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Deducting mortgage interest on your taxes: a good thing or bad?

For decades the mortgage interest deduction (MID) has been masquerading as a promoter of homeownership and healthy communities when it’s mostly just a subsidy for the well off that costs the treasury a boatload of money. As for the communitarian benefits of homeownership, recent history has shown that it’s not all that it’s cracked up to be.

So, with the federal government in deep financial distress and the MID costing the treasury an estimated $131 billion in 2012 (or $210 billion if you add in ancillary tax breaks), why not end the deduction, or at least phase it out? Aside from shrinking the deficit, phasing out the MID would provide a much-needed correction in the housing market, tilting it away from super-sized homes that require excessive driving toward a more efficient housing model better tuned to future needs.

Indeed, phasing out the MID should be part of a larger effort to end all kinds of government subsidies — including those for oil companies — that prop up the wasteful and excessive lifestyles of the past while shifting encouragement to clean energy alternatives and housing choices that fit the demands of future communities.

President Barack Obama made a good start on Thursday when he proposed a new tax credit and other measures to encourage businesses to invest in clean energy technology — steps that he said could save $40 billion a year on utility bills. Earlier this week, the president said his budget, set for release later this month, will propose eliminating $4 billion a year in subsidies and tax breaks to oil companies. (Those same companies would get some of that back in new incentives for natural gas production.)

Commission proposed scrapping it
Obama has been silent of late, however, on the mortgage interest deduction. Several times in 2009 he had hinted at its demise. His deficit reduction commission proposed in its final report last year that the MID be scrapped in favor of a flat 12 percent tax credit. But the MID never came up in his State of the Union address. While the president touted a simplified tax code and said that the government must rein in “spending through tax breaks and loopholes,” he offered no specifics on the MID’s fate.

It’s clear that the real estate industry would vigorously resist any attempt to roll back the deduction. It’s “one of the pillars of our national housing policy, and limiting its use will have negative repercussions for consumers and home values up and down the housing chain,” Michael Berman, chairman of the Mortgage Bankers Association, told

Lawrence Yun, economist for the National Association of Realtors, even went so far as to tell the Wall Street Journal that ending the deduction would “surely put us in a broader economic recession.”

Those comments carry the ring of desperation, however, as the downside of homeownership becomes more apparent. “There’s an increasing understanding that single-family housing has been over-subsidized, and that’s to the detriment of the broader economy,” Mark Sandi, chief economist at Moody’s Analytics, told the Wall Street Journal.

‘Not the most enlightened public policy’
Christopher Leinberger, an urban land strategist at the Brookings Institution, told me: “It’s not the most enlightened public policy unless you believe in reverse Robin Hood policies — take from the poor and give to the rich.” As for its spatial impact, Leinberger said the MID disproportionally helps drivable suburban places at the expense of walkable, urbanized locales that typically have more renters. Renters — including larger numbers of younger people and down-sizing baby boomers — don’t get the tax break. Yet that’s the portion of the housing market that needs to be encouraged, he said.

Jim Solem, a local consultant who works with the “Rethinking Housing” coalition, said that ending the deduction now would probably depress home prices even further. Still, he said, there’s “a new reality” afoot that may keep values down for years, both because aging Boomers are “trapped” in their homes and because younger people lack the job stability of past generations. 

The best report I’ve read on MID comes from the Urban Institute and the Tax Policy Center. The report [PDF] traces the deduction’s history to the beginnings of the Federal Income Tax in 1913, when all interest payments were made deductible. The rationale of homeownership being good for the community didn’t emerge until after World War II. By 1986, when most deductions were eliminated in a broad reform, the MID survived as a sacred cow.

Actually, it’s available only to the one-third of taxpayers who itemize, meaning that its benefit accrues almost entirely to the upper-middle class. (The very wealthy tend to have paid off their mortgages.)

The report spells out the benefits of homeownership on communities (owners take better care of property and are more apt to be engaged in civic affairs, etc.). But it concludes that those people would likely own homes and care for property with or without the deduction. The deduction’s main impact, it says, it to encourage relatively wealthy buyers to purchase larger, more expensive homes or second homes. It notes that the value of the deduction has risen and fallen tenfold over the past 50 years while the rates of homeownership have remained stable — between 63 and 68 percent. (Other reports note that Canada has a similar rate of homeownership without MID.)

If the object is to increase homeownership, a tax credit available to all taxpayers would be fairer and probably more effective, the study concludes.

