The Mortgage Interest Deduction: Revenue and Distributional Effects

Abstract

Conventional estimates of the size and distribution of the mortgage interest deduction (MID) in the personal income tax fail to account for potentially important responses in household behavior, and thus overstate the increase in revenues and the progressivity associated with eliminating the MID. Were the MID to be eliminated, households would sell financial assets to pay down their mortgage debt, and the smaller holdings of these taxable assets would offset some of the revenue gains from taxing mortgage interest. We build on previous work that estimates the consequences of removing the MID using a framework that allows for portfolio rebalancing. Our estimates of the revenue loss of the MID are robust to various assumptions about household rebalancing behavior and the ratio of the conventional estimate to the rebalancing estimate is relatively stable over time. Based on these findings, we provide a rule of thumb for policymakers for estimating behavioral responses to changes in the MID.