Economy & Business

The Corner

The Indefensible, Ineffective Mortgage Deduction

The mortgage-interest deduction is just one of those things: Just about everyone who’s studied it thinks it’s a horrible policy, but it’s probably not going anywhere because so many upper-middle-class families benefit from it.

Why is it a bad policy? Like all deductions, it’s more valuable to people in higher tax brackets. It rewards people for buying bigger homes, not just becoming homeowners. Because it applies to mortgage interest, which represents risk, it subsidizes risky loans more than sound ones. And unsurprisingly, given all the forgoing, the benefits overwhelmingly go to wealthier taxpayers.

Also, according to a new study (co-authored by Obamacare architect Jonathan Gruber), it might not boost the rate of homeownership at all.

The study is a close look at a reform that Denmark enacted three decades ago, slashing the deduction for wealthy taxpayers but reducing it much less or not at all for others. In effect, this raised interest rates by 80 percent for the rich, 30 percent for the middle class, and not at all for those with lower incomes. The abrupt change in policy — applied to some taxpayers in Denmark but not others — allows the researchers to see how home-buying decisions changed in response.

The results? The effect on homeownership was about zero – an estimate that holds up through several different approaches to calculating it and is rather precise because the authors have an enormous data set. There is, however, “a clear effect of tax subsidies on the size and value of homes,” as well as on households’ interest expenses.

One limit here stems from the fact that the policy change focused on the wealthy and to a lesser extent the middle class. It’s possible that these folks will buy homes no matter what, while those lower on the income spectrum might buy or not depending on the subsidies available. It would be quite odd if subsidies couldn’t have any effect on homebuying no matter what, after all.

But given how skewed toward the wealthy America’s own deduction is, this suggests we’re throwing away a lot of money helping rich people buy bigger houses.


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