Eliminate the Mortgage Interest Deduction Now

Shout Bits has argued that the Mortgage Interest Deduction is not so helpful to regular Americans, but with interest rates at historic lows, now is the time to eliminate this market distortion. Not only does the MID encourage buying unaffordable homes and promote market bubbles, the primary beneficiaries are wealthy individuals and large banks. Eliminating this deduction would actually help most ordinary homeowners.

For 2012, a couple filing jointly can claim an $11,900 standard deduction, even if they have no otherwise deductible expenses like mortgage interest. Therefore, the first $11,900 in mortgage interest paid by such a couple generates no tax savings for them. Today’s national average 30 year fixed mortgage coupon rate is 3.8%, which means that a mortgage smaller than $313k (11900/.038) generates no tax savings for a couple filing jointly. Now, a $300k mortgage is not unheard of, but it is clearly not for the struggling working class.

Since the first $313k of a mortgage balance is not deductible, the tax incentive is to borrow as much as possible. After all, Uncle Sam is kicking in about a third of the interest expense above $11,900. Further, the tax code discourages paying down mortgage balances, since as interest payments fall, so does that tax benefit. This perverse incentive leads to speculative bubbles which burst when incomes fall below the point where an income tax deduction is available. The MID certainly contributed to the real estate crash of 2008.

Worse still, a recent study by Andrew Hanson at Georgia State University concludes that the tax code’s reach into the mortgage market increases mortgage rates for modest homeowners. Mortgage lenders siphon off 9 to 17% of the government’s subsidy intended for homeowners (as much as $1.7bln per year) in the form of higher rates. Not only does the MID not benefit smaller borrowers at all, according to Prof. Hanson’s study, it costs them hundreds of dollars extra, even if they cannot take an interest deduction.

It is always wrong, corrupt, and perverting for the government to manipulate markets as it does with the MID, but now is the perfect storm of minimal benefits and maximum harm. Mortgage rates cannot fall much further due to structural cost limits, so the interest deduction benefit is nearly as small as it ever can be. Likewise, with tighter lending criteria, only the well-off can qualify for loans big enough to earn an interest deduction above $11,900.

With the Federal Government looking for ways to raise taxes, the very worst choice would be raise marginal rates. Instead, a flatter and broader based tax code is the answer that is more just and stable. Eliminating a deduction that only benefits the well-off, while harming modest borrowers and enriching big banks, is an obvious choice. The time is now.

3 thoughts on “Eliminate the Mortgage Interest Deduction Now

  1. Yeah…Just STFU.

    Millions of people have structured their finances around the deduction, deciding how much they can afford and how much they have to save and how many exemptions to claim. Now you want to go and screw it all up.

    People have to know what the costs are going to be going into a large purchase like a home. You can’t just change the rules in the middle of the game.

  2. There are many ways to address the disruption of eliminating targeted deductions from the tax code. The easiest would be to eliminate deductions from new mortgages but grandfather it for existing ones. Another would be to slowly reduce the allowable MID cap from the current $1MM to zero over 15 to 20 years.

    SB has argued the same for public employee pensions and Social Security. These programs are un-affordable and cannot survive as is, but is not fair to take the benefit away from people who were promised these benefits. Pensions and SS can be gradually converted to defined contribution plans without hurting the people too committed to them to change now.

  3. Many comments on other web sites pointed out a few possible flaws in this Shout Bits.
    1. Homeowners almost everywhere must pay property taxes, which are also deductible for many taxpayers. That cannot be separated from the MID, so fair enough, a mortgage less than $300k may benefit some taxpayers in high tax States.
    2. There are other deductions like charities. Same point, but consider the corrupt charities like Media Matters that benefit from this deduction.

    SB is categorically against personal income tax deductions because they distort markets, encourage uneconomic personal decisions, and they also promote government graft and corruption. Taxation is a necessary evil, but the best way to raise the necessary revenues is a flat tax with no itemized deductions (e.g. the flat tax that Steve Forbes proposed in the 1990′s).

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