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How the mortgage interest deduction hurts our cities

How the mortgage interest deduction hurts our cities
MinnPost photo by Corey Anderson
The mortgage interest deduction, according to a 2010 analysis by the Tax Policy Institute, disproportionately benefits the top fifth of earners.

Homeowners these days remind me of the 600 members of the Light Brigade -- you know, those "half-a-league-half-a-league-onward" guys. But instead of having cannon to the right of them and cannon to the left, they are beset on all sides by policy wonks who would like to eliminate or scale back the home mortgage interest deduction or MID.

Just to remind you, or in case you are somewhat tax-challenged, people who own their homes are allowed to deduct from their income all interest paid on any mortgage up to $1 million. So, if your interest comes to $10,000 a year and you're in the 28 percent tax bracket, you save $2,800 on your taxes.

Even though they hinted, Mitt Romney, Paul Ryan and President Obama didn't have the cojones during the campaign to say that this deduction, which has been one of the pillars on which American homeowners based their investment in a dwelling that was a huge multiple of their earnings, might disappear. But analysts at the Cato Institute and the American Enterprise Institute (on the right), the Brookings Institution and the Center for American Progress (on the left) and the Simpson-Bowles Commission (bipartisan) have all said that maybe we can't afford it any longer.

Now comes criticism of the MID from another quarter: Smart Growth America, a nonprofit whose aim is to fight urban sprawl and "make it more affordable to live near work and the grocery store." A report out this week called "Federal Involvement in Real Estate"  takes a holistic look at the government's $450 billion annual spending on grants, loans, loan guarantees and tax breaks for housing and commercial property. The report's contention: "U.S. taxpayers are failing to get the most out of all these large federal investments."

So what else is new?

The largest share of the federal government's involvement in real estate comes from FHA loans and loan guarantees, about $1.23 trillion from 2007 through 2011, according to Smart Growth America. It's not all money out the door. Only if homeowners fail to repay does the government lose money. Of course, bad loans have currently put the agency in the red by about $34 billion.

After that, the government's biggest commitment to real estate is the home MID, which accounted for $400 billion in tax expenditures over the same five-year period, says Ilana Preuss, Smart Growth America's vice president. Tax expenditures, in case you're wondering, are revenues the government gives up by allowing credits, deductions, exemptions and other goodies.

Broad political spectrum

It's hard to believe that so many analysts from such a broad political spectrum are coming out against a tax break that has been termed "the other third rail of American politics," the first third rail being Social Security. Supposedly, any politician who recommends its disappearance or phase-out would incur such wrath from the 65.5 percent of households who own homes that he or she would immediately frizzle like bacon on an overheated griddle.

But when there's a $1.1 trillion budget deficit lying out there, any government giveaway deserves some scrutiny. And, much to my surprise, a December poll conducted by Princeton Survey Research Associates found that 41 percent of the public favored reducing the mortgage interest deduction for all taxpayers. (Twenty-one percent wanted it pared for those earning over $250,000, and 31 percent opposed any change.)   

So what is the rap on the mortgage interest deduction?

Well, according to Preuss, it is no longer doing the job it was designed to do, namely encourage homeownership, which, to the American way of thinking, is an absolute good (a belief that may be debatable). For evidence, she relies on another study — by the Reason Foundation, a libertarian think tank. It points out that while the total amount devoted to the mortgage deduction has fluctuated since 1994, homeownership has remained fairly constant, at about 65 percent. (It climbed to nearly 70 percent during the housing bubble, but then collapsed when it burst.)

The deduction doesn't induce lower-income people to buy homes. If they can't itemize — because the standard deduction is larger than their write-offs — they can't claim it. Instead, the MID encourages those who are well off to spend more on a house they would have bought anyway — or to take out a bigger mortgage and go more deeply into debt.

The deduction, according to a 2010 analysis by the Tax Policy Institute, disproportionately benefits the top fifth of earners — because the bigger the mortgage and the higher your tax bracket, the more you save. In 2010, for example, households with incomes over $200,000 received a $6,253 write-off, those earning $75,000 to $100,000 got a $1,046 deduction and people with incomes of $20,000 to $30,000 saw a tax benefit of only $340. About 40 percent of the $72 billion in revenue forgone by the government went to families with incomes over $200,000. Another 35 percent went to households whose annual incomes were between $100,000 and $200,000.