But as the current housing crisis illustrates, homeownership can be too great a burden in an economy that no longer offers the stable employment that it once enjoyed. All kinds of forces — economic, environmental and social — are forging a new housing market. It will be unlike the monolithic, single-family, auto-oriented suburban market of the post World War II era. It will be more varied. There will be a greater number of smaller homes, shorter driving trips, more transit, more multi-family housing types, more mixing of homes, offices, shops and other attractions. The challenge for government is to shift its subsidies in ways that encourage rather than encumber the emerging market.

Cheers and boos

Boos for higher taxi fares in Minneapolis. The City Council expanded cab service several years ago with an eye toward more competition and lower costs. Looks like it’s not working. The city already allows some of the most expensive cab rides in the nation — rides are cheaper in New York, Chicago, San Francisco, Denver, Atlanta and Washington, D.C. Higher fares will just deter more riders. I’d love to see a semi-deregulated system: more taxis, lower fares, more riders, more convenience.

Cheers for St. Paul’s refocused efforts on downtown development. The Capital City Partnership will target business retention, growth and recruitment while cooperating with a new metro economic development organization (yet unnamed). The Riverfront Corporation, meanwhile, will focus on public places and civic engagement, especially on the Central Corridor, Lowertown and Great River Park. More in the coming weeks.

Cheers for the selection of Patrick Born as the Metropolitan Council’s new regional administrator. As Minneapolis’ finance director, Born has been a pivotal figure in guiding the city through difficult times while showing considerably more discipline and foresight than the state on issues like paying down debt and explaining hard choices to voters.

In metrospect: Three significant stories this week

Wal-mart surrenders to preservationists on Virginia battlefield site. The Washington Post reports on the giant retailer’s decision to abandon plans for a future store on the site of the Battle of the Wilderness (1864) in Orange County, Va.

Dashed plans: Dreams that went nowhere. This New York Times slide show highlights proposed projects in the city’s history that never happened, inspired, perhaps by the failure of Mayor Michael Bloomberg’s idea for a giant sports stadium on Manhattan’s West Side.

Buy local? MSP does poorly in national survey. This new study from Civic Economnics and the American Booksellers Association ranks metro areas on the vitality of their local retail shops. The Mid-Atlantic, New England and Pacific Northwest do best; the Midwest does worst. Top 25 markets for local retailers include New York, San Jose and Austin. Bottom 25 markets include Sioux Falls, Cleveland and Columbus, Ohio. Of the 17 U.S. metro areas with more than 3 million people, Minneapolis-St. Paul ranked next to last.

Comments (15)

  1. Submitted by Steve Rose on 02/04/2011 - 10:29 am.

    “While the president touted a simplified tax code and said that the government must rein in “spending through tax breaks and loopholes,” he offered no specifics on the MID’s fate.”

    While I agree that the government must rein in spending, tax breaks are not spending. That thinking is upside down. We citizens that earn the money are not a government expense.

    Any change in the MID rules must be phased in very gradually. In the 5th inning of a baseball game, it is unfair to decide that five strikes equals one out and the side is retired following five outs. People buying a house went into it with a certain financial structure. It is not fair to change the rules abruptly. Though, Hennepin County had no qualms increasing my property taxes 85% in 1991. I have a different idea of what is fair.

  2. Submitted by Ray Schoch on 02/04/2011 - 11:13 am.

    I have several friends in other parts of the country who rent, specifically because the employment situation doesn’t allow them the stability necessary to make home ownership seem worthwhile. I’ve done both – rented and owned – and am a homeowner in Minneapolis rather than a renter for two reasons.

    One is the MID. It’s basically the only reason I’ve bothered to itemize my taxes every year. On the other hand, the assertion about ownership applying primarily to (and/or appealing to) the upper middle class seem off the mark, at least slightly. I’ve never managed to reach even median income for the housing market I lived in, so I’ve never qualified as “upper middle class,” and usually, if I think of myself as middle class at all, it’s in the context of hanging on by my fingernails. In that context, the MID is worth pursuing.

    My second reason is, in some ways, twofold. My current work requires both display space and a “workshop” or “studio.” While I could certainly find rental living space, landlords are often less-than-enthused about numerous holes in walls and window frames to display artwork. Yes, I could rent studio space that would allow those things, but the combination of rent for living space and rent for studio space, plus utilities for two separate spaces, is more than I can afford. Having a basement studio/workshop is more cost-efficient for me, and since I’m the landlord, I don’t mind putting holes in walls or window frames that I’m already paying for.

