Beating Back the Home Mortgage Interest Deduction
October 24, 2005
You would think from listening to the folks in the real estate, mortgage banking and home construction industries that the world will end if home mortgage interest deductions are reduced… But in any case, the roof will not fall in if the home mortgage interest deduction is changed in the manner suggested by the president’s panel.
The fact is that only one-third of taxpayers (46 million out of 130 million) itemize their returns. And only a tiny percentage of those deduct interest on mortgages of $300,000 or more. Earlier this year the Congressional Budget Office estimated that limiting the tax break to mortgages up to $500,000 would affect only 1 percent of all homeowners…
There is simply no tax policy justification for allowing large home mortgage interest deductions. Both conservative and liberal public finance experts have long criticized the home mortgage interest deduction because it shrinks the tax base, thus requiring higher tax rates. That’s right, you are paying higher tax rates because of the home mortgage interest deduction.
The mortgage deduction also distorts economic decision-making, effectively subsidizing ever-larger home purchases by making it cheaper to borrow money. (And at the moment, borrowing is already pretty cheap.) That, in turn, has fueled the out-of-control real estate market. People have been buying houses that they might not otherwise have been able to afford. Yet, really smart people since the time of Adam Smith have warned against using the tax laws to distort markets. Perhaps it is time we listened. (Full piece here.)
As we’ve written before, the home mortgage interest deduction is terrible tax policy, forcing up income tax rates and dragging down economic growth. Unfortunately, thanks to its political popularity, the smart money is likely on modest reforms if any.