Second homes

Preuss of Smart Growth America points out another inequity. "The mortgage interest deduction can be claimed on second homes as well," she says. Some 30 percent of those who take the deduction on their principal residence take one on a second, too. In the meantime, those who rent apartments receive no write-offs at all.

Giving such a hefty tax advantage to homeowners over renters encourages the construction of single-family homes rather than apartments. And this is continuing at a time, says Preuss, when families increasingly want apartments. If financial incentives were neutral, cities would probably have more people living in more efficient patterns (in smaller homes or multi-family buildings) closer to their jobs.

What if the deduction were withdrawn? Would the housing market collapse?

To hear the National Association of Realtors tell it, the result would be disastrous -- a drop in housing values of about 17 percent. But that's a matter for debate. Jeremy Horpedahl, an assistant professor of economics at Buena Vista University in Storm Lake, Iowa, calculates that housing sales might drop by 0.4 percent; home prices by 3 to 6 percent. Of course, seeing any retreat in the housing market now that it's making a comeback would not be a terrific development, to say the least.

Smart Growth America is still formulating its recommendations on the MID, FHA and everything else. But others have already determined that the MID must go. Both Simpson-Bowles and the Center for American Progress advocate dumping it and phasing in an 18 percent housing tax credit. (A credit is deducted dollar-for-dollar from your tax bill.) So if a family pays, say, $8,000 in mortgage interest each year, it would get a credit of $1,440, no matter their tax bracket. And they would not have to itemize to receive it.

That fix would still not rectify the imbalance between renting and owning. But it might go a long way toward correcting our tax code's tendency to give breaks to those who need them least.

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Comments (28)

Photo

Interesting photo choice on a story about suburban sprawl.

The article isn't about

The article isn't about suburban sprawl, it's about the MID. It just so happens that one of the entities against the MID believes that it promotes urban sprawl and is attempting to fight said urban sprawl.

The larger point of the article, and of the slightly less biased organizations, was that the MID as it sits serves mainly those higher income individuals with larger mortgages and second homes. The picture of what appears to be higher end homes in, again what appears to be, a higher end neighborhood fits the larger point of the article quite well.

why dismiss the suggestion so quickly?

Why does it make someone "biased" to suggest that the MID contributes to sprawl? That word gets tossed around too much. It either does or it doesn't. And considering it gives incentive for people to buy and build bigger houses on more land than they could otherwise, it seems to be reasonable enough supposition to at least engage.

Interest deduction

If this deduction were taken away those in middle class and on down would be financially devastated. Whether banks will admit it or not they take into consideration the interest deduction when they determine an eligibility for a mortgage loan. Raising someones taxes that much would start another housing crisis, Many, many people depend on that deduction to make ends meet.

Not True

Banks don't take any taxes or credits into account when looking at eligibility for a mortgage. All mortgage approval follows the same process, and it's all done on net income.

"Many, many people depend on that deduction to make ends meet."

The fact that this is true says 2 things:

1) Realtors are successfully pitching this to potential homeowners as one of the benefits of buying a home, a major factor in influencing home buy vs rent choice (which also favors suburban sprawl). The lower cost of mortgages/tax/insurance per sqft compared to an apartment seems great until people realize the maintenance costs of their homes.

2) These people should not have purchased the home they did if they are relying on MID to "make ends meet." Barring some extreme circumstances (unexpected long-term medical issues and bills, taking on additional family members, etc) I would bet that the vast majority of those teetering on not making ends meet even with MID are in the situation because of stretching their budget too thin in an effort to get their "dream home/location."

Also, as the author points out, most families in lower income brackets (I would suppose many of them that come close to the ~54k median US salary) cannot itemize deductions and therefore cannot take advantage of this MID anyway.

I would further guess that the recommendation by Smart Growth America would not be an immediate end of MID, at the very least for people already owning a home and taking advantage of it. A phased approach for existing mortgages, immediate removal of the second home deductions, and a change to how progressive the deduction is for higher earners. Assuming congress/Obama is willing to put it through...

itemized deductions

"The deduction doesn't induce lower-income people to buy homes. If they can't itemize — because the standard deduction is larger than their write-offs — they can't claim it."

