Mortgage Interest Deduction Research Articles

REVENUE COSTS AND INCENTIVE EFFECTS OF THE MORTGAGE INTEREST DEDUCTION FOR OWNER-OCCUPIED HOUSING

We analyze how changes in the income tax deduction for home mortgage interest would affect loan-to-value ratios on owner-occupied homes, the distribution of income tax liabilities, and the consumption of housing services. Using the 2004 Survey of Consumer Finances, we estimate that repealing the mortgage interest deduction in 2003 would have raised federal and state income tax revenues by $72.4 billion in the absence of any household portfolio adjustments, but by only $58.5 billion if homeowners drew down financial assets to pay down their mortgage debt.

Market Conditions and Housing Choices: A Comparison of Homeownership Across Three Decades

This article uses information on out‐of‐pocket housing cost and house price appreciation along with the geo‐coded version of the Panel Study of Income Dynamics to consider the differences in the impact of these and other variables on the tenure choices of sample households across three time periods, the 1970s, the 1980s and the 1990s. Specifically, an extended continuous time probability model is used to examine households' transitions from renting to owning and subsequent possible transitions either back to rental tenure or to another owned home during our three observation periods. Coefficient estimates show that financial variables such as house price appreciation and out‐of‐pocket housing cost play an important role in determining all the transitions. In addition, the analysis demonstrates the interesting result that the cumulative likelihoods of homeownership derived from the model are consistently lower than the probabilities of an initial transition to homeownership from rental tenure during the observation period. Finally, the magnitude and timing of the impact on homeownership of a policy experiment that eliminates the mortgage interest deduction are shown to differ substantially across the three decades.

Measuring Increases In Horizontal Equity In The Absence Of Certain Itemized Deductions And Phase Outs

A topic that generates extensive debate and concern is the perception of fairness in the US tax system. This “fairness” is often defined as vertical equity – taxpayers with different amount of income pay different amounts of taxes, and horizontal equity – taxpayers with the similar income pay the same level of taxes. Since the late 1980s, the number of phase outs in the United States individual income tax system has increased substantially. The effect of these phase outs has, in some cases, increased certain societal-valued activities, while at the same time discouraged reduction in taxes to others who are viewed as upper-income. On the other hand, some of these phase outs, and the ability to use them, may simply be a matter of luck or timing, or both. When this is the case, the tax liability of two people with very similar incomes may become very different, thus decreasing horizontal equity. This study begins by examining changes in horizontal equity (as measured by the coefficient of variation) when deleting two individual tax deductions. Using the Internal Revenue Service Tax File database for roughly 60,000 married filing joint returns, we examined the sensitivity of equity measures to two “artificial” changes in the tax laws – the disallowance of the mortgage interest deduction and the charitable contribution deduction. Not surprising, we find the disallowance of either or both deductions increases horizontal equity. Additionally, in the absence of phase outs (using the 1989 IRS tax file), we prove that as income groups become more numerous (and hence narrow bands of income), horizontal equity increases as well. This outcome is at odds with prior tax equity studies that make the assumption that increasing or decreasing the number of equal circumstance groups (taxpayers with similar income) will have no substantive effect on the outcome of horizontal equity measures. It also shows that increasing phase outs, when only benefits some in even very narrow income groups, has the effect of decreasing horizontal equity. This study has important implications in two respects. First, from a methodological standpoint, prior studies should have strengthened their assumption on the number of equal income groups used. Second, from a public policy perspective, continuing to increase the number of phase outs within the tax system further distorts horizontal equity, thus undermining the fairness and equity perception of the tax system.

Comment on Pauly: The Constitutionality of the Affordable Care Act--Comparisons with the Home Mortgage Deduction

No one calls the home mortgage deduction an "individual mandate" to buy a home, so why should Obama's "mandate" to obtain health care under the Affordable Care Act (ACA) be unconstitutional, asks Edward Song of The Song Law PC.

Comment on Song: Mortgage Interest Deduction

A proper income tax base should allow a deduction for mortgage interest expense, according to Richard Gordon of Case Western Reserve University.

