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Study: Tax subsidies like the mortgage interest deduction have ‘zero effect on homeownership’
If you had told me in 2007 that the United States would suffer a cataclysmic housing market collapse, I might have guessed that at some point there would be a big public discussion and rethink about the role of housing the US economy.
For instance: What is the true value of the mortgage interest deduction, a roughly $100 billion-a-year subsidy for home ownership? Is that the best use of that dough given the wide variety of US economic challenges? Does the deduction boost home ownership and thus support various “positive externalities” such as more connected communities and better maintained properties? (Another question: Is the high cost of housing in high productivity cities hurting the American economy?)
This debate really hasn’t happened outside Washington wonkdom. The Trump administration has already stated that tax reform doesn’t mean changing the deductibility of mortgage interest. (That, after apparently toying with the idea.)
But it should! More evidence for this comes in a new working paper “Do People Respond to the Mortage Interest Deduction? Quasi-Experimental Evidence from Denmark” by Jonathan Gruber, Amalie Jensen, and Henrik Kleven. The researchers examined the issue via a natural experiment of sorts thanks to how Denmark in the 1980s slashed the mortgage deduction for wealthy taxpayers. (Far less so or not at all for lower-income homeowners.)
From the paper:
Across the world, investments in owner-occupied housing are heavily subsidized through the tax system and various other policies. In countries such as the U.S., the largest subsidy comes from the deductability of mortgage interest payments combined with the absence of a tax on the imputed rents. While these subsidies have been motivated by the possibility of positive externalities from owning, there is no conclusive evidence on the existence of such externalities.
As a result, many economists argue that the current policy regime leads to overinvestments in housing as well as excessive borrowing by homeowners. Furthermore, the subsidy is inequitable, because higher-income households tend to own more housing and therefore benefit more from the subsidy.16 Despite having debated the mortgage interest deduction for decades, we have relatively little evidence on the impact of this policy on real housing demand and none that live up to the current empirical standards in the empirical literature….
We present three main findings. First, the mortgage deduction has a precisely estimated zero effect on homeownership. This holds even in the very long run. Second, the mortgage deduction has a sizeable impact on housing demand at the intensive margin, inducing homeowners to buy larger and more expensive houses. Third, the largest effect of the mortgage deduction is on household financial decisions, inducing them to increase indebtedness. These findings suggest that the mortgage interest deduction distorts the behavior of homeowners at the intensive margin, but is ineffective at promoting homeownership at the extensive margin and any externalities that may be associated with it.
Homeownership is good to a point, but should we be subsidizing large and more expensive homes? Hmm. Apparently we are only getting more of that latter.
Obviously the chances of big change here are small. But there is a way forward. My AEI colleague Alan Viard has proposed replacing the mortgage interest deduction with a 15 percent refundable credit, one available to all homeowners, including those who claim the standard deduction and those with no income tax liability. The credit would be limited to interest on $300,000 of mortgage debt (in 2013 dollars), with no tax relief for mortgages on second homes or on home-equity loans.
As he notes, “the current tax treatment is more geared toward the latter objective, offering the largest benefits to taxpayers in the highest brackets and providing more-generous treatment to taxpayers who itemize than to those who claim the standard deductions. Indeed, the current tax policy may actually impede homeownership for taxpayers of more modest means because the preferences for high-bracket itemizers drive up the demand for homes and boost home prices.”