    Steve seems on the mark, however, about the MID being something that benefits the “haves” and is unavailable to the sizable chunk of the population that either doesn’t want to own, or that simply can’t afford it.

    A sizable drawback to ownership – conveniently given very little attention by media, and for obvious reasons downplayed by the industry – is the cost of maintenance. Every landlord knows that water heaters self-destruct, ice dams cause interior damage, furnaces don’t last forever, and are expensive to replace, and that general maintenance of a structure constitutes a significant expense over and above whatever the payment might be on the mortgage. Many homeowners, especially new ones, don’t factor maintenance into the family budget at all, or else drastically underestimate what it will cost.

    My experience in Colorado, and what I’ve seen in my incomplete explorations of Twin Cities suburbs, reinforces the idea in Steve’s piece that the MID essentially encourages sprawl and McMansions. The building of 4,000-square-foot houses for families of 4 people (and the real estate commissions that go with those kinds of sales) seems a lot less likely if there’s no MID, and I agree that the MID encourages auto-centric residential development. A more energy and cost-efficient society, not to mention one which displays less economic bigotry, will require both mixed-use development and mixed-income housing within that mixed use.

    Comments from realtors strike me less as “desperate” than merely self-serving. Smaller houses, fewer owners, means smaller and fewer sales, which translates, in the current real estate business model, to less frequent and smaller commissions, and thus less income. There’s no reason to expect realtors to agree to lower incomes, so the operative questions ought to revolve around what seems best for the society as a whole. In that context, it seems important that our next-door neighbors to the north have similar home ownership rates WITHOUT the MID as an enticement.

    I’m inclined to agree with the assertion that the stereotypical community benefits of home ownership (owners take better care of property and are more apt to be engaged in civic affairs, etc.) are just as likely to take place without the MID as they are with it. I’ve been pretty much the same citizen for decades, with the same interest in public policy, regardless of whether I was renting or owning. What I’ve found interesting (read: bigoted) is the assertion from homeowners that renters, especially in multi-family situations, are automatically more prone to crime, sloth, and degradation. A woman once wrote to the planning commission on which I was serving that, “First come the apartments, then come the slums, then comes the crime,” as if those were natural and automatic stages of development.

    Attitudes like that will have to change, and with the collapse of the housing bubble, cannot be justified. I can live without my MID as long as I’ve been persuaded that others who are more affluent are also carrying their fair share of the increased tax burden, and if the outcome is a more efficient and more just society.

  3. Submitted by David Peterson on 02/04/2011 - 11:51 am.

    Totally agree on the taxi fare issue. I spend a year living in Korea and loved the accessibility of taxis. Any time of day or night you could generally hail a taxi in under 5 minutes, and generally get a fare under $10 for quite long drives. Cost of living issues aside, MPLS could certainly improve. It was very disappointing returning to this system.

    As far as buying local, I wonder if strong local support for Target skews us to non-local buying. I know I feel like I am buying local while shopping there, while that is most likely not the case.

  4. Submitted by Brian Simon on 02/04/2011 - 11:55 am.

    “While I agree that the government must rein in spending, tax breaks are not spending. That thinking is upside down. We citizens that earn the money are not a government expense.”

    Whatever it is, its a government program that reduces the revenue available to the treasury. You say potato, I say potato.

    More important is the analysis cited by mr Berg, specificially: what is the program intended to do, and is it meeting those goals?

    While I’m in favor of eliminating the deduction, there is a compelling argument for spreading that rule change over time, to avoid the financial shock. Pulling numbers out of thin air, I’d probably start with an eligibility cap of $500K of principal, reducing that cap to zero over 15 years or so.

  5. Submitted by Howard Salute on 02/04/2011 - 12:05 pm.

    Imterest deductions were eliminated, except if it was mortgage interest. So, people opened credit lines secured by their home. The interest on this borrowing was mortgage interest and therefore deductible. Just what Uncle Spender wanted. However, this introduced people to the concept of using their home equity like a savings account. And we know how that turned out.

  6. Submitted by John Olson on 02/04/2011 - 12:11 pm.

    As the Urban Institute report from April, 2010 points out, up to $100,000 of interest on Home Equity Lines of Credit (HELOCs) in addition to deductibility of interest on a first mortgage.

    The report also points out in the relevant footnote that HELOCs are frequently used by homeowners for purchases of automobiles and other durable goods. Interest deductions on credit accounts were eliminated with the Tax Reform Act of 1986. However, use of HELOCs essentially allows the homeowner deductibility for these purchases on top of the first mortgage interest.