They can't claim it before they buy a home. But the interest amount, even for smaller home mortgages, surely is what kicks most people at the margin over the threshhold so that they can start itemizing, especially when coupled with the property tax deduction.

Many low-income homeowners don't...

Many low-income homeowners don't itemize at all, and so don't get the credit. Even after they buy the home and are paying on a mortgage.

Apartments vs Houses

You neglected the fact that houses cost more than apartments. I dump a fantastic amount of money improving and maintaining my house, let alone the increased costs like utilities. The MID helps offset some of these costs. (Also, isn't there a property tax refund for renters making under a certain amount? I got it a couple times when I was in college.)

And being a middle class family that depends on MID and other deductions, you're damn right that I would protest its elimination. If our society can't afford that, then we surely cannot afford a bloated defense budget. Let's talk about the elephants in the room before we talk about the mice.

I will not sit and abide further attacks on the tax benefits received by the middle class. My wife and I will lose about $200 a month (that's TAKEHOME pay) because the payroll tax holiday expired, whilst the 1% won't notice it. We certainly do have a tax problem in this country -- namely, it's far too regressive.

That needs to end.

Renters tax credit nearly gone...

While this renters tax credit did exist when you were in college, it was always a significantly smaller (percentage-paid-wise) credit than the homeowners credit. And, during the budget cuts of the last many years, it was raided more than once to close the gap and balance the State's budget.

It does still exist, but it's much, much tinier now than it was when you were in college. And even then, you got shortchanged.

$200 a Month

If you're losing $200 a month to an increased payroll tax, you aren't middle class.

nice recap

This is a good summary of this huge, long-standing, regressive homeowner subsidy. I first read about the unforeseen negative side effects of this in David Cay Johnston's book, Perfectly Legal, which is all about the US tax code and how its weighted to favor the (very) wealthy. (http://www.salon.com/2004/02/09/johnston_8/) The Mortgage Interest Deduction merits a chapter.

yes on MID phase out

The myth of the mortgage interest deduction needs a counterattack so that the public gets re-educated. Harris' piece is a good start. With young people and oldsters renting more, we are seeing the beginning of a good trend. This should help. Also as Harris, explains, there are other ways to compensate lower income home buyers. Glad she's writing for MinnPost.

I don't see the connection

while the value of home ownership is indeed questionable these days, how exactly does it benefit cities if more people rent? Pushing people to rentals will not automatically get them out of the suburbs

As for this "Instead, the MID encourages those who are well off to spend more on a house they would have bought anyway — or to take out a bigger mortgage and go more deeply into debt." have you got any supporting evidence? I think it encourages people to buy because we know there is that deduction, but the blame for overspending or over-extending more likely belongs with mortgage brokers.

I agree there is no sense in having this deduction for 2nd homes though.

And the timing of this could not be worse. People like me with underwater mortgages in combination with recession induced income reductions need any bit of help we can get, that deduction might mean I can replace a few items in my wardrobe which are full of holes when I get my tax refund.

At the end of the day, it is

At the end of the day, it is the homeowner that signed the paperwork, not the mortgage broker. I am a Realtor, and I saw many times during the bubble years where people were buying outside of their abilities, against their agent's advice, simply because they could. They did not think about the future, they only saw dollar signs. Ultimately, it's the homeowner that took the shortcut to ownership laid out by the real estate agents, mortgage brokers, banks, and the government. Just because the road is there, doesn't mean you need to go down it.

The MID should be seen as an incentive, and not be relied upon to make ends meet as many people do. I do believe we should phase out the MID, along with most other credits and deductions available to persons and businesses. Remove the "tax loopholes", which will increase tax revenue, and that will allow us to lower the tax rate.

Yeah, because

brokers and banks never used any predatory lending techniques to get people interested or convinced they could afford XX.

You can use the rhetoric all you want that the deduction isn't an incentive (perhaps you personally don't, and I commend you for it). But the reality is real estate firms, large and small, pitch homeownership with all its benefits and include one of them being more affordable through the deduction. They will even calculate what the deduction will be for you come tax time given a mortgage amount and your salary.

renting and density

"while the value of home ownership is indeed questionable these days, how exactly does it benefit cities if more people rent? Pushing people to rentals will not automatically get them out of the suburbs"

I don't know enough to say whether this is correlation or causation, but the majority of renters in the U.S. live in multi unit buildings an use non-automobile transportation more than their home-owner counterparts (data here: http://www.nmhc.org/Content.cfm?ItemNumber=55508). Thus although renters may live in suburbs, they tend to live more urban lifestyles than others.

