Taxes and Borrower Behavior: Evidence from the Mortgage Interest Deductibility Limit

Abstract

This paper estimates the behavioral response to mortgage interest tax deductibility by studying the discrete change in the net-of-tax marginal interest rate that occurs at $1 million in mortgage debt. Using data on 2004-2016 mortgage originations, I estimate excess bunching in the loan distribution based on a counterfactual that accounts for bunching at salient loan amounts. Findings suggest excess of about 54,000 loans at the deductibility limit, or 4.5% of the sample. The level of bunching implies an average reduction in borrowing around the $1 million limit of 9.4 percent, and mortgage demand elasticities between − 0.132 to − 0.115 for home purchase loans. Estimated elasticities imply that from 2004-2016 the MID induced $49.52 billion in deadweight loss in the mortgage market.