The Mortgage Interest Deduction: A Better Way Forward
The Mortgage Interest Deduction (MID) should be drastically reformed. It is flawed in three major ways: 1) it does not significantly impact homeownership, 2) the amount of resources it allocates towards homeownership appears unjustified, and 3) it disrupts the accumulation of affordable housing by encouraging larger than needed homes. Hence, the MID is failing to effectively achieve its apparent goals of stimulating asset-accumulation and strengthening communities through homeownership, it is detracting from such aims by inefficiently allocating resources towards homeownership, and it is acting as a barrier to widely available affordable housing. To correct these flaws, the scope of the MID should be reduced, its structure altered, and savings obtained from such reforms should be allocated towards strategies that facilitate family savings and a greater supply of quality affordable housing.
The MID does not significantly impact home ownership.
A variety of empirical studies have found that the MID has little impact on homeownership. See Toder (2010). This result is no surprise given the MID’s structure – it primarily benefits wealthy individuals, who would likely purchase a home without the deduction. Only those that itemize their taxes can obtain the MID, and while 98% of those earning above $125,000 itemize, only 23% of those making less than $40,000 do so. Id. Furthermore, “the average value of the MID rises steadily with income from $91 for those with annual incomes less than $40,000 to $5,459 for those making more than $250,000.” Id.
The amount of resources the MID allocates towards homeownership does not appear to be justified.
In 2012, the MID will cost the federal Treasury about $131 billion – nearly three times the total annual expenditures of the Department of Housing and Urban Development. Id. Until recently, few questioned the wisdom of such an aggressive government strategy to encourage homeownership. Homeownership is often viewed as an effective means of asset-accumulation – it lifts people out of poverty and economic insecurity. However, our recent economic crisis has shown that, like most investments, housing is a risky investment. Of course, overall, housing may be less susceptible to losses than other forms of investment, such as the stock market or a business. But, investment in housing also prevents many families from being able to diversify, which limits their ability to shield themselves from risk. Furthermore, our recent crisis has illustrated that poor housing investments can paralyze the entire economy, compounding the risk of housing as an asset-accumulation strategy.
Many also cite various studies that have found correlations between homeownership and good citizenship to justify extensive government resources being allocated towards homeownership. However, such studies should be approached cautiously; they find correlation between good citizenship and homeownership, not causation. Homeownership might simply be correlated with good citizenship because wealthier people buy homes and such individuals have more time to devote towards their communities. Additionally, according to Glaeser (2011), homeownership may have deleterious effects on citizenship because homeowners typically live in single-family detached homes, which create distance between neighbors and higher costs of connecting with a community.
Given the uncertainty surrounding the soundness of housing as an asset-accumulation strategy and the mixed perspectives on the relationship between homeownership and citizenship, investing billions of dollars into homeownership through the MID appears unjustified.
The MID disrupts the accumulation of affordable housing by encouraging larger than needed housing units.
According to Glaeser (2011), the MID encourages excessively large housing units because people typically receive a bigger deduction when they buy a larger home. Because the MID mainly benefits the wealthy, these individuals in particular are being driven to purchase larger than needed homes. This has important implications for our nation’s supply of affordable housing.
As noted by Rosenfeld (2007), housing stock is usually passed down from the wealthy to those with lower incomes. Today’s luxurious homes are tomorrow’s affordable housing stock. But, if the wealthy are being encouraged to buy extremely large homes, this transition is less likely to occur. Large homes are expensive to maintain in terms of electricity, heating, and repair costs. In addition, home size is correlated with price so larger homes will likely always be more costly than similarly situated smaller homes. Thus, by encouraging larger homes, the MID is limiting the future supply of affordable housing.
Reforming the MID
Transform the MID into a refundable mortgage interest credit
The MID should be turned into a refundable mortgage interest credit that is only available to individuals earning less than $100,000 annually. The maximum credit allowable should be $1,490. A mortgage interest credit up to a maximum of $1,490 available to all individuals buying a home would cost the government the same amount as the current MID. Toder (2010). Hence, limiting the availability of the credit to those earning less than $100,000 will significantly decrease the costs of the MID. In addition, altering the deduction in this way will make it a more effective tool with respect to homeownership because its benefits will accrue to those on the margins between renting and owning rather to individuals that already have the desire and ability to buy a home. The MID will be transformed from a blunt instrument into a precise and efficient tool.
By turning the MID into a refundable mortgage interest credit for people earning less than $100,000, people “on the fence” about buying a home will have greater access to the financial benefits it provides. For example, someone making $30,000 who only pays a few hundred dollars a year in income taxes will be able to receive cash amounting to over a thousand dollars each year, depending on their mortgage interest payments, when they purchase a home. In contrast, under the current MID, they would receive at most, if they itemize, a few hundred dollars in tax breaks. Under this proposal, buying a home will be more financially feasible for such an individual and, therefore, she will be more likely to make the leap to homeownership.
In addition, adopting this reform would greatly mitigate the tendency of the MID to encourage excessively large housing units because the scope of benefits a homeowner could receive would be capped at a lower level and a much smaller segment of the population would have access to the MID.
Use savings from the restructuring of the MID to incentivize localities to make affordable housing more widely available and to develop programs that facilitate family savings
The federal government should use funds saved from the reform of the MID to award grant money to localities that alter their zoning regulations to allow more multi-family dwellings, see Glaeser (2011). In localities across the U.S., zoning regulations prevent the development of multi-family dwellings – housing that can accommodate middle and low-income individuals. This leads to the artificial limiting of the supply of affordable housing. In addition, such regulations contribute to the concentration of poverty, which poses an enormous obstacle to building strong communities. Hence, by incentivizing localities to alter their zoning regulations, the federal government can both strengthen communities and increase access to affordable housing.
The money saved from reforming the MID can also be used to create programs that facilitate family saving. For example, matching savings funds programs can be established for families below a certain income level. Such programs will help families accumulate assets, thus providing families with a viable option, other than investing in housing, for achieving financial stability.
Realtors, mortgage bankers, and homebuilders will likely react defensively to the this proposal because such individuals believe they greatly benefit from the present structure of the MID. Furthermore, many homeowners will be unhappy with the prospect of losing some of their current tax benefits. However, the first group’s opposition can be quelled by demonstrating to them that their client bases will be enhanced as a result of the proposals’ likely effect on homeownership, and the current disdain for massive government intervention into the housing market will limit the effectiveness of homeowner opposition.