up on home ownership which may have some real benefits in terms of maintaining communities. Given the Internet's ability to list homes and provide recent pricing data, it's hard to understand why anyone should pay 6% to a listing agent. That's a lot of equity loss if someone is buying and selling within a few years. It might also be best for localities to increase property taxes while minimizing transfer taxes.

  8. Anonymous  ::  3:28 pm on May 28th, 2010:

    It should be done away with, but the best way to do it would be to phase it out for the top income earners or home values. It would be unfair to simply slap on these costs to even upper middle class homeowners.
    You could incrementally reduce the deduction down to zero for those that own homes above a certain percentage of the average median home value in that area. That would at least be a start, and perhaps then it would be good to convert the remaining deduction into a credit.

  9. Anonymous  ::  3:51 pm on May 28th, 2010:

    Of course we should eliminate the deduction for home mortgages. And, we should not replace the tax deduction with a tax credit.
    Once you net out all of the various effects (e.g., gross home prices and interest rates going up due to subsidy in the face of demand and overall tax rates going up due to loss of federal revenue), the “home owner's deduction” is revealed as a transfer tax that moves money from renters to financial firms. This has the ultimate effect of inhibiting, not supporting, home purchases by first-time buyers.
    Similar unexpected consequences occur with nearly all other special provisions in the tax code.
    A constitutional amendment that required taxation to be deployed for revenue generation and only for revenue generation (i.e., banning all social, political, or financial engineering through special tax provisions) would go a long way towards increasing transparency in government.
    If a special interest wanted government benefits, then Congress would have to pass a bill authorizing direct payments from the treasury for the desired amount of subsidy.
    This openness would make it much more difficult to generate political support for many subsidies (I don't want my tax dollars spent on that!) that now too easily slip through.
    Tax breaks are financially equivalent to direct government payments, but they are easier to hide. Let's ban these hidden payments and require Congress to openly and honestly vote for cash payouts to special interest groups.
    Then the voters could decide which of these payments are really justified.

  10. Anonymous  ::  5:34 pm on May 28th, 2010:

    Whether it's kept or dumped, the deduction should definitely not become a credit. Just imagine if there's a $2,000 credit. That equals the interest on a $40,000 loan at 5%. Within a year every single eligible home in America will have one of these “free” mortgages. It would end badly if the credit is later discontinued.
    Also, the suburbs are heaven on earth. It might be hard to tell from M St in DC, but there is plenty of land and cheap homes in America – you could get a vacation home bigger than your garret in Adams Morgan for about 50k in Florida right now. I've seen land in Texas for $10 an acre. Overall, this article is about as good an analysis as I would expect from a think tank on M St. Now K St, that's where you get the A grade material.

  11. Anonymous  ::  5:43 pm on May 28th, 2010:

    Of course we should dump the mortgage interest deduction. Since 40% of the populace pays not income tax, who cares. Government needs more money to continue the bail outs of banks, investment banks, casino mortgage and insurance companies, auto companies and the like. Enter the printing press and the taxpayer. Since Congress is not going to change the tax rates for hedge fund managers, or put a transaction tax on flash traing computer jocks, or even call into account the nonsense at AIG, pick on the group that has no lobbying clout – the middle class taxpayer. Have studies done by academia about progressive, regressive and flat tax options. Talk about social commitment etc. Blah blah blah – but be sure to intellectualize the remeoval of what little “tax subsidy” there is for the common working stiff. After all, it is his money that pays for healthcare, food stamps, subsidized housing, Pell grants etc. These are not “tax subsidies” they are ENTITLEMENTS. Wow – such a big difference. GET A CLUE!!
    Brian Paulson
    Littleton, CO

  12. Anonymous  ::  5:58 pm on May 28th, 2010:

    I completely agree. I currently use the interest deduction but think it should be abolished removed.
    I also don't think a credit should be used, rather use the money for paying down the debt (which we know won't happen) or reduce everyone's tax rate by an equal percentage. Obviously the $131 billion won't amount to much, but if everyone paid .5% less in taxes, we all benefit…and then start looking for other equivalent deductions that don't make sense.

  13. Anonymous  ::  6:43 pm on May 28th, 2010:

    We should absolutely dumpt the home mortgage and property tax deductions and the exemption for children and replace them with an expanded Child Tax Credit of $500 per month per child to be paid with salary, either as part of the personal income tax or the employer's business income tax. Note that because the big ticket item for most families is housing, this change will actually increase funds for the home building industry.