The Economic Implications of House Price Capitalization: A Survey of an Emerging Literature

House price capitalization – the adjustment of house prices to changes in local public service and tax levels – has long been thought to be a means of testing for efficiency in the local public sector. In this article I argue that the extent of house price capitalization itself may have important economic implications. In doing so I synthesize an emerging literature that explores the conditions under which public and private investments and intergovernmental transfers are capitalized into local house prices and the broader implications of such capitalization. The main insights are: (i) House price capitalization is more pronounced in locations with strict regulatory and/or geographical/physical supply constraints; (ii) capitalization can – under certain conditions – induce the provision of durable local public goods and club goods; and (iii) capitalization effects – which are habitually ignored by policy makers – have important adverse consequences for a wide range of policies such as intergovernmental aid or the mortgage interest deduction

The Geographic (and Political) Distribution of Mortgage Interest Deduction Benefits

The Geographic (and Political) Distribution of Mortgage Interest Deduction Benefits

Historical Federalist Perspective On The Home Mortgage Interest Deduction For Federal Income Tax

This paper contributes to the on-going federal income tax debate by bringing to light the consequences of the tax laws and regulations under which our economic system operated during the post-Regan era. Specifically, this study offers a federalist perspective on one of the largest personal federal tax expenditures - the deduction for home mortgage interest (HMI). Discussion also includes background, current status, and proposed changes to the tax code for of the HMI deduction. This paper analyzes current national political rhetoric from a federalist perspective (i.e., with consideration given to the right of states to equal treatment). The distribution of the HMI deduction tax benefit between states is introduced here as a possible missing consideration in the national level political debate that dominates current discussion of the HMI deduction.

The Effect of Homeownership on Geographic Mobility and Labor Market Outcomes

This paper examines the effect of homeownership on mobility and labor income and provides new evidence that owning a home makes workers less likely to move in response to labor market shocks. To identify this effect, I develop and estimate a structural dynamic model of housing choices, migration decisions and labor market outcomes. I find that owning a home has a large negative effect on the probability of moving in response to a labor market shock and a small negative effect on labor income. Owners suffering from a decrease in home equity are 40 percent less mobile. I conduct two policy experiments. The first shows that the home mortgage deduction has a positive effect on homeownership, affects mobility and creates an incentive to buy larger houses. Second, I find that if the down payment requirement for buying a home is eliminated, homeownership exhibits a large increase, while the mobility and labor income of households experiencing negative labor market shocks decrease.

Rethinking Federal Housing Policy

Problem: Federal housing policy is made up of disparate programs that a) promote homeownership; b) assist low-income renters’ access to good-quality, affordable housing; and c) enforce the Fair Housing Act by combating residential discrimination. Some of these programs are ineffective, others have drifted from their initial purpose, and none are well coordinated with each other. Purpose: We examine the trends, summarize the research evaluating the performance of these programs, and suggest steps to make them more effective and connected to each other. Methods: We review the history of housing policy and programs and empirical studies of program effectiveness to identify a set of best principles and practices. Results and conclusions: In the area of homeownership, we recommend that the federal government help the nation's housing markets quickly find bottom, privatize aspects of the secondary mortgage market, and move to eliminate the mortgage interest deduction and replace it with a 10-year homeownership tax credit. In the area of subsidized rental housing, we recommend that the current system of vouchers be regionalized (or alternatively, converted into an entitlement program that works through the income tax system), sell public housing projects to nonprofit sponsors where appropriate, and eliminate some of the rigidities in the Low Income Housing Tax Credit program. In the area of fair housing, we recommend that communities receiving Community Development Block Grants be required to implement inclusionary zoning programs. Takeaway for practice: In general, we recommend that federal policy build on proven programs; focus on providing affordable housing for low- and moderate-income families and provide the funding to meet that goal; avoid grandiose and ideological ambitions and programs; use fewer and more coordinated programs; offer tax credits, not tax deductions; and promote residential filtering. Research support: Partial funding support was provided by the National Science Foundation.

Housing Tenure Choice, Race and the Recommendations of the President’s Advisory Panel on Federal Tax Reform

In this paper, we estimate the impact of tax policy on tenure choice using probit and housing expenditure regressions based on Public Use Microsample data from the 1990 and 2000 US Census. We find that tax policy has important impacts on tenure choice, and that the impact increased for blacks and hispanics between 1990 and 2000. We find that funding a tax credit with reductions in the mortgage interest deduction would increase home-ownership among minorities, but that the increase would be attenuated by lack of access to funds for down-payments. We also think a political consensus for reducing the mortgage interest deduction is unlikley, so we examined the possibility of giving households an option between a refundable credit and a deduction. Not surprisingly, this would also increase the ownership rate, but the impact would again be attenuated by liquidity constraints.

Who Cares About Mortgage Interest Deductibility?

