Mortgage Interest Deduction, part 2

(Part 2 of 5:  See part 1 for historical background)

We finally arrive at the heart of the matter:  Is the MID actually a good idea?  In this part, we’ll look at the (honestly, pretty silly) arguments for it, straight from the NAR.  Remember folks, these are the people who are lobbying, and very likely influencing, your Congressmen.  Without further ado, I’ll go through them, one by one, as presented here:

More than 60% of the families who claim the mortgage interest deduction have household incomes between $60,000 and $200,000, estimates the NATIONAL ASSOCIATION OF REALTORS®.

This is both misleading and irrelevant.  The primary argument against the MID, which I will cover in more detail later, is the cost.  Though this cost may be hidden in the sense that it’s not on the federal government’s balance sheet, the fact remains that most estimates put the lost tax revenue due to the MID at around $120 billion per year.  With that in mind, the figure that would be more helpful to provide would be the number of dollars of tax savings, split by income bracket of the taxpayers who claim the MID, rather than the number of filers as they have done here.  The NAR in this case, and in my experience usually, does not provide the raw numbers from which they quote their figures, so I have no way of telling exactly how many of the roughly 120 billion dollars go to upper, middle, and lower class taxpayers.  But, I’ll go out on a limb and make the educated guess that the majority of the tax savings, in dollar terms, go to taxpayers with high incomes.

What I’ve always found more puzzling about this line of argument though, is that the income distribution of the beneficiaries of the MID is all basically a distracting sideshow.  If you really advocate lowering taxes on the middle class, as the NAR is (at least implicitly and, in my opinion, disingenuously) arguing that it does, why go through an indirect, inefficient route of creating the MID, which obviously will only affect some middle class taxpayers?  Why not change the tax rates on the middle income tax brackets directly?

As a thought exercise, I could just as well propose a tax rebate for lower-class citizens whose last name begins with the letter “L”, and then make the exact same argument.  My proposed tax break would benefit only lower-income taxpayers, so it must be good, right?  I’ll revisit this point in part 4.

A disproportionate number of those high-income taxpayers live in areas where housing is especially expensive, such as California and New York. In high-cost housing markets, lowering the $1 million cap would add a tax burden on families who already must pay high prices for homes.

Hmm, they’re switching gears a bit, here.  Now we’re supposed to feel sorry for people with $1M mortgages (presumably, the same people with incomes over $200K)?  Just last paragraph they were trying to downplay the effect of the MID on the high-income earners.

I essentially do agree with the basic point though, that changes to the MID, including the $1M cap, would increase the tax burden on current homeowners.  I think there is some legitimate room for debate whether it is fair for current homeowners make the presumption that their housing-related tax breaks will remain the same for as long as they have their mortgage.  However, as I’ll eventually discuss in part 5, my suggested resolution of the MID would actually not affect taxes for current homeowners, so I’ll grant this argument for now, and leave aside the issue of whether we should treat tax breaks for existing homeowners as an entitlement.

Home owners already pay 80% to 90% of the income tax in our country, and among those who claim the mortgage interest deduction, almost two-thirds are middle-income earners, says NAR Chief Economist Lawrence Yun. So home owners, who are the pillars of federal income tax revenue, would have to shoulder a bigger tax burden.

Of course, they’ve left out the relevant facts here for us to interpret this argument.  OK, homeowners pay 80-90% of the income taxes (which sounds plausible to me, so I’ll grant it without actual figures to back it up), but there are a couple other things we need to know:  What proportion of taxpayers are homeowners?  (Wikipedia says it’s around 67%, but the article from Houselogic doesn’t say).  And, the more relevant question:  What proportion of income earned in the US is earned by homeowners?  I’ve actually struggled to find a good answer to this question.  Suffice to say, it’s well-known that the average income of a homeowner is higher than that of a renter, so we can safely assume that the proportion of income earned by homeowners is definitely higher than 67%, but how much higher is something I’m still looking in to.

And even if we were to have an exact figure, it’s an accepted fact by nearly everyone involved in tax policy discussions that a progressive income tax is, overall, a good thing.  Given this basic premise, homeowners should pay a disproportionate share of the taxes (relative to the proportion of the national income that they earn) according to this principle, given their higher average income.  In fact, if you think about it a little bit, arguing that homeowners would pay too high a share of the total tax burden without the MID is essentially arguing against the progressive tax system itself.  If the MID and other homeowner tax benefits were repealed, homeowners and non-homeowners would be treated exactly the same under the tax code.  Sure, homeowners would end up paying a disproportionate share of taxes, but it’s not due to an inherent bias the resulting system would have against home ownership, but rather because of underlying demographic differences between the two groups.  If you think that’s unfair, you could argue that we need to adjust the tax rates for the higher income brackets, but the disparity is not a good reason to keep the MID.

Home values could fall 15%, says Yun, as buyers discount the value of the mortgage interest deduction in their purchase offers.

Ah, now we get to what I think is the real reason that the NAR is so strongly against any change to the MID.  Remember, real estate agents (whom the NAR represents) are, in nearly all cases, paid as a proportion of the price of their real estate transactions.  Of course the NAR will oppose any policy which they think will result in lower home prices.

Once again, I don’t know how they arrived at the exact figure of 15%, but my back-of-the-envelope calculations suggest that it may be reasonable.  Indeed, I will grant that home values would likely decline some amount, possibly in the neighborhood of 15%, if the MID were repealed, and for exactly the reason Mr. Yun argues.  The problem is that that 15% (or whatever percentage it really is) of home values is, and has been since mortgages became the most common vehicle for home ownership, artificial value, which is only there because of the subsidy provided by the MID.  Essentially, we’ve been inflating house values for years by the MID, and as Mr. Yun points out, ending the MID would deflate the house values back to what I would call their true market value.  The thrust of the fiscal argument against the MID is that it is necessary for the long-term fiscal health of the US to stop this artificial subsidy.  We’re essentially paying $120 billion a year just to avoid a one-time drop in home values that may or may not actually be as big as the NAR is predicting.  Even if the drop will be as high as 15%, is it worth the government paying $120 (and likely more in future years) billion every year, forever, just to prevent this drop from happening one time?  I certainly think not.  Further, I think it’s possible to mitigate the effect of this one-time drop by phasing out the MID.  More on that later…

In summary then, yes, home values will decline, but the MID is still too pricey to be worth it.

It’s faulty to link the mortgage meltdown to the country’s support for home ownership. The meltdown is rooted in lax underwriting and faulty ratings by credit rating agencies of the securities backed by the mortgage, says Yun.

Well, whaddya know!  I almost totally agree with this statement.  Much as I generally dislike the MID, I cannot in good conscience try to blame it for the recent housing bust.  The MID has been in place, unchanged, through several boom and bust cycles in real estate values, definitely including the most recent one.  You can’t sensibly blame the MID for the run-up in prices when the MID was already there long before the run-up.  I do, however, think that there’s a little more to the underlying causes of the bust than what Mr. Yun is arguing here, though I certainly agree that the reasons he cites do partially explain it.  But that’s beyond the scope of the MID, so I’ll leave it alone for now.

Of course, to be clear, this argument is not an argument for the MID, it’s an argument against an argument which is against the MID.  So, I will not further consider the recent real estate crash as a reason to oppose the MID, but I think there are others, some of which I’ve hinted at in this entry, and the rest of which I’ll get to in part 4.  But first, in part 3, we’ll examine some other, more thoughtful arguments for the MID.

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One thought on “Mortgage Interest Deduction, part 2

  1. Pingback: Mortgage Interest Deduction, part 3 | rantingonrealestate

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