No, not all mortgage interest is deductibe!

Marlys says: "Just to remind you, or in case you are somewhat tax-challenged, people who own their homes are allowed to deduct from their income all interest paid on any mortgage up to $1 million."

Marlys, I think you are the one that is tax challenged. And just to remind you, qualified residence interest is deductible up to $1,000,000 for acquisition debt. Mortgage interest may not be deductible if is not related to acquisition debt. So, not all mortgage interest is deductibe.

You were saying?

So the disparity..

.. is you're saying vast sums of people have second mortgages on their homes not claiming interest deductions and therefore the MID isn't an incentive to buy a home nor is it a tax break the progressively favors wealthy home-owners?

Beyond that, the numbers she quotes in the study by Smart Growth America are only showing what the Federal gov't is already allowing under its own, current, policies. I'm confused by the argument?

seniors who have paid off mortgages get no benefit, either

Because this MID is on the INTEREST, the benefit is greatest on the mortgages that are largest and have the most interest.

That means
1) those who have paid off their mortgages get no benefit
2) those most of the way through paying off their mortgages (and who pay relatively little interest) get very little benefit
3) those with small mortgages get little benefit.

That means the MID has the least benefit for
1) seniors
2) fiscally responsible people or long-term homeowners
3) low-income people

There is also plenty of research doing international comparisons showing the MID doesn't actually incentivize homeownership, as other countries without a similar credit have similar ownership rates.

I'm not sure what good this big pile of tax expenditures -- which costs both the State of Minnesota AND the federal government huge sums -- gets us. It subsidizes upper-income households. And second homes (which lead to sprawl). And doesn't actually get more people owning homes (if that's really a good thing). And it costs us tons of money we might want to use elsewhere.

This homeowner, for one, is all for ditching the MID. Phase it out, if you have to. But I'd rather pay teachers.

Second homes leading to sprawl?

Back in the 1890's maybe when people had homes in Minneapolis and on Lake Minnetonka.

Not a lot of folks have a primary home in Hennepin County and a second home in an adjacent county.

Second homes are just as likely to be in another state or even another country I don't think this is a sprawl issue.

I don't think oldsters and youngsters are renting more anywhere but in the central cities and perhaps not by choice but because of income and health limitations. If you are in assisted living technically you are renting but it isn't driven by housing preferences.

Lots of good questions

The housing bubble seems to created a huge discussion about the value of home ownership - as an investment and as public policy with the additional discussion around tax policy.

I do know that the MID saves me money as a middle class person so I like it!

I think that it is generally safe to say that when people own something, they will take better care of it. Housing stock maintenance is generally higher with high levels of home ownership. It would be interesting to look at the data of housing maintenance citations around the metro and what percentage of problem properties are rentals. Indeed, there are numerous stories and controversies of neighborhood transitions when properties go from home ownership to predominantly rentals - neighborhoods around the University and St Thomas are prime examples.

As to the tax benefits to those who do not itemize, I assume that the standardized deduction is designed to include some comparable housing subsidy. In addition, we heard plenty in the presidential campaign about those who do not pay income taxes ( I do recognize that they pay a significant percentage of their income in other taxes!!!!) so the impact on lower income people may be minimal.

The idea that the MID affects choices of housing types and locations is questionable. A million dollar downtown condo mortgage = a million dollar exurban mortgage.

We have also seen the importance of housing investment to our economy. When housing construction stopped, our economy stopped. When someone buys an existing house, they generally invest additional money in the house with quality improvements. When investors buy a property to rent, a coat of paint and some cheap carpeting might be the only investment they make to get it rented in a hurry ignoring real maintenance investments.

Clearly, the large settlements that our banks are now quietly paying related to shoddy to illegal mortgage practices shows the housing bubble was a bit more than people buying more house than they could afford. Housing values are rising again and those that buy now are likely to get some nice returns on their investment over the long term. Personally, the idea of burning the mortgage and living in my home for the cost of utilities, taxes and maintenance sounds pretty nice!