We use the US Survey of Consumer Finances to measure the change in federal tax liability that would result should mortgage interest no longer be deductible from taxable income. We argue that the elimination of this housing tax provision would lead households to reshuffle their balance sheet, thereby lowering the amount of interest income taxes collected. We find that the cost of this tax provision is between 36 and 66 percent of the estimates produced by the US Office of Management and Budget, depending on the types of assets one assumes would be used to lower mortgage debt following the removal of the provision. Furthermore, since mostly rich households would be in a position to reshuffle their balance sheet following such a change in tax policy, the distributional effects of this program are much smaller than conventionally believed. While the focus of this paper is on the elimination of mortage interest deductibility in the US, the results of this study shed some light on the impact and distributional consequences to expect should mortgage interest deductibility be introduced in Canada.

Capping the Mortgage Interest Deduction

In this paper we examine the economic implications of several policy options for capping the mortgage interest deduction (MID). We extend the standard user-cost model of owner-occupied housing to include a cap on the mortgage size receiving tax-favored status. Our user-cost estimates for taxpayers with mortgages above the current-law cap are 4.41 percent higher than estimates from a model without the cap. We simulate the share of mortgage dollars that would be subject to three alternative cap policy variants and summarize the distributional impacts of each proposal, computing the share of mortgage dollars impacted across U.S. Metropolitan Areas.

Taxing Owner-Occupied Housing: Comparing the Netherlands to Other European Union Countries

This paper compares owner-occupied housing tax regimes in the Netherlands and the other countries in the EU-15. the Netherlands appears to stand apart in two respects. First, in Luxembourg and the Netherlands owner-occupiers have to include an imputed rental income in their taxable income. Second, in the Netherlands, the tax-deductibility of mortgage interest payments is almost unrestricted. The tax regime of owner-occupied homes increasingly erodes the personal income tax base in the Netherlands, so that higher tax rates are needed to collect a given amount of revenue. However, elimination or reduction of the mortgage interest deduction can only be realized gradually. Due to a lack of data both within the various tax regimes and across time periods, a comprehensive multivariate time-series comparison among the various tax regimes in the EU-15 is not possible. Thus, the statistical analysis is limited to bivariate comparisons.

The Variation of Homeowner Tax Preferences by Income, Age and Leverage

It is well known that owner‐occupied housing has long received favorable tax treatment in the U.S. federal income tax system relative to a system in which all income, regardless of its source, is subject to taxation. As a result, many economists have argued that the United States overinvests in owner‐occupied housing relative to the investment that would result from a neutral income tax system. In addition, the distribution of the subsidy is often viewed as inequitable because high‐income households receive the largest subsidy per dollar of housing. This article uses the 2005 American Housing Survey, conducted by the U.S. Department of Commerce, to perform a microlevel analysis of the current magnitude and distribution of homeowner tax preferences. We then assess how the magnitude and distribution of tax preferences would be altered by replacement of the mortgage interest deduction with a 15% credit.

Mortgage interest deductibility and homeownership in the Netherlands

This paper considers the growing amount of mortgage interest paid in the Netherlands against the background of its full fiscal deductibility, increasing homeownership rates, innovation in the mortgage market, and changes in the Dutch income tax system. Its main conclusion is that arguments in favor of fiscal deductibility are weak. Since the deductibility puts pressure on the income tax base, it is likely that sooner or later the facility must be limited or abandoned.

Tax Reform and Incentives to Encourage Owner-Occupied Housing: Analysis of the President's Tax Reform Panel Recommendation to Convert the Mortgage Interest Deduction to a Tax Credit

Public policy designed to encourage home ownership has operated primarily through the federal income tax system in the United States. With multiple incentives for home-ownership, the income tax system is the main tool by which the federal government encourages families to become home-owners and accumulate wealth in the form of real estate. Recent policy debate over reform of the tax system has questioned whether a mainstay of this system, the mortgage interest deduction (MID), is the best way to accomplish the stated objective. Last year the President's Advisory Panel on Federal Tax Reform recommended converting the MID into a 15% tax credit subject to regional caps related to median house prices, touching off a vigorous public debate on the importance of the MID. The purpose of this paper is to examine economic implications of that recommendation. We model how switching from the MID to a credit would affect housing finance choices between debt and equity and show how these changes would have changed the tax benefits for various households. Furthermore, we simulate the number of mortgage originations in 2004 (the most recent year which data is available) that would have been subject to the caps in the Panel's recommendation, and we identify the specific urban housing markets that would have been most severely affected. Finally, we conclude with policy discussion of the proposed credit alternative.

