The Mortgage Interest Myth

There is a persistent myth that the Home Mortgage Interest Deduction (HMID) does the following: (a) promotes home ownership by (b) providing a financial benefit to the middle class taxpayer. That’s the funny thing about myths; they aren’t true. In fact, the truth here is the exact opposite. The HMID has not expanded homeownership in any meaningful way. Between 1960 and 1997 the rate of owner occupied homes has bounced around in the 62-66% range. This is no different than other Western countries that lack a tax favored deduction for mortgage interest. Why? The HMID is a government subsidy and subsidies drive the costs of whatever they are subsidizing upward (healthcare, education, sugar, etc). The government is effectively paying people to engage in approved behavior (home buying). However, these subsidies do not occur in an information vacuum: home sellers are aware of this subsidy and adjust asking prices upward accordingly. There is no net benefit to the buyer (who pays more upfront and is then reimbursed by the government) or to the seller (who gets more when selling but paid more when buying). The only consistent beneficiary is the real estate agent. The National Realtors Association lobbies hard to maintain the HMID. Their protestations to the possibility of losing this part of the tax code make clear current policy benefits them. Their reaction makes sense in light of the fact that by their own admission the HMID drives prices upward (as much as 15% higher) thus effectively keeping all home prices 15% higher than they otherwise would be. A government-sponsored program that maintains artificially high prices is beneficial for what reason again?

The second part of this myth is that the HMID actually benefits the middle class. As of 2009 only 22% of federal returns took advantage of the HMID and of that only 30% were classified as “middle class”. In other words, only a mere 6% of returns constitute middle class usage of this deduction. The average tax savings for people in this group is only $152/year. The primary beneficiaries of the HMID are the “wealthy” – those making over $200k/year. Over 70% of returns above $200k/year claim the HMID. Because the wealthy pay disproportionately more tax they reap a likewise disproportionate advantage from this deduction with an average savings of $1862/year. Technically no taxpayers “benefit” from the HMID. Absent this deduction they would have paid a lower price for their home so their net payment is roughly the same.

Eliminating tax subsidies coupled with a lowering of marginal rates would allow a tax savings to be spread around to ALL taxpayers, not just a narrow few. In fact, Obama’s own “Deficit Commission” aka the bipartisan Bowles-Simpson Deficit Reduction Plan called for eliminating nearly ALL tax exemptions coupled with lowered rates. Those benefiting the most (the wealthy with large exemptions) from current exemptions will effectively pay more tax even with decreased marginal rates because the net benefit to all other taxpayers from lowered rates must come from somewhere if revenue neutrality is maintained.

It’s time to let go of tax myths that act as obstacles to change and move toward a simplified tax system (ideally the Fair Tax but for now we are discussing income tax) with a low (and ideally flat) rate structure and broad base that is built on a relative foundation of fairness (to the extent that the concept of “tax fairness” is not an oxymoron) that does not attempt to manipulate behavior by rewarding a few for behavior that many are unable to participate in.