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Friday, October 8, 2010

Trends and the Tax System - The Home Mortgage Interest Deduction

I think that a consideration of trends is helpful in reforming a tax system. For example, today's economy has become more global than in the 1960s when many of our international tax rules were put in place. Updating to reflect today's ways of living and doing business should be considered.

Today, USA Today reported on a trend of more people renting their homes than buying them, apparently due to both the economy and benefits of renting rather than owning. See Should you rent or buy your own home? by Christine Dugas. The article refers to a survey indicating that even some that can afford to buy a home are renting instead and fewer think it is part of the American dream to own a home.

There are tax policy reasons to reform the home mortgage deduction rules, perhaps this trend where more do not view home ownership as key to success, also helps drive success.

Earlier this year, the Tax Policy Center issued a report on the home mortgage deduction. They summarized the work of various studies that found that the deduction does not really increase home ownership. Instead, the bulk of the tax benefit goes to those in the top fifth of income levels and really just encourage them to buy a more expensive home. The report also notes that home ownership rates in countries without a mortgage interest deduction is similar to the US. (See Reforming the Mortgage Interest Deduction by Toder, et al (May 2010).)

In a report, Economic Survey of the United States, issued in September 2010 by the OECD, the value of the home mortgage interest deduction is questioned. The report notes that the deduction should be reduced or eliminated because it does not encourage home ownership, but only the ownership of more housing by higher income individuals. They suggest phasing out the deduction as Britain did over 12 years ending in 2000.

And, we should not forget that only about 1/3 of individuals even itemize and not all of these itemizers have mortgage interest.

And, the mortgage interest is not just on a loan to buy a home, but also allowed for home equity debt (up to $100,000 of debt) and on a second home! This deduction is one of the most costly in the tax law. Without it, or with a reduced deduction, the tax rate of renters and others could be lowered. The deduction also encourages over-investment in housing because its effective tax rate is zero compared to a much higher rate on corporate investment.

I think another trend is one caused by the home equity loan - borrowing too much!

The home mortgage interest deduction seems to viewed as an entitlement any suggestions to cut it back are maligned. But, it is used by less than 1/3 of individuals yet is one of the most costly provisions in the law - seems like a serious equity issue. And it does little to encourage home ownership.

Do you think it is time to reduce and improve the deduction as a way to keep lower rates or perhaps to help pay down the debt?


Peter Reilly said...

The home mortgage interest deduction is something of a sacred cow. The $1,000,000 limitation was supposed to make it less relevant over time, but inflation hasn't cooperated.

Unknown said...

Canada has good demand-supply balance in home loans, though. My uncle is planning to move there and has contacted an Edmonton mortgage broker for renting a house. I think they found a Calgary mortgage company that could help them find the best and affordable home there. They aren't planning to stay for long there, though. Just for two to three years, maybe.