  14. Anonymous  ::  7:08 pm on May 28th, 2010:

    This is EXACTLY what the last Tax Reform Panel (under Bush) proposed. That proposal went nowhere, even though the real estate market crash had only just begun.
    As I said, if real estate prices triple or more due to money printing by the Fed (after the Chinese stop rolling over the T-bonds they own), we can get somewhere on this issue.
    Come to think of it, reform will occur by default. The mortgage interest deduction is capped at interest on $1M, not indexed in any way. If the average house price reaches $2M or more due to inflation, current law will phase in the reform Howard wants!

  15. Anonymous  ::  9:12 pm on May 28th, 2010:

    THOMAS JEFFERSON ~ January 1787 :
    “A little rebellion, now and then, is a good thing, as necessary in the political world as storms are in the physical”

  16. Anonymous  ::  9:12 pm on May 28th, 2010:

    THOMAS JEFFERSON ~ January 1789
    “Once the people are well informed, they can be trusted with their own government; that whenever things get so far wrong as to attract their notice, they may be relied on to set them to rights.”

  17. Anonymous  ::  9:56 pm on May 29th, 2010:

    ” The government *should not* be in the business of declaring which lifestyle choices are to be favored by the populace.”
    Its hard to disagree with this statement. Based on that, its hard to justify supporting the tax deductibility of charitable or work related expenses. Both are just as much a lifestye choice as having a mortgage. How much would that increase tax revenues?

  18. Anonymous  ::  12:59 am on May 30th, 2010:

    Until the government wishes to stop social engineering by using the tax code it will never happen.

  19. Anonymous  ::  6:53 pm on June 2nd, 2010:

    As mentioned, most middle class taxpayers do not itemize. Thus, this “middle-class” tax deduction goes primarily to the affluent who are more likely to itemize. However, the value of the deduction does get capitalized into higher home prices, making it more difficult for people of modest income to afford a home. For all these reasons, the home mortgage interest deduction should be limited and phased out. Those of us who understand this issue should speak out. Keeping silent (or being cynical about the likely success of special interests in maintaining this deduction) does not help politicians acquire the courage or the arguments necessary to make this happen.

  20. Anonymous  ::  6:18 am on June 3rd, 2010:

    By all means, eliminate it but don't stop there. Eliminate the infrastructure that supports it too. While we're at it, lets quit subsidizing population growth by allowing deductions for dependents.

  21. Anonymous  ::  4:00 pm on June 8th, 2010:

    Actually, if we stop subsidizing population growth, there is no need for government at all – or voluntary society. We will simply die off as a species.
    Private savings for retirement absent population growth is also a losing proposition, since without workers and customers for their work, owning stock is meaningless. You can't eat a stock certificate. You need people to grow and process food – and to eat it as well. Capitalism is as much of a Ponzi scheme as Social Security.

  22. Anonymous  ::  10:52 pm on July 20th, 2010:

    Thanks for this looks like a great article town planning jobs

  23. Anonymous  ::  8:29 pm on August 2nd, 2010:

    One thing I noticed was not addressed here is how the home mortgage deduction also effects the purchase of rental properties. If the deduction were removed, the number of rental units would fall in time harming those who need them. I would like to see how this plays into the question and if you have data on the subject.

  24. Anonymous  ::  4:19 am on August 3rd, 2010:

    I see people misusing incomplete information regarding this tax credit to actually purchase homes where they cannot afford the monthly payment. So while I agree that it helps the middle class suburbanites (I am one of them), I have seen it hurt people who think they will get a giant check back at tax time and live virtually rent free! After doing appraisals and comp checks for nearly ten years, it's the uninformed people who I worry about. If they don't like the way it works out for them, they just dump the house and go back to renting…mortgage crisis all over again.

