November 05, 2005

Reich on the Mortgage Deduction

Lots of ink getting spilled on one particular proposal from the President's Tax Reform Panel: paring back the mortgage interest deduction. Robert Reich has nothing but bad things to say about the deduction-- and nothing but good things to say about the panel's proposed reforms.
You couldn't design a more regressive housing policy if you tried. The home mortgage interest deduction cost the Treasury $63 billion in lost revenue last year, and the rich got most of it. Yet the entire budget of the Department of Housing and Urban Development — which, among other things, provides low-income housing — was just $35 billion.
Read it here.
I'm right there with Reich on all of this. The only qualm I have about the commission's plan--which involves paring back the thing so it only applies to "average" sized mortgages, then turning it into a credit so it's more valuable to low-income folks and less valuable to the wealthy--has to do with people's expectations. Homeownership is not always an easy decision. For many, it's a dollars-and-cents thing. Plenty of long-term renters, I bet, get pushed into homeownership not because they've always dreamed of it but because one day, their rent gets hiked just a bit too high. For the upper-income folks who would be hurt by the commission's proposal, getting the smaller credit could very well change the calculus about whether homeownership is a good deal.

In the scheme of things, this is nothing to cry excessively about. It's about as troublesome as it would be for current stock market investors if the federal capital gains tax rate got pushed back up to equal the earned-income rate: it's a little sad that people's expectations got screwed, but it's the right long-term outcome. The pulling-the-rug-out move here isn't all that wrong-- but it ain't quite right.

Another interesting objection is raised by Professor James Maule, who points out that if you eliminate one tax-induced market distortion while leaving other related distortions intact, you can making the remaining distortions even worse:
The tax law currently props up McMansion purchases, exurban sprawl and the resulting energy waste, and inflated vacation home markets, but the tax law also props up an inefficient energy exploration and production industry, the construction of shopping mall after shopping mall and excess commercial and office building capacity, a variety of supposedly beneficial and favored social behavior, and a long list of other special interest group favorites. What happens if the reduced demand for home mortgages causes banks to lend their money to shopping mall developers or the builders of unnecessary commercial and office building space?
Which amounts to a (correct) warning from Wonkville that if Congress seizes on this one tax break and leaves the rest intact, all we're really getting out of it as a nation is a little better-well-spent tax revenue.

This is a crazy-dreamer objection, and one I have a ton of sympathy for. But let's take the incremental reforms when we can get them.

5 Comments:

At 2:11 PM, Blogger Paul said...

"For the upper-income folks who would be hurt by the commission's proposal, getting the smaller credit could very well change the calculus about whether homeownership is a good deal."

A minor correction; it's unlikely to change the decision about whether homeownership is a good deal, but it may well change whether the ownership of a particular house (a McMansion) is worthwhile.

 
At 5:09 PM, Blogger Katherine Blauvelt said...

The Panel wrote in its final report: "Estimates suggest that between 85 and 90 percent of mortgages originating in 2004 would have been unaffected by the proposed Home Credit mortgage limit." (page 73). But don't we want mortgages to be effected, to have revenue savings, et al? What am I missing?

 
At 11:02 PM, Blogger Matt G said...

Katherine, this is a good question. The 85% number does seem pretty high, and that does make you wonder where the money's coming from. I can think of two explanations:
1) Some mortgages are completely losing their deductibility. Second homes are out under the Panel's suggestion. So people writing off interest on their second homes will bear the brunt of this.
2) More generally, the benefits of the current deduction are pretty narrowly targeted. The Panel says (in the same neighborhood as the stat you cite) that the richest 12% get more than half of the benefit. So paring back the deduction available to a small group of high-end folks really could yield some revenue.
Having said that, I haven't seen a revenue estimate for how much of the current revenue loss ($65 billion a year) this proposal would make up.

 
At 9:01 AM, Blogger Jesse said...

I think a lot of middle class people would use the standard deduction if mortgage interest was converted to a tax credit. This probably makes up for the reduced amount of the credit vs. the deduction at their marginal rate.

 
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