I'm not understanding how the

I'm not understanding how the MID encourages urban sprawl, shouldn't it encourage urban growth? It's simply a fact across the country that prices are higher in urban centers for homes. The higher prices, the higher the MID deduction would be able to take. So, the MID deductions would be lower in the suburbs and higher in the cities, so if people want more of a deduction, stay in a bigger city.

Higher prices are what encourage urban sprawl. My $150,000 home I bought in the burbs would be $225-250k if it were within St. Paul's city limits, That is about $400-$500/month more you'd be paying out in a mortgage, which is more than the MID would give anyways. I'd rather live in the burbs regardless of the MID or not.

I'm actually in favor of getting rid of the MID entirely, but not on the same logic. You don't have try to justify taking a credit away, just say you want to make the tax system simpler. If a person now has a federal tax rate of 15%, and everyone in their income range over the past 20 years has had an average effective tax rate of 7%, take away all deductions and just make the tax rate 7%. Everyone wins, no complexities, you keep more of your money during the year, no need for the credits, and it doesn't matter if you own a home or not to get this rate. Just take the extra money, save it, and buy a home now. Win-win

Encourages Sprawl

The % of units that are rented is far higher in areas where population (and job) density are higher. The only exception is typically in the extreme central business district locations where high-rise condos exist.

So you are a potential Joe home buyer or renter, haven't decided yet. The number of properties available to buy (rather than rent), per acre, in centralized, more dense (and sustainable, both financially and environmentally) locations is fewer than areas further and further out. You also notice that price per sqft in the centralized area is higher than further out (as a result of lower land prices). You then also notice that the number of options to buy vs rent is vastly increased in the further out location. You determine that, with the mortgage interest deduction, you can afford to BUY further out instead of renting a smaller space closer in for the same price (sometimes even lower), and the MID helps go toward either the difference in price or the difference in transportation costs one incurs by living further out.

That is how the MID, among other factors of government spending/subsidizing of roads and development incentives, have helped shape our development pattern of sprawl.

I would argue that even though other countries have similar home ownership rates as the US without the incentive, and we've also proven the incentive's inability to further induce home ownership, that the MID is unsuccessful at bringing higher levels of home purchasers, but successful at determining the location. Without the MID, you would see far more small flat ownership or side-by-side/duplex/etc ownership than we do today. People would be making a choice to own and amortize some of the costs because they know they are in a stable job and community and want to stay.

Speaking of tax challenged

How do I benefit by taking out a $300,000 mortgage, paying whatever five-figure annual mortgage payment to get a $5000 tax deduction?

Because that $5,000 credit

offsets the transportation and/or maintenance costs associated with the 300,000 home. The alternative would have been renting at a higher $/sqft closer in but with lower maintenance/transit costs and less square feet. People see the benefit of more space for the same money, essentially.

Without this alteration in the free market of real estate, people's decisions would sway back in larger percentages to owning $300k home closer in with less space and lower transit costs OR renting a place.

Can we also take a step back

And evaluate the premise of the MID and other home-ownership boosting tactics? That is their goal - whether or not it is being achieved is up for debate. The premise, as far as I've seen, is that the American Dream of owning a home boosts the economy. Heck, we even use housing prices and number of new constructions and sales of existing homes as positive economic indicators.

However, a post by Richard Florida from earlier this year points out that by nearly all measures of economic output, home ownership rates are not correlated with positive results:

http://www.theatlanticcities.com/jobs-and-economy/2012/06/homeownership-...

"Still, our findings seem to undercut the conventional wisdom that homeownership and economic development go together.

The economic growth and development of cities and regions is generally thought to be driven by three key factors: innovation, human capital, and productivity. Homeownership, it turns out, is not related to any of them.

Take innovation and high-tech industry. Homeownership bears little relation to either, being weakly negatively associated with the concentration of high-tech industry (-.20) and not associated at all with innovation (measured as the rate of patenting).

Or consider the percentage of college graduates or share of highly-skilled knowledge/creative jobs. Again, nothing. The arrow in fact points in the wrong direction. Homeownership is weakly negatively correlated with both the share of college grads (-.27), and with the creative class share of the labor force (-.30).

What about productivity? Once again, no connection to homeownership. Homeownership is weakly negatively associated with economic output per capita (-.19)."

Certainly questions the reason behind doing it in the first place.