  25. Anonymous  ::  5:14 am on August 28th, 2010:

    The writer of this article either has an agenda or is ignorant of economincs and finance as he leaves out major factors and issues that people should understand. The U.S. is in the worst economy it has seen since the great depression, and, in many ways, the worst ever. While the percentage of the working population that is unemployed in not as high as the Great Depression, the actual number of unemployed people far surpasses those unemployed in the 1930s as you population is so much greater. The value of a personal residence is dictated by the net cash the owner will be out of pocket. Buying allowing a deduction for mortgage interest, the value of a home is higher than if no deduction was allowed. If the mortgage interest deduction suddenly was removed, the net cash homeowners will be out of pocket increases by their marginal tax rate. Today, most homeowners (EXCEPT FOR THE VERY WEATHLY) rely on the mortgage interest deduction to be able to afford the out of pocket cash flow needed to pay their mortgages. Eliminating the mortgage interest deduction at this point only will accomplish few things: 1- Many people will no longer be able to afford their homes and the default and foreclosure rate on homes will increase dramatically. Default on mortgages and foreclosures already are the greatest they have every been in the history of the United States. The banking industry already is in major financial trouble. Elimination of the mortgage deduction would just exaserbate this situation. 2-July alone posted the largest decline in home sales in US history at 27%. The inventory of homes available for sale in US is at record highs. This, in turn, does two things. Since the supply of homes far surpasses demand, the value of homes continues to decline. As home values decline, more and more mortgages exceed the fair market value of the homes they encumber, which, in turn, increases the default and foreclosure rate. It creates a vicious downward spiral. 3- The real estate industry creates more jobs than almost any other industry in the United States. Real estate construction has already been hit dramatically creating millions of unemployed workers. As noted above, elimination of the mortgage interest deduction only would increase unemployment.
    I could go on and on. I wish people would educate themselves before reading and listening in ignorant people writing self righteous articles and then jumping on the bandwagon.

  26. Anonymous  ::  9:48 pm on September 8th, 2010:

    Why would anyone consider reducing the home mortgage interest tax deduction in a depressed real estate market. That is exactly the kind of response that reminds me of the 1930s tightening on the banks. Good thing someone learned a lesson from history. The economy and jobs are directly tied to the housing market. When home prices were going up, businesses did well and hired. People remodeled and took pride in their home. What is wrong with investing in America?
    Is $131 billion expensive in today’s spending environment? No, that is cheap compared to the $800 billion plus stimulus and plans that look like a stimulus; are supposed to act like a stimulus, but have other names. Imagine if we have spent $800 billion on the housing market, or even half. Suppose we have increased the home mortgage interest tax benefit through means of a tax credit. If we have spent only $393 billion on incentives for taxpayers to pay their mortgage, imagine the impact on those toxic mortgage assets. Increasing the benefit of paying the home mortgage would quickly revalue those assets and who would need a Toxic Asset Relief Program (TARP)? We wouldn’t even need to suffer through the failure of loan modification programs.
    For a proportion of the expenditures for the last two years, we could have had a rebound in the housing market, avoided much unemployment pain, and be much less straddled with debt. We would have a strong economy, generating tax revenue by now. When the housing market is over heated, as in the period 2005 – 2006, consider cooling techniques. When the housing market is cold, be wise and learn from history.

  27. Anonymous  ::  12:51 pm on September 17th, 2010:

    I really like the work that has gone into making the post. I will be sure to tell my blog buddies about your content keep up the good work. Thanks

  28. Anonymous  ::  12:34 am on October 26th, 2010:

    You have some semi-reasoned arguments (for a realtor), but you mainly point out that right now may be a bad time to remove the deduction. There are, however, very strong arguments as to whether taxpayers should subsidize this industry over the long term; I don't think we should. Housing should be an economic decision like any other economic decision: can I afford it at this price (without a government subsidy)?

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  31. Spiral Deduction Connection  ::  7:01 pm on January 18th, 2011:

    […] Should We Dump the Home Mortgage Interest Deduction – TaxVox Similarly, there is no clear connection between home ownership and the availability of mortgage deductions in other countries. The exact relationship between home ownership and other social benefits is just as uncertain. It creates a vicious downward spiral 3- The real estate industry creates more jobs than almost any other industry in the United States. Real estate construction has already been hit dramatically creating millions of unemployed workers. […]

  32. LPN  ::  12:42 pm on January 29th, 2011:

    Awesome post. I’ll be passing this post on for sure

  33. Giving The President His Due On Tax Reform « Poverty & Policy  ::  7:09 am on March 19th, 2011:

    […] Tax Policy Center puts the total cost of this year’s subsidy for home mortgage interest alone at $131 billion. […]

  34. wy  ::  5:15 pm on May 13th, 2011:

    Massive effective tx increase coming for the middle class!! – lifting the social security cap and removing mortgage interest deduction. 150K doens’t go far for a family in the Northeast paying NY or NJ taxes. Taking away the social security cap and removing mortgage interest deduction will result in thousands of dollars more taxes for this group.

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