Modifications in mortgage interest deductions to stimulate homeownership!

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Industries that employ middle-class workers promote homeownership thanks to the mortgage interest tax deduction. There is also broad public support for this deduction with six out of ten Americans being against its elimination.

Nevertheless, analysts warn that this support is misplaced given the fact that more than 64% of the MID tax benefits are enjoyed by tax filers who earn over $100,000 a year. A study released by the Mercatus Center at George Mason University indicates that the main beneficiaries of the deduction are people with high income. Almost no benefits at all reach the low-income households interested in making a home purchase.

In addition to performing an assessment of the effectiveness of the tax break policy, the study also looks into the mortgage interest deduction. Based on the available data, policy makers should seriously consider a replacement of the MID with a fixed $900 credit that applies to all taxpayers who have a mortgage.

The ultimate goal for the housing-related tax credits and deduction lies in the stimulation of homeownership. In the current format, the MID does not provide enough support for the increase of homeownership among its intended beneficiaries. The results are quite contrary to the intended ones as the policy encourages a higher debt level among homeowners. Briefly, the MID provides a tax break to tax payers who are the most likely to buy homes due to their high income. The advantage of the MID to high income households is that they thus get access to homes that are approximately 10 -20% larger than those they would otherwise purchase.

The inconclusiveness of the relationship between homeownership and MID is reflected in the policy of other countries too. After the United Kingdom eliminated the MID, there was a major increase in homeownership between 1975 and 2000 from 53% in 1974 to 68% in 2001. Although it may be hard to determine objectively whether homeownership increased because of the MID phase out, it was clear that this measure did not impact homeownership negatively.

The objective would be to stimulate homeownership among buyer categories that don’t have sufficient funds (i.e. savings) to buy home equity. Nevertheless, there are foreign countries like Switzerland where there are low homeownership rates despite higher rates of household savings.

Hence, the elimination of the MID would have a minimum impact on low- and middle-income tax payers. Economic inefficiencies can only be eliminated by a full cancellation of tax-favorable housing policies in exchange for lower marginal tax rates for all tax payers. The living standards would improve for all low- and middle-income tax payers if the MID were replaced by higher standard deduction and lower marginal rates.

The Tax Reform Act of 1986 proved this hypothesis as it reduced marginal tax rates and increased the standard deduction. Lower- and middle-income households used the MID less and less; the reduction was not that large for high-income households either.

With the elimination of the MID, there may be a slight decrease in the housing demand among certain low-income categories of prospective buyers that can itemize thanks to sufficient mortgage interest. This decrease does not appear significant due to the fact that the MID has a low frequency of use in low-income cases. It is large loans with limits above those set by Freddie Mac and Fannie Mae that will suffer a major decrease.

The housing industry would break free from the current tax-driven over-evaluation if a better tax code were implemented. If a revenue-neutral tax reform was enacted, the tax bias towards housing might change. This means that instead of housing investments, higher-income households would shift focus to bonds or stocks.

Promoting homeownership among low and middle-income households should be a priority if tax-favored housing must exist. The government needs to support those homeowners that don’t have the financial means to purchase a home without federal subsidy; this support would come from a different tax-favored housing policy. If a $900 credit was provided as non-refundable to mortgage owners, there would be a 5% increase in homeownership among low- and middle-income households. This shift could also cause a 1% decrease among high-income households.

The reform of the MID from deduction to credit implies that the policy goals of supporting homeownership would match reality. A simple tax code could also cause a step forward in higher tax fairness, while increasing equality of investment opportunities.

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