The mortgage-interest tax deduction
I see this claim a lot:
"The federal tax system gives us a handout, through the mortgage-interest deduction, to help us purchase these pricey homes."
But the claim is false. Making mortgage interest tax deductible was a one time windfall to those who bought houses before it was known that the interest would be made tax-deductible. Once that's fact became known, it was included in the house price. Today, homeowners pay more for a house than they would if the mortgage interest was not tax-deductible: in fact, the price is higher by the present value of the stream of future deductions, at least in equilibrium. Thus, there is no net benefit for homeowners. (Of course, if the deduction were repealed, house prices would drop, so repeal would certainly hurt present homeowners.)
"The federal tax system gives us a handout, through the mortgage-interest deduction, to help us purchase these pricey homes."
But the claim is false. Making mortgage interest tax deductible was a one time windfall to those who bought houses before it was known that the interest would be made tax-deductible. Once that's fact became known, it was included in the house price. Today, homeowners pay more for a house than they would if the mortgage interest was not tax-deductible: in fact, the price is higher by the present value of the stream of future deductions, at least in equilibrium. Thus, there is no net benefit for homeowners. (Of course, if the deduction were repealed, house prices would drop, so repeal would certainly hurt present homeowners.)
I'm not seeing how this could be true of new houses
ReplyDeleteLets say the cost of a house (land+labor+materials) = 90,000 and the builder makes $10,000 profit.
Lets assume that land is in plentiful supply and the quantity of labor and raw materials used in the building industry is small so any changes in demand for houses will not affect their prices very much.
The govt start to subsidize home loans so the demand for houses goes up. Initially the price of houses goes up and so does the profits of builders. This will very likely lead to the supply of new houses increasing until the prices (and profits) are back to where they were before the change.
So buyers really do benefit from the loan subsidy as they can buy the same house for less when both the cost of the house and the cost of the loan are taken together.
And as I can only but think the prices of existing houses is pinned by the prices of new houses so I'm going to be bold and challenge your claim !
(Even if you relax my assumptions on land, labor and raw-material prices then I don't think the gain to home-buyers is lost completely unless you take them to the opposite extreme)
I think I may have over-stated my case: the right statement would be *most* of the deduction goes into house prices.
DeleteBut...
"Lets assume that land is in plentiful supply and the quantity of labor and raw materials used in the building industry is small so any changes in demand for houses will not affect their prices very much."
This is not good S&D analysis. Draw the curves, and then move the demand curve. Most definitely, the price goes up. That is standard micro I.
When I first read your post my first thought was "well, it would depend upon various elasticiities of supply and demand, wouldn't it"?
DeleteAnd I ended up thinking about it in the way I described where (with some likely unrealistic assumptions) all the benefits went to home buyers just to prove the point.
You're right - assuming normal sloping supply and demand curves the prices of houses will rise - this is (sort of) captured in my "Even if you relax my assumptions on land, labor and raw-material prices then I don't think the gain to home-buyers is lost completely unless you take them [the assumptions] to the opposite extreme".
I'm telling you guys, the demand curve is probably not as elastic as you think.
DeleteIf the mortgage tax deduction goes away, I am pretty sure Landlords Inc. will be perfectly willing to step in and borrow the money instead, deduct the interest as an expense, and buy up those houses to rent out, jacking up prices in the process just the same. Yeah, maybe you could make policy somehow disallow deductions for any loan with houses as collateral for everyone, but people would probably find a way to game it.
Another approach might be as I heard proposed as part of the Trump rax plan (which may or may not be true, as I am not sure they ever released an official plan) to just give everyone a ginormous standard deduction and get rid of the itemized stuff (like the mortgage interest deduction). I think that would have the advantage of letting renters in on potentially not paying taxes on their housing expenses (the same way homeowners aren't taxed on imputed income), but I think the downside would be it would appear pretty regressive on the low end of the income curve (because if it was,say, $50K, then everyone who made less than that would not get the full benefit).
But eh, whaddaya gonna do? Tax policy is hard. I think the eggheads have at least got it pretty close to right on this point. I used to also be of the opinion that the mortgage interest deduction was bad policy...until I became a landlord and realized I was competing with average people for houses. They should have the same consideration as a business gets. To not have it would really slant the playing field and distort markets. Would almost be anti-distributist. :)
I like to call IP a handout to irritate people in favor of it.
ReplyDeleteI kind of think this isn't true (the quote from the article and also your own analysis.)
ReplyDeleteYour analysis would be correct if you were talking about property taxes. Property taxes do take a chunk out of the imputed income from owning a house, and so when discounting to NPV, the price would be lower. But the mortgage interest deduction is merely taxing *one way of paying for housing*, and not the housing itself.
I think if you got rid of the deduction, you would see more people renting and more people paying cash, which would then reduce demand for mortgages and therefore the interest rate and also probably fees and closing costs charged by lenders (maybe it would make it cheaper to buy points, too, or something like that). But I don't think the price of the house itself would change much.
So maybe it is a subsidy for banks or something, if it is anything at all. I wouldn't get rid of it, though. Should businesses pay income tax on interest they pay on loans, or should that be deductible as an expense? I think if you answer that question, you've answered the question for housing. The 'real' controversy (to the extent there might even be one) to me is that imputed income from owning a home is not taxed. But even there, it kind of is -- through the property tax. Seems like basically the federal government has set aside this kind of taxation for state and local levels and doesn't cut into it.
But what do I know?
Interesting point: the percentage of cash buyers is much higher than I would have guessed!
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