Mortgage Interest Deduction A Good Idea?

It has been mentioned here and elsewhere that the mortgage interest deduction in the tax code is a roundabout way of subsidizing banks. If interest rates are determined by supply and demand then the demand for interest rates is only dependent on what a taxpayer’s “effective interest expense is”. For example, if interest rates are at 4.0% and you can deduct 100% of it at a 25% tax rate, the borrower is essentially only paying 3.0%.  The bank receives 4.0% interest, the homeowner pays 3.0% and the taxpayer is left footing the 1.0% difference.

A new study suggests that most of the incidence of the subsidy falls on the lender. This means that most of the subsidy is directly fueling the pockets of the largest mortgage originators. What the study did was quite clever. Since only up to $1,000,000 in an outstanding mortgage is deductible, the authors looked at the split between $1m to see if there is a substantial decline in interest rates. What they found is that it very closely reflects the drop in tax deductibility. The US taxpayer is then left on the hook to pay the $98 billion shortfall in taxes that this tax policy causes.

Suburban McMansion

Would the glut of McMansions continue with less subsidies?

Similar to our argument on the uselessness of tax exemption for charitable contributions, the suggestion that this tax policy should be revoked is incredibly politically nonviable. Home-ownership and politics go hand in hand. I have yet to hear a substantially convincing argument, however, proving that an aggressive push for universal home-ownership leads to anything besides a government-subsidized mandate to pay banks. The closest I have heard is that home-ownership leads to higher property values (outside of simple privatized supply and demand) due to the extra concern a homeowner will have for his or her property. That’s a nice way of saying that renters are jerks who ruin their homes (which may be true).

There is precedent, however, for other countries having much lower rates of home-ownership and not needing the deduction. I am of the opinion that mortgage interest rate deduction is an outdated mode of encouraging home-ownership and that without it the housing market will continue to sell. Property values may decrease slightly, but compared to the extra $98 billion dollars that non-home owning tax payers will receive, it will be negligible. Since most of the incidence of the subsidy falls on banks (similar to the issue of most of the incidence on gasoline taxes falling on consumers), the claim that the tax provision exists as a boon to housing consumer demand may be bunk. Add to the fact the government repurchase of Fannie Mae and Freddie Mac and the explosion of FHA’s balance sheet, it appears that all the hidden costs in propping up our housing market and home-ownership rates may be foolhardy. Consider also that those who itemize their taxes and claim the largest deductions are those who are near the $1m mortgage mark and make the most money, an effective subsidy of the rich and powerful.

It may be politically non-viable, but tell your congressman or congresswoman and elected officials to remove the tax deductibility of charitable contributions and mortgage interest rates. No budget cut, a slight increase in taxes and over $140 billion. With our current deficit running around $1.17 trillion a year, cutting that by 15% may start to be an enticing prospect.


Cameron Daniels


  1. capacitated says

    I’m a rent slave with a chip on my shoulder but I don’t interpret the message as saying that renters are jerks who ruin their homes.

    My take is that because leasehold improvements belong to (are retained by) the landlord, it usually is not rational for a renter to put time, effort, and more importantly money, into improving the property.

    While renters are expected to NOT ruin their home and to take good care of them, all homes naturally decline over time due to normal use (occupancy wear and tear) and exposure to the elements. Maintaining existing quality necessarily requires inputs over time, which must come from the landlord since (as noted above) renters have neither an obligation nor an incentive to improve the property.

    But landlords are profit-maximizers, and generally can be expected to provide sufficient inputs to maximize profit and nothing beyond.  Landlords do not live in their rental properties, so outside the luxury rental market (a tiny niche), their upkeep standards are not close to what they demand in their own homes.

    So I’d say it could be argued that renters are victims of greedy landlords who charge as much as they can while providing inferior housing that they would put up with themselves.

  2. freeby50 says

    Yeah this one seems politically impossible. 
    I think theres a better shot at putting a cap in the mortgage interest deduction.    If you make only the first $500k of the loan deductible then that would eliminate the deduction for rich peoples mansions.  

  3. says

    This puts a cap on my argument that we should get rid of the mortgage deduction for another reason: we have far bigger incentives for people to get into debt in the tax code than we have encouraging people to save. We’d all be better off if we improved savings rate.