Could eliminating the mortgage interest deduction create a stronger housing industry? Definitely, if you focus on the economics of the future, not the traditions of the past.
Why does Warren Buffet think it’s right to be fearful when others are greedy, and be greedy when others are fearful? Because it’s un-common sense that often leads to the greatest opportunities.
That’s why I’m contrarian when it comes to saving the mortgage interest deduction. I learn from the past; not simply preserve it. I’m okay with asking, what might happen if we moved on? Other industries repealed their subsidies, and grew stronger. New Zealand farmers did it in the 1980s. They’re growing faster than at any time with subsidies. If farmers, why not REALTORS?
Could we really eliminate the mortgage interest deduction (MID)?
Two Presidential commissions have recommended eliminating it; so, too, many researchers. Of course, the deduction remains popular. Bloomberg notes that 51% of Americans support keeping it. Still, that’s 41% said they’d be willing to give it up.
But doesn’t the mortgage interest deduction help first time buyers convert from renting? That’s seems a fine piece of circular reasoning, that usually comes from a “post-purchase cash flow scenario” compared to renting. You see, you can’t access the deduction if you can’t access homeownership.
And these days, to access home ownership, you need something the MID doesn’t offer: Cash.
Even after home ownership, MID’s effectiveness appears marginal.
It only helps Americans who itemize their federal taxes. Fewer than 40% of Americans do, says the Tax Foundation. Among homeowners, only half do. Of those that itemize, two-thirds have incomes greater than $75,000.
That’s not the profile of a renting first time buyer who need help these days.
What about the unintended consequences of tax subsidies?
Writing off mortgage interest impacts how much people borrow. It certainly didn’t discourage people from borrowing to the hilt last decade. Interest-only loans seem the very antithesis of home ownership. Before the great wars, hardly anybody borrowed to buy a home in America. In the postwar period, the social norm was to put 20% down. By 2010, the typical buyer financed 92% of their home. Some even more with government backing.
Writing off mortgage interest matters, but perhaps not the way we expected.
What’s the MID worth?
An average of $2,000 last year for those that claimed it. But it cost the government around $100 billion in the budget, including the borrowing for it. That’s called taxes.
Can we predict what would happen if MID went away.
I believe we can. In fact, I think the market wouldn’t care. According to the National Association of Realtors August 2011 Confidence Index, nearly 29% of single family home purchases was completely cash. The Boston Globe reported more than a third of homes sold in Massachusetts this year were all cash. Some were investors, but not all. Nearly all of the foreign buyers from Canada and Brazil are using cash to snap up deals in desirable markets, too.
If a third of the marketplace bought homes last year, without the benefit of the mortgage interest deduction, then it tells us that MID isn’t a big incentive for home ownership.
What is? Cash.
How would eliminating the mortgage interest deduction give more buyers more cash?
Simple: Apply the $100 billion federal budget savings towards lowering their federal tax burden. That instantly puts more cash in more pockets with every paycheck.
Read the tea leaves: Today’s consumers are as careful about borrowing as banks are about lending. We might even return to using cash, if debit card fees keep rising. Certainly, Baby Boomers won’t leverage up again in their lifetimes. They spent much of their home equity on college tuitions; they will hedge what’s left against health care costs. Too many lost it all in the last decade, anyway. As Boomers exit the workforce, it’s cash-and-carry for them.
What about first time buyers?
Today’s college graduates are carrying an average debt load of $30,000. Unemployment and wage stagnation for twenty-somethings means renting a lot longer than their parents. They will remain unqualified for new mortgage debt until they can earn more cash to pay down their existing debts.
The mortgage interest deduction doesn’t address these problems.
But returning the $100 billion every year to consumers’ paychecks will. Eliminating this (and other) subsidies, and lowering taxes, is the best way to increase everyone’s access to home ownership. Higher paychecks help people sustain mortgages every month. They could even reduce strategic defaults and foreclosures during tough times.
Imagine a tax policy that built business cycle resilience into the housing market by giving people more cash.
Can history guide us?
We know direct buyer tax credits don’t work, so it’s hard to imagine how sustaining the MID will work to increase home ownership. Historically, writing off interest has never been a good idea. Prior to the Tax Reform Act of 1986, credit card interest was deductible. You could buy a TV on your credit card and get a tax rebate from the IRS. We quickly put a stop to that. But we left the job unfinished, with the MID remnant haunting the tax code for more than 25 years.
If we accept that giving away direct credits didn’t work, maybe we need to examine if giving tax deductions really works either. Especially when a third of the market says it’s perfectly fine taking action without it. As long as it has the cash. Tax policy should support the marketplace as it will be in the future, not how it was in the past.
It’s not just home ownership that’s at sake; it’s the future of home sellership as well.