Mortgage Interest Deduction Reform

For years, I’ve been proposing reforming the mortgage interest deduction, most recently suggesting reform as a tool to both reduce the deficit and invest in policies and programs that are likely to spur more productive and innovative economic growth than traditional homebuilding (e.g., expanding investment in advanced research and development ANY LINKS).

It has been conventional wisdom for quite some time that reforming the mortgage interest deduction is a “fool’s errand” given the presumed, unassailable power of the real estate lobby in the United States.  Yet the political calculus appears to be changing in the aftermath of the Great Recession and in the face of federal budget deficits.   Recent budget proposals put forth by both President Obama (link) and House Budget Chairman Paul Ryan (link CHECK THAT MID REFORM IS PART OF MIX) show that reforming the mortgage interest deduction is in the realm of possibility.

A new Pew report out [last week TRUE?] gained some media attention and, along with an Urban Institute paper from earlier this year, should only add more fuel to the reform fire.

The Pew report provides new evidence of the uneven geographic distribution of the mortgage interest deduction, both across and within states.   This shouldn’t be surprising since, as the report finds, “the geographic distribution of this tax expenditure is skewed towards areas with relatively high incomes and property values.”    Examples of the skewing include the following:

The percentage of tax filers deducting mortgage interest ranged from a high of nearly 37 percent in Maryland to a low of 15 percent in West Virginia and North Dakota.

The average mortgage interest deduction for all tax filers (not just those taking the deduction) in 2010 varied from a high of $4,580 per tax filer in Maryland to a low of $1,192 per tax filer in North Dakota.

The Pew report questions the assumed political invulnerability of the mortgage interest deduction in two respects.   The obvious implication: why would low home value states continue to support the spatial skewing of this subsidy?   A less than obvious takeaway: wouldn’t high value states like California or Maryland be better off with more federal incentives for production and innovation?

At the same time, a recent paper out of the Urban Institute throws cold water on theories that MID reform would “undermine the value of owner-occupied homes … and hurt the economy by impeding the recovery of the depressed housing market.”   In fact, the Urban paper suggests that now is actually the perfect time to implement reform, as “mortgage rates are so low that the MID is small by historical standards” and high rental rates could cause “increasing demand from investor-owners that might substitute for any decline in demand from homeowners.”

The economy that led up to the Great Recession was one characterized by excessive consumption and debt, aided and abetted by tax expenditures like the mortgage interest deduction.  We should ideally be trying in this post recession era to build an economy fuelled by innovation and production, buoyed by smart and strategic public investments.  Reforming the mortgage interest deduction would be a good place to start.

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