How Not to Fix the Housing Market

By :: May 16th, 2011

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.


  1. Steve Thompson  ::  11:32 am on May 16th, 2011:

    Here is a projection showing what is expected to happen to the real estate market in the United States over the next year:

    With the massive number of vacant homes either on the market or awaiting listing, it will be a long time before the American real estate market reaches balance between supply and demand.

  2. Michael Bindner  ::  1:38 pm on May 16th, 2011:

    Well done. I am not sure, however, that ending this deduction should go to reducing the deficit. There are reasons to be for higher income tax rates as a disincentive to pay CEOs and hedge fund manager way too much. Right now, income tax rates for that class are way too low and are a principal reason the middle class income only grows by the rate of inflation.

    Ending the deduction for interest and property taxes should instead pay for expanding the child tax credit to a refundable $500 per child per month – distributed with payroll as part of business rather than personal income taxation. Some families would grow, while existing families will likely improve their housing. Mature families would have a defacto pay cut – indeed all families and long-term workers would likely receive lower base pay under such a regime (net of credit) – but that makes such workers more competitive when compared with recent graduates.

    The housing sectors, however, would not be hurt by such a shift – although high end housing providers may have to lower their prices to their high end customers. Most likely, they will also be forced to build more affordable housing. That is not a bad thing.

  3. Michael Bindner  ::  1:44 pm on May 16th, 2011:

    Oh, the way to fix the housing market is to sell Fannie and Freddie’s inventories to the Federal Reserve at the underlying market values of the assets, letting the Fed order servicers to do principal reduction (which they are doing on their own MBS portfolio, but quietly), and then letting the Fed do an IPO in each Fed region for a Fannie and a Freddie at that level.

  4. Sid F  ::  1:57 pm on May 16th, 2011:

    This post illustrates a couple of points.

    1. As socio-economic characteristics of an economy change over time, the effectiveness and rationale of various economic policy decision also change over time. When the mortgage interest deduction was first introduced, the distribution of income in the U. S. was much narrower than it is today. As the distribution of income has shifted to the wealthy, the benefit of the MID has shifted to them.

    2. The debate over whether or not these types of deductions are “expenditures” is irrelevant, except for one possibly important exception in point 3. The MID is what it is. Whatever one calls it is not particularly important and invites ridicule (see Jon Stewart).

    3. Calling the MID an expenditure may give Republicans political cover to end it. After all, Republicans want to cut government expenditures, so if the MID is really an expenditure, reducing or eliminating it is consistent their policy goals. Of course, to adopt this thinking Republicans would have to be somewhat capable of self-deception, although that might be the case.

    4. The benefit of the deduction is even more skewed to the wealthy than the data would indicate. The full benefit of the MID is realized only if the taxpayer’s other itemized deductions would fully utilize the standard deduction. If not than the benefit is reduced by the marginal tax rate times the excess of the standard deduction over all other deductions other than the MID.

    In the example in this post, with a family in the 15% tax bracket and an interest deduction of $12,000 and a standard deduction of $11,400, if their other itemized deductions were only $8,400, the benefit would be 12,000 – $3,000 times 15%, or $1,350 instead of the $1,800 in the example.

    Unless the methodology which measures the benefits includes this aspect of the tax code, it will overstate the benefit of the MID to low and middle income taxpayers who itemize and take the MID. (You would think being part of the economics profession that they would understand analysis at the margin.)

    Finally, if the Grover Norquist’s of the world oppose an elimination of the subsidy for ethanol production because if would increase revenues and the size of government, it is hard to see how they would back elimination or modification of the MID.

  5. M. Volker  ::  3:39 pm on May 16th, 2011:

    This may come as news to you Mr. Williams, but the MID was not put in place as a special perk for the wealthy. You may also be too young to remember, or even ignorant to the fact that at one point, ALL interest paid was deductible – car loans, boat loans, credit-card interest, etc. I believe it was under Reagan that virtually all but the MID were removed when marginal rates were cut from 70% to 28% for top-earners. You should also attempt to appreciate the rationale for the MID at its inception, and still true today: “owners” of homes have a stake in their upkeep, the maintenance of safe environments, establishing and building a sense of community, and creating incentives to build value over time in an owned asset (often the most valuable investment people ever attain).

    If you want to go so far as to say that we should not use the tax code to incent ANY behaviors, I can get behind that. But you can’t stop at the MID. We have people with “negative” income taxes through the EIC; a screwed up AMT that limits deductions for things like the MID; education expense deductions; and more. Go with the Fair Tax, and I’m 100% with you.

    When you have 51% of American workers having no federal income tax liability at all, yet another article bemoaning “tax breaks for the rich” doesn’t cut it. Yes, that’s right – fewer than half the wage earners are paying ALL of the federal income taxes. The problem is spending, not revenue.

  6. Jon  ::  4:16 pm on May 16th, 2011:

    “The way to fix the housing market” was to allow for some form of cramdown bankruptcy when this whole thing started. But of course the Very Serious People don’t care on whit about actually keeping people in their houses, so any solution that actually did that, even if Pareto optimal for the market had to be rejected out of hand.

    Though it’s no solution because it’s politically impossible, this is probably still the most likely to succeed. Perhaps add Chapter 17 (to keep with the odd numbers) to Title 11 that allows some limited for of bankruptcy available only once that doesn’t discharge anything, and only modifies mortgages on primary residences.

