Are tax breaks immortal?
WASHINGTON -- If you want to understand why the tax code is so hard to overhaul, consider the case of the mortgage interest deduction. The issue is so sensitive that the House and Senate are dealing with it in completely opposite ways.
To its many defenders and beneficiaries, the mortgage interest deduction symbolizes and subsidizes the American Dream. It promotes homeownership, which gives people a stake in stronger neighborhoods and safer streets. And, of course, homeownership is the ticket to the middle class.
By allowing homeowners to write off their mortgage interest expenses -- thus reducing their taxes -- the government purportedly encourages all these good things. The cost in lost tax revenue is considered money well spent. In 2017, that would be $64 billion, according to the Office of Management and Budget.
Case closed? Not exactly. For years, many economists have argued that the standard narrative about the deduction is mostly a self-serving fairy tale. The reality, they say, is that the subsidy promotes oversized homes and higher real-estate prices. Upper-middle-class households are the main users of the deduction, which barely -- if at all -- raises the homeownership rate.
"People are being bribed by the government [through the mortgage interest deduction] to buy exceptionally big homes," says economist Jonathan Gruber of the Massachusetts Institute of Technology. In effect, there's a subsidy for McMansions. Homeowners rely more on debt, because some interest expense can be written off.
Gruber recently did a study with economists Henrik Kleven of Princeton and Amalie Jensen of the University of Copenhagen that seems to prove the point. Like the United States, Denmark has a mortgage interest deduction. In 1987, the Danes reduced the deduction's generosity. If the deduction increased homeownership, a reduction should have diminished it. That didn't happen.
"The mortgage deduction has a precisely estimated zero effect on homeownership," the study concluded. "Just under 60 percent of the population are homeowners, a number that has stayed remarkably constant over time," it said. This stability suggests that factors other than sheer economics -- culture, psychology, geography -- influence homeownership.
The erosion of the subsidy did have an effect but not on homeownership. What did decline was the size of homes people bought and the amount of debt they assumed.
The same dynamic applies to the United States, Gruber says. For decades, the homeownership rate has hovered around 64 percent. It spurted briefly to nearly 70 percent during the 2000's housing "bubble" but has reverted to 64 percent.
Reducing or eliminating the deduction would cause homebuyers to purchase smaller homes with less debt -- a good thing, Gruber says. People could use the extra cash to save for retirement, to pay for children's college or to cover daily expenses.