Encouraging Homeownership?

Whaddya say we give about $77 BILLION to the middle and upper middle class to help them buy homes?

If from a standing start, the policy considerations started out that way, I doubt it would be particularly popular. Nevertheless, that’s roughly what America does every year through a tax deduction called the Mortgage Interest Tax Deduction.

Basically, the idea works like this: When you pay your mortgage, you pay the bank Principal (usually) and Interest (always). The interest is the cost of borrowing the money – it’s a personal expense like utilities, your mobile phone bill, or food. But it’s an expense only born by those that can afford to, and have chosen to, buy a home. Now to encourage you to take the risk of buying a home (the perceived justifications for this we’ll come on to) the US government allows you to take that interest cost and deduct it from your income to reduce your taxes.

Here’s how it works…

Tim earns $100,000 per year. Tim owns a house that he bought for $900,000, for which there is an $800,000 mortgage. With an interest rate of 5%, Tim’s annual mortgage interest is $4,000.

If the income tax rate is 40%, under normal circumstance, Tim would pay $40,000 in tax, and be left with $60,000. With a mortgage interest tax deduction, the $4,000 Tim paid in mortgage interest is deducted from the gross $100,000 earned before taxes are calculated. Thus, it’s as if Tim only earned $96,000, and would thus pay $38,400 in tax, keeping $61,600. The benefit of the deduction is $1,600 more in Tim’s pocket!

Now consider a few additional points:

  1. The bigger a mortgage you take on, the more you save. Americans can declare mortgages worth up to $1 million (including on second homes such as ski lodges or summer homes).
  2. Therefore, rouhgly speaking the wealthier you are, the more of a benefit this represents.
  3. This is a particular incentive to those that live in parts of the US with higher home values, and thus bigger mortgages.
  4. The benefit can only be declared if taxes are ‘itemized’. This effectively means that it only helps those with incomes and deductions high enough to exceed basic personal allowances (in various jurisdictions, individuals don’t pay tax on the first, say, $4,000-$11,000).
  5. It’s usual to allow businesses to deduct expenses like interest from their profits before charging corporate tax, but mortgage interest is one of the only deductions offered for personal income tax purposes. Like I said before, you don’t get to deduct your utilities or mobile phone (save to the extent that you use them for business).

So with a basic understanding…why is this in place? The initial implementation was a vestige of the pre-WWI US economy. In 1913, the US enacted income tax, which featured a deduction for all forms of interest (not just mortgages but other loans too, etc.). But the income tax also only impacted income over $3,000, a level earned by only 1% of the US. The sense in offering a deduction was that those earning over that were likely declaring business income from farms or other small family businesses. In this case, offering a deduction for personal interest encouraged business investment.

Fast forward to 1986. Amendments were made to income tax deductions that stopped deductions for interest….except mortgage interest. A real estate lobby was strong enough at that point to encourage this to continue on the premise that homeownership was an important social end for the stability of communities and the wealth of American families – a premise long challenged and one I struggle with personally as a strong proponent of rental housing. This is largely the basis for the maintenance of the deduction today. See this recent press release from the National Association of Realtors on the subject.

Here’s why I struggle:

  1. There’s very weak evidence that this deduction actually stimulates homeownership. Indeed Canada doesn’t have the deduction, and has a higher homeownership rate than the US. Granted Canada offers other incentives like nil capital gains tax on the sale of the personal residence….but the point remains.
  2. I don’t really understand why homeowners cause stronger communities than renters. Indeed few challenge the strength of German or Swiss communities, and they have far lower rates of homeownership than the US (c.52% and 44%, respectively vs c.64% in the US and c.67% in Canada).
  3. At low rates of income, American’s can’t really take advantage of the deduction anyway, so I don’t see how it’s support for the aspirations toward homeownership.
  4. If indeed it does somehow support homeownership, it’s a demand-side subsidy, which would have the effect of driving prices up, rather than a supply-side subsidy (creating more housing) which would make the cost of housing actually cheaper for more people to access.

I think the National Association of Realtors’ release supports my point. They argue that  homeowners are wealthier (allegedly 45x that of renters), and concern that prices could fall by as much as 10% if the deduction is dropped (feels high given my worked example above, but let’s say they’re right). I think the intentions here are pretty transparent…wealth transfer to the middle class…but why?

By contrast, the budget for Housing & Urban Development, the department that supports affordable housing initiatives for those priced out of housing altogether (as both renters and homeowners), looks like it will be just c.$38bn this year…vs. a subsidy worth twice that for people like me who would likely endeavour to buy homes regardless of the deduction.

This one’s a big sticky subject, but as ever….would love your views.

The reading list:

  1. NYT – Who Needs the Mortgage-Interest Deduction, 2006
  2. Atlantic – Taking Aim at the Mortgage-Interest Deduction, 2017
  3. NAR – House Delivers Tax Hike on Homeowners,  2 Nov 2017
  4. Glaeser + Shapiro – The Benefits of the Home Mortgage Interest Deduction, Jan 2003
  5. Wikipedia – Home Mortgage Interest Deduction
Encouraging Homeownership?

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