The Mortgage Interest Deduction is Not the Holy Grail

The Mortgage Interest Deduction is Not the Holy Grail


The issue of home ownership can be emotional. Home ownership has been tied to wealth creation, community and family stability, and economic development for so long that these benefits are etched seemingly permanently in our national creed.

Along with the aforementioned benefits is the financial benefit of the mortgage interest deduction. The mortgage interest deduction is viewed by some as important to achieving the social policy of home ownership. Allowing homeowners to deduct their interest payments on loans provides the incentive for some buyers to enter into the market and buy a piece of the American Dream. That’s been the argument we have been hearing from our parents, other family members, and friends for years and around sixty percent of the population has bought into it.

I always thought that home ownership was about living in a physical space with the comfort of knowing that the keys jiggling outside your door don’t belong to a nosey landlord dropping by to do a maintenance check or to that roommate you had to take in for financial reasons. It’s amusing to me that the federal government wants to pursue social policy that promotes an atmosphere where one can enjoy peace and quiet of their physical space without worrying about the landlord dropping by unannounced. It’s also amusing that the federal government is willing to subsidize our interest in having our own little front yards where we can practice putting golf balls or a private driveway where the kids can dream of being LeBron James while shooting hoops.

What’s not amusing is that the cost of this government tax expenditure i.e. revenues that the government decides not to collect, can cost the U.S. government approximately $100 billion. That’s just less than one-tenth of the federal deficit. What’s even more amusing is that the federal government never meant to subsidize home ownership in the first place; that the mortgage interest deduction was merely “the last man standing” after Congress decided to get rid of a number of deductions, leaving the holy grail of mortgage interest deductions intact.

You see, back in 1913 when the U.S. Constitution was amended to authorize collection of a federal income tax (feeling Wesley Snipes right now), all loan interest was deductible. The government never specifically articulated a social policy of encouraging home ownership via tax policy. If you owned a home back then, more than likely you owned it outright because you paid cash for it. In addition, although many Americans had moved off the farm, income generated from farming and from small businesses was still prevalent. The interest tax deduction was offered in order to encourage production. If you borrowed money for the purpose of investing it into an income generating activity, the government supported you by allowing you to right off the interest on your loan.

As the economy changed with increased industrialization and urbanization, Americans began financing more consumer items, such as automobiles (thank you Henry Ford) and houses (gotta love that post-World War II G.I. Bill). The nation could afford in the 1950s and 1960s to invest in these tax expenditures, but the realities of budget deficits in the 1970s and 1980s forced politicians to take a closer look at tax expenditures with a decision to get rid of some of them.

So soon after buying my first car in 1986, Congress decided to eliminate the tax deduction for interest on automobile loans (bummer), but house owners got to keep the mortgage interest deduction. The deduction, by then, had become a selling point for real estate agents in need of commissions and housing developers in need of getting rid of inventory.

Compounding the sales pitch were the Clinton and Bush II administrations. The policy out of both camps, particularly the Bush camp, was that home ownership, to bite a little bit on Larry Kudlow, was the best path to prosperity. Home ownership was to be the lynchpin of Mr. Bush’s ownership society, so real estate agents and land developers were no doubt grateful for the federal government’s complicity in their sales promos.

The Obama Administration has gone one step further by tying the salvation of the macro economy to the salvation of the individual home owner by instituting a policy that incentivizes banks to renegotiate mortgages with home owners threatened by the possibility of foreclosure. It would be antithetical for this Administration to offer the mortgage interest deduction on the altar of the fiscal cliff.

The problem with tying the mortgage interest deduction to the macro economy is showing a link between the deduction and national output. I would argue that there is no connection, and for that reason alone, we should get rid of the deduction.

First, a house is “consumed” by an end user. Houses are not used as an asset in the generation of revenue and income. Most homeowners use them to sleep and raise families in.

Second, the deduction takes approximately $100 billion in tax revenues out of the government’s hands; revenues that could be used for contracting out the overdue construction of infrastructure, an activity that creates jobs.

Third, while a significant number of consumers consider the tax write-off as a benefit for buying a home, that is not the driving or primary reason. The primary reasons are stability, family, and the social status that comes from stability and family.

Fourth, the housing market is driven by price, supply, and demand. In housing it’s driven by two prices: the price of the home, and the price of the money you have to “buy” (borrow) in order to buy the house. The write-off is the last thing in a buyer’s decision matrix when looking at the home.

Fifth, the mortgage deduction keeps people out of the market. What? Out of the market? Yes. If a homeowner invested $10,000 of their own capital in a home that cost $180,000 and two years later it’s determined that the home can sell for $200,000, the home owner can realize a 100% return on their capital investment by entering the market and selling it. Staying in the home because of a mortgage write off that on average provides a benefits of less than $2,000 (and a benefit that continues to decline to zero within 15 years) not only is a bad investment move, but keeps the home off of the market and out of the hands of someone willing to pay the home owner the “rents” on that investment.

Sixth, like any government subsidy, the mortgage interest deduction distorts market pricing. In other words, if you get rid of the subsidy, prices for homes will fall because the deduction is no longer factored in as a benefit the buyer receives. A reasonable seller will make an offer that includes what the seller projects as the benefit the buyer will get from the deduction. In other words, the smart seller wants a piece of that future value and will increase his offer price accordingly. Take away the deduction and the seller loses that bargaining chip.

Yes. This is a perspective that land developers don’t want you to hear and real estate agents probably don’t understand themselves, but if you are going to interfere in the markets with a subsidy program that takes away resources from infrastructure investment, shouldn’t the subsidy be used to encourage entrepreneurial activity on the part of the individual who gets the subsidy?

Time to stop worshipping at the altar of hype and get rid of the mortgage deduction.