Time to Phase Out the Mortgage Interest Deduction?

The $72 billion program fails to increase homeownership rates and has become an entitlement for small group of wealthy homeowners.

Monopoly pieces on tax return

Five Figures to Consider

21% of American tax filers claim the mortgage interest tax deduction
The mortgage interest deduction costs the government $72 billion annually
$48 billion is annual HUD budget
Zero is amount of mortgage interest tax deduction in Canada and the U.K.
64% is approximate homeownership rate in U.S., Canada and U.K.

When people talk about the U.S. having a housing-affordability issue (81% of Americans feel this is a key issue), they are probably thinking about millennials living at home with their parents, seniors on a fixed income and the 11.4 million people who spend more than half of their household income on housing. What likely doesn’t come to mind are high-income people taking the mortgage interest deduction to help buy bigger or second homes or finance renovation projects.

Home ownership has long been a cornerstone of the American Dream, and the federal government has a roughly $200 billion a year budget to help Americans rent and buy homes. The majority of the budget, 70%,  goes toward subsidizing  homeowners through tax deductions. One such deduction, the mortgage interest deduction (MID),  allows taxpayers to deduct mortgage interest payments from taxable income on primary and second home mortgages up to $1 million (6% of US home mortgages are over $500,00) and home equity loans up to $100,000. The larger your mortgage and the higher your income tax rate, the more valuable each dollar of your deduction is. In order to receive the benefit, you must itemize your tax returns. Only 21% of tax filers claim the mortgage interest deduction,  76.8% of whom have incomes over $200,000.  Most people take the standard deduction of $12,500 as it exceeds the combined value of their itemized deductions thus rendering the MID rather ineffective at encouraging homeownership.   It may, however, incentivize those high-income itemizers who are buying homes anyway to take bigger mortgages  since they will get to deduct a portion of the interest on their tax returns.

The  $72 billion tax revenue the government forfeits each year through the MID dwarfs HUD’s entire $48 billion budget.  Seven  million households with incomes over $200,000 receive a larger share of federal housing benefits than the 50 million households with incomes of $50,000 or less. Due to funding limitations, only one in four people who are eligible for rental assistance in the U.S. actually receives it.   That leaves the other 75% at best, severely cost-burdened or at worst, homeless.

Though only a sliver of Americans claims the MID, 60-90% of the public supports it, perhaps because taking it away could cause home prices to fall.  Why? Because without the deduction, there would be no tax benefit to taking on a mortgage. People would be less encouraged to reach for higher priced homes.  Many other countries, however, including the U.K. and Canada, have zeroed out their mortgage interest deduction and saw no effect on homeownership rates.  Great Britain phased out its MID over a twenty year period; both homeownership and home prices rose dramatically.  Increased demand due to lower prices of entry level homes had a positive domino effect up the ladder.  Today, the U.K. ($361,150) and Canada ($387,719) have similar average home prices to the U.S. ($390,000) and similar homeownership rates, each approximately 64%.

The Trump Administration’s Tax Reform Plan further cuts HUD’s budget by $6.8 billion and still results in an estimated $1.2 trillion decrease in federal tax revenues. Meanwhile, the MID remains intact. Smart fiscal policy?

FIVE FIGURE THINKING
No one is entitled to rent or buy a home. However, creating an environment that affords as many Americans as possible a habitable home promotes stable communities and economic growth. The MID is an unnecessary  handout to a small group and is ineffective at promoting home ownership. It’s time to scrap it and free limited government resources for better use.