Emerging Competition and Risk-Taking Incentives at Fannie Mae and Freddie Mac

Abstract: This paper examines two major forces that may soon increase competition in the U.S. secondary conforming mortgage market: (1) the expansion of Federal Home Loan Bank mortgage purchase programs and (2) the adoption of revised risk-based capital requirements for large U.S. banks (Basel II). The authors argue that this competition is likely to reduce the growth and relative importance of Fannie Mae and Freddie Mac and hence their franchise values and effective capital. Such developments could, in turn, lead to more risky behaviors by these two GSEs. It is this last consequence that warrants greater regulatory awareness. JEL classification: G21, G28 Key words: government-sponsored enterprises, mortgages, securitization, risk-based capital, moral hazard, charter value I. Introduction The Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) dominate the U.S. secondary market for conforming singlefamily residential mortgages as both investors in and securitizers of these loans. (1) For example, in 2002, these two government-sponsored enterprises (GSEs) acquired the credit risk on $1.5 trillion in conforming mortgages, or 78 percent of the $1.9 trillion in conforming mortgage originations that year. (2) Such activity over the past decade or so has resulted in Fannie Mae and Freddie Mac becoming the second and fourth largest U.S. companies, respectively, when ranked by total assets as of year-end 2002. As GSEs, Fannie Mae and Freddie Mac have federal charters (3) that include provisions that serve to lower their operating costs directly (e.g., state and local income tax exemptions) as well as create the perception that their obligations have implicit federal backing (due to, among other things, having access to a line of credit with the Treasury). (4) The presence of such federal benefits naturally leads to questions about their purpose, size, and distribution. That is, should the federal government support housing finance through GSEs? and if so, how they should be structured so as to maximize social benefit and minimize taxpayer risk? Indeed, public interest in these issues has recently been heightened in the wake of hedging and accounting travails at Fannie Mae and Freddie Mac (Frame and White, 2004). Like the mortgage interest deduction and a myriad of other governmental policies, Fannie Mae and Freddie Mac are a mechanism by which the federal government encourages the construction and consumption of housing. (5) While such encouragements do provide benefits for households in their roles as buyers and consumers of housing services, these benefits are not free. The encouragements for housing significantly reduce the resources available for and thus impose costs on the other sectors of the economy (e.g., Mills 1987; Taylor 1998). Further, it's unclear that that federal sponsorship of Fannie Mae and Freddie Mac actually has a material impact on homeownership rates (Feldman, 2003). As a result, Calomiris (2001) and White (2003) argue that Fannie Mae and Freddie Mac should be fully privatized and replaced with targeted explicit subsidies for first-time, low- and moderate-income homebuyers. Such subsidies, the authors argue, would be more effective in dealing with the genuine positive externality that accompanies home ownership and would be less distortionary. The size of Fannie Mae's and Freddie Mac's obligations raises questions about the extent of potential taxpayer liability, systemic risk exposure, and the appropriate safety and soundness regulatory regime for GSEs. As of year-end 2002, Fannie Mae had total assets totaling almost $890 billion and net off-balance sheet mortgage guarantees of over $1.0 trillion, while Freddie Mac had about $720 billion in total assets and net off-balance-sheet mortgage guarantees of over $740 billion. (6) Furthermore, both of these enterprises are highly leveraged, with ratios of total equity capital to total assets of 3. …

Regional Differences in the Utilization of the Mortgage Interest Deduction

The value of federal income tax deductions, such as the home mortgage interest deduction (MID), varies across geographic regions. This study uses 1995 tax data to investigate the extent to which the current mortgage deduction is used and how the utilization differs across regions. The authors show that substantial regional differences in using the MID are related to differences in income, the level of house prices, the rate and form of state and local taxation, and demographic differences that affect homeownership and the amount of mortgage debt. About 40% of the explained regional variation in itemization is due to regional differences in house prices; another 20% is due to differences in state and local income and property taxes. About two thirds of the explained regional variation in the average size of the MID is due to regional differences in housing prices and state and local income and property taxes.

The Benefits of the Home Mortgage Interest Deduction

The home mortgage interest deduction creates incentives to buy more housing and to become a homeowner, and the case for the deduction rests on social benefits from housing consumption and homeownership. There is little evidence suggesting large externalities from the level of housing consumption, but there appear to be externalities from homeownership. Externalities from living around homeowners are far too small to justify the deduction. Externalities from homeownership are larger, but the home mortgage interest deduction is a particularly poor instrument for encouraging homeownership since it is targeted at the wealthy, who are almost always homeowners. The irrelevance of the deduction is supported by the time series which shows that the ownership subsidy moves with inflation and has changed significantly between 1960 and today, but the homeownership rate has been essentially constant.