    This, of course, won’t happen. But then, neither will ending the tax credit you talk about.

    Also, if the fact that this tax skews towards the wealthy is so important, you could always, you know, tax higher incomes more.

  7. Michael Bindner  ::  7:49 pm on May 16th, 2011:

    Fair Tax will never be passed, although components of it might be. A VAT would work to make individuals cognizent of their taxes, while a VAT-like Net Business Receipts Tax could replace most income tax payment while more effectively reducing the size of government – not by taxing government as a not-so hidden across the board spending cut but by allowing employers to provide services that government now supplies to families, young workers and retirees. Indeed, a high enough NBRT would be an essential replacement for the health care reform recently passed.

    Under no conception of reality is stopping higher income tax collections by a consumption tax in any way fair (or possible, given poll numbers on tax policy).

    While a NBRT might replace Social Security retirement, like most of the Fair Tax Proposal, it leaves too much government in place (indeed, it is idiotic to say you want a 30% de facto cut in government while forcing all tax expenditures into direct expenditure). It would be much easier to privates Social Security by shifting redistribution from payment to personal account accumulation by equalizing the employer contribution to the average (and possibly even shifting all contributions to employers), and investing the proceeds to company voting stock. That would have zero administrative costs. Much more libertarian.

    If you really want liberty, then the private sector must guarantee equality.

  8. Michael Bindner  ::  7:59 pm on May 16th, 2011:

    I think you have a typo. First, the total deductions would be $9000 over the standard deduction, so the real benefit would be 9000 x .15, which is $1350. That’s a $26 per week subsidy. Not too terribly much, unless its your $26.

    This is why what I propose below is a better deal.

  9. Michael Bindner  ::  8:00 pm on May 16th, 2011:

    There is more than one way to do this than cramdown. The Fed could buy up the Freddie and Fannie portfolios. Indeed, Geithner could use the revenue from this to avoid the debt ceiling for a bit.

  10. Michael Bindner  ::  8:35 am on May 17th, 2011:

    Oh, the reason a Net Business Receipts Tax is like Fair Tax is that it would be applicable to government and be the method by which public sector salaries would be reduced as personal income tax rates are reduced. The federal government would pay a PILT to states for taxes they would otherwise pay, although states might actually pay taxes. It all depends on how much reform leads to responsibility shifting. If an identical tax is collected at both levels, it is likely that the federal tax would go down somewhat in exchange for the elimination of aid to states, who would then raise their tax rates by an equal amount to fund education and TANF. To the extent that the NBRT has privatization mechanisms for these services, employers would take the deduction at the state level.

  11. Michael Bindner  ::  8:36 am on May 17th, 2011:

    The reason the NBRT is better than the Fair Tax is that it cuts government out of the loop to a large extent. Fair Tax still forces everything through government hands.

  12. What’s the Future of the Mortgage-Interest Deduction? |  ::  4:09 pm on May 18th, 2011:

    […] give plenty of reasons to dislike it (see below). They say it unfairly benefits wealthy homeowners (even mortgage interest on second homes can be deducted) and is far too […]

  13. What’s the Future of the Mortgage-Interest Deduction? | Loan Finder  ::  8:14 pm on May 18th, 2011:

    […] give plenty of reasons to dislike it (see below). They say it unfairly benefits wealthy homeowners (even mortgage interest on second homes can be deducted) and is far too […]

  14. Alfreda Weiss  ::  10:08 am on May 22nd, 2011:

    Amazing to me that after the crime spree based on arrogance, ignorance and greed on Wall Street that destroyed our housing market, we are talking about the mortgage interest deduction. My son lives in a house that at its peak was $700,000 that now would barely bring $300,000, but he still pays a mortgage of $500,000 while he suffers through a job that has almost disappeared due to the economy. This is Sacramento of today. He bought the home because in San Francisco his payments on his small rental flat were equal to his mortgage payments in Sacramento factoring in the mortgage deduction. Perhaps 7 trillion dollars has been lost in equity due to this disaster. It is not time for little people to give up their mortgage interest deduction. Sacramento will be a rental market for many years with only fat cat investors able to buy the massive numbers of foreclosures for 10 cents on the dollar. Buying a home for the middle class has been a good idea for a long time and maybe we can return to that in the future without destroying every little thing that helped those who are not wealthy. Yes, I think my son should walk away from the money pit he lives in, but where would he go?

  15. Mike  ::  9:03 pm on July 31st, 2011:

    Or, you can let me people purchase homes on the assumption that there’s a mortgage deduction and then pull the rug out from under them Mr. Williams. You can feel good about taxing those “rich” people while simultaneously running them out of their home. Some of the problems with our tax codes which Williams (conveniently) ignores:
    1. We don’t tax wealth, we tax income. You probably spent your entire working life building up to your current income level. That’s not success in the minds of Democrats, that’s wealth; prepare to be taxed you bad rich person!(?)
    2. We tax income independent of cost of living. If you live in a high cost area your employer probably pays you more money. If he didn’t, you’d probably look elsewhere for a job. Unfortunately, income tax only looks at gross, not net income (gross minus cost of living). So in the minds of Democrats you will likelier count as wealthy. And that means Democrats (out of some cookie-cutter definition of “fair”) would like to add some additional taxes to your cost of living. Now Williams would like to deny you a tax credit that makes the home you own unaffordable too, oh well. By his determination you were too well off anyways. He has a way to fix that for you, you bad rich person.

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