Abstract
This paper measures the welfare effects of removing the mortgage interest deduction under a variety of implementation scenarios. To this end, we build a life-cycle model with heterogeneous households calibrated to the U.S. economy, which features long-term mortgages and costly refinancing. In line with previous research, we find that most households would prefer to be born into an economy without the deductibility. However, when we incorporate transitional dynamics, less than forty percent of households are in favor of a reform and the average welfare effect is negative. This result holds under a number of removal designs.
Highlights
When the mortgage interest deductibility (MID) was passed into law through the Revenue Act of 1913, it was largely insignificant
The focus of this paper is on the transitional dynamics of repealing the MID, the answers to these questions are relevant for our purpose
Much less is known about how a repeal of the MID would affect current households and, in particular, how these effects depend on the design of the removal policy
Summary
When the mortgage interest deductibility (MID) was passed into law through the Revenue Act of 1913, it was largely insignificant. The direct negative effect of increasing the user cost of owner-occupied housing is more prominent, especially for relatively young households that have just entered the housing market and are highly leveraged Given that it is beneficial for the lion’s share of households to remove the MID in the long run, we explore two alternative policies that are less abrupt and give households time to adjust their asset holdings before the MID is repealed. Floetotto et al (2016) study the short-run impact of an MID repeal using a life-cycle model that includes a bequest motive In their analysis, mortgage interest deductions are claimed against earnings that are subject to a proportional labor income tax rate, and all homeowners are implicitly assumed to itemize deductions. The interest rates on mortgages and bonds are exogenous and the supply of both assets is perfectly elastic
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