Is the Mortgage Interest Deduction on the Table?

October 26, 2010

The Wall Street Journal reported Monday that President Obama’s deficit commission is mulling the idea of reforming the mortgage interest deduction as a way to help solve the nation’s budget problem.

You can expect the typical reaction from those in the housing industry (Realtors® and homebuilders) who will claim this is the end of the world as we know it, as well as the anti-tax caucus who won’t accept any tax increase ever.

But here’s a fact: as far as tax increases go, limiting MID would be one of the least damaging in terms of economic efficiency. Scaling back MID is likely less preferable to some spending cuts (say eliminating most farm subsidies), but it’s much preferable to raising marginal tax rates. To say otherwise (that all tax hikes are equally bad) is a sign of ignorance of basic public finance because the tax burden includes not just the payment from individual to government but also the excess burden.

Whether the MID should be limited therefore depends upon a simple calculation. Is the harm done from the MID tax increase alone greater than or less than benefit from the other policy change that is induced by the MID tax increase? If MID limitation crowds out future tax increases that would come to pay down the deficit, then MID should be limited, given that MID limitation is one of the best possible tax increases. If MID limitation ends up causing spending to be higher than it otherwise would have been, then whether MID should be limited depends upon the value of that spending. Again, it’s mostly a question of the extent to which starve/feed the beast works.


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