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Doyle McManus / Interest deduction on mortgages just distorts economy

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Posted: Tuesday, February 12, 2013 12:01 am

Doyle McManus / Interest deduction on mortgages just distorts economy

Would you support a tax reform measure that could help reduce the federal deficit, remove a needless distortion in the economy and make the system fairer?

Me too, which is why I'm taking aim at a sacred cow: the home interest mortgage deduction.

If you listen to home builders and real estate agents, they'll tell you that the mortgage interest deduction is what makes homeownership possible for millions of Americans.

Yet last year, homeownership in the United States, battered by mortgage foreclosures, sank to 65 percent, a 17-year low, while next door in Canada, where there is no deduction for mortgage interest, homeownership continues to rise, reaching more than 69 percent last year, says Toronto's Financial Post.

The reason is that our mortgage interest deduction doesn't really support homeownership; instead, it supports mortgage indebtedness, which isn't the same thing at all.

If the goal is to increase homeownership, a better idea might be to offer a tax break aimed at middle-income families buying starter houses - a tax rebate for interest on the first $200,000 in mortgage debt, for example.

But that's not how the mortgage deduction works. First, it's only useful to people who itemize deductions, which only about 30 percent of taxpayers do. Second, it helps people with big mortgages more than those with small ones. Third, like all deductions, it helps people with the highest incomes (who get the equivalent of 39.6 percent of their mortgage interest knocked off their tax bill) more than people with lower incomes (who get 25 percent or less off if they itemize). Moreover, mortgage interest on a vacation home is deductible too, as long as the total debt is under $1 million.

But don't take it from me. Take it from the economists at the Mercatus Center, a mostly conservative think tank at Virginia's George Mason University.

"Most taxpayers do not benefit from this deduction at all or receive a very small benefit," they wrote in a report issued last month. "The only taxpayers who do receive a large benefit are those in the upper income brackets. ... Its primary effect is to encourage Americans who would have already been able to afford a house to take on even more debt.

"Recent empirical research suggests that the mortgage interest deduction increases the size of homes purchased but not the overall rate of homeownership," they wrote.

And it's not just conservatives: Policy wonks in both parties support trimming the mortgage interest deduction.

But wait, you and your real estate agent will say. Won't such a change knock a hole in home values?

Yes - at least at the high end, where high-bracket taxpayers take on million-dollar mortgages. At the lower end, where homes are bought by people of modest means? No effect on prices at all, economists say. And even at the high end, the Mercatus report found, "it is likely to have little effect."

You can be sure that home builders and Realtors, whose businesses thrive on big houses and high prices, will push back hard against any proposal for change.

"We've been preparing for this debate for a year and a half," Jim Tobin, chief lobbyist at the National Association of Home Builders, told me recently. "The housing industry is just coming out of its depression," he argued. "This is not the time to dampen that recovery."

OK; not this month, then. But by the end of the year, the economy, and the housing industry, are likely to be in better shape.

The mortgage interest deduction subsidizes big houses and bigger mortgages, but that's not a good use of tax dollars. Its benefits flow disproportionately to the wealthy and do nothing for the working poor.

The deduction currently costs the Treasury about $100 billion a year. That's money we could use to lower taxes, shrink the deficit or pay for Medicare - a debate Obama and the Republicans will surely have.

There aren't many policy changes that would increase government revenue, remove distortion from the economy and make the distribution of income fairer all at the same time.

Fellow homeowners, let's take this one for the team.

Doyle McManus is a columnist for The Los Angeles Times. Readers can email him at doyle.mcmanus@latimes.com.

Posted in on Tuesday, February 12, 2013 12:01 am.

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