How Not to Fix the Housing Market
The American housing market is in trouble. Prices continue to fall, many would-be buyers can’t qualify for mortgages, sales remain sluggish, and the backlog of potential foreclosures continues to grow. The benefits of the temporary tax credits offered in 2009 and 2010 have long since worn off. Meanwhile Congress is working to revamp Fannie Mae and Freddie Mac while the FHA gets tougher and tougher on new borrowers.
Housing clearly needs another boost and I have just the ticket.
Let’s use Fannie and Freddie to deliver direct cash payments to buyers when they first take out mortgages and then send them checks each year until they pay off their loans. To boost demand as much as possible, let’s give the most money to rich people who buy the biggest houses.
After all, because jumbo mortgages have higher interest rates, giving bigger subsidies to people who buy the biggest houses in the most expensive markets makes sense. To really encourage people to borrow the most they can, let’s pay 35 percent of the mortgage interest for the highest-income homebuyers but only, say, 10 or 15 percent for moderate-income people who borrow less.
Of course, if you happen to live in a place that has cheap housing and low property taxes, you won’t need any subsidy so we won’t give you one.
It may sound kind of crazy, maybe even totally misguided, but it just might work.
Oh, wait a minute—we already have a subsidy like that: the good old mortgage interest deduction. If you have enough deductible expenses to itemize, the federal government effectively pays part of your mortgage. And the bigger your loan and the more you earn, the more interest the government pays. Take a hedge fund manager making $1 million a year and paying $50,000 in annual interest. The government pays 35 percent of that interest, a very nice $17,500. Meanwhile, a married couple holding down retail-sector jobs that pay a combined $60,000 gets just 15 percent of their $12,000 interest paid—$1,800. TPC projects that in 2015, more than 60 percent of the deduction’s benefits will go to those in the top 20 percent of the income distribution and more than a third of that to those in the top 5 percent. The Joint Committee on Taxation estimates that the deduction cuts federal revenues by nearly $100 billion each year.
As a spending program, the whole thing sounds stupid. Who would design a program that subsidizes consumption of the wealthy many times more than everyone else? Why should the government pay you more for buying a bigger house? And even if there are good reasons to encourage homeownership (a debatable proposition), there’s little evidence that our current tax subsidies have increased the percentage of people who own homes.
As Congress looks for ways to close the nation’s budget deficit, it makes a lot of sense to focus on ridding the tax code of its many subsidies, as both the president’s fiscal commission and the Bipartisan Policy Center suggested last year. Tax expenditures reduce federal revenues by more than $1 trillion every year, sometimes sensibly but sometimes in ways that defy common sense, as in the case of the mortgage interest deduction. Slim down or get rid of the bad ones and we could lower tax rates and still raise more revenue.
As for the mortgage interest deduction, scrapping it overnight could seriously damage the already weak housing market. Current homeowners already near mortgage default could tip over the edge. Homeownership costs net of taxes would jump, putting the opportunity out of reach for many Americans. But Congress could phase the deduction down or replace it with a more equitably distributed tax credit and thus improve the tax code over time without doing great damage to the housing market. (TPC has estimated the distributional effects of a range of alternatives.)
When you describe the mortgage deduction as the spending program it is, it sounds really foolish. If more people saw it that way, it should be really easy to persuade them that we really need to reform this subsidy.