    Financial institutions aggressively marketed HELOCs and many homeowners took advantage, assuming that the value of the equity in their home would continue to expand. It didn’t quite end up that way.

  7. Submitted by David Thompson on 02/04/2011 - 12:22 pm.

    “phasing out the MID would provide a much-needed correction in the housing market, tilting it away from super-sized homes that require excessive driving toward a more efficient housing model better tuned to future needs.”

    Now THERE’s a statement that is not supported by the facts. Most people who buy homes are financing their purchases. Most home sales are for used homes, not new McMansions. My oldest son and his wife just bought their first home last year – a post-war rambler in Richfield. Even with two incomes, they couldn’t have done it without the first-time homebuyer’s credit AND the MID. They are now expecting their first child. What, you want to put an end to the American Dream of home ownership? For shame! I don’t want my grandchildren limited to growing up in a “multi-family housing type”.

    The super-sized home market was driven by mortgage fraud. People bought homes they couldn’t afford, financed by banks who immediately re-sold the mortgates. What we really need is mortgage reform (you shouldn’t be able to re-sell 100% of a mortgage), not tax reform.

    And another thing. My 89-year-old mother lives in a senior’s co-op apartment building. This was a great invention for active seniors. They get companionship, hot meals if they want it, staff to take care of the exterior and common spaces. However, the number of vacancies in her building is increasing. There are a lot of seniors who want to move in, but they can’t sell their houses. Families need houses, seniors need to move out of houses, but not enough transactions are taking place because people can’t get financing. We need a tax policy (and housing finance policy) that stimulates these transactions. Your proposal would put an end to the housing market as we know it.

  8. Submitted by Kevin Slator on 02/04/2011 - 12:23 pm.

    “For decades the mortgage interest deduction (MID) has been masquerading as a promoter of homeownership and healthy communities when it’s mostly just a subsidy for the well off…”

    Huh? The vast majority of taxpayers who claim the deduction earn less than $200,000. It’s a wide supported deduction that greatly benefits the middle class, not the “well off.”

  9. Submitted by Chris Reynolds on 02/04/2011 - 12:29 pm.

    Consider also that the presence of the deduction helped encourage the constant refinancing and ‘cashing out’ of home value.
    Those who are responsible and pay down their mortgage are punished for it, or at least many of them feel that way, because they lose the tax benefits but they are still making those monthly mortgage payments.

  10. Submitted by Victoria Wilson on 02/04/2011 - 12:35 pm.

    Despite what the studies claim, I do believe the mortgage interest deduction influences buyers to buy a home and that homeownership brings stability and intrinsic wealth to our neighborhoods. I’m pretty sure that landlords are able to deduct the interest on a mortgage secured by a rental property, so in effect the deduction brings parity to the two arrangements.

    The deduction also offers another benefit. Except for the occasional accountant, I don’t believe most homebuyers focus on the pecuniary nature of their purchase, and are pleasantly eased into all the small expenses that accompany homeownership with the slight increase in their paycheck. After all, the landlord will no longer be over to replace the washer in the faucet, shoo the squirrels out of the chimney or paint the south side of the house which is once again showing wear.

    The abuse of the mortgage interest deduction came in the 80’s with the acceptance of second mortgages as a means of financing consumer debt. Consumers were incented to tap the equity in their home without a payment scheduled that appropriately reflected their purchase. Is it really wise to pay off a car in 30 years, 15?

    Perhaps it would be sensible to allow homebuyers to an interest deduction schedule based on the mortgage used to purchase the home, and limit it to that. Whether consumers refinance or tap more equity, they would maintain the decreasing tax benefit, established at time of purchase, for the duration of their ownership.

  11. Submitted by Bob White on 02/04/2011 - 01:08 pm.

    Good summary of reasons to eliminate mortgage interest deductibility, Steve. But the fed push for home ownership really began before WWII, during the Depresseion, with the creation of the FHA in 1934. HUD lists the historical reasons:

    1.Two million construction workers had lost their jobs.

    2.Terms were difficult to meet for homebuyers seeking mortgages.

    3.Mortgage loan terms were limited to 50 percent of the property’s market value, with a repayment schedule spread over three to five years and ending with a balloon payment.

    4.America was primarily a nation of renters. Only four in 10 households owned homes.

    Implicit in the reasoning was that ownership was better than renting.

  12. Submitted by Jim Gabler on 02/05/2011 - 12:37 am.

    Thanks for the excellent article on the MID, Steve. I read all the posts, also, and overall they’re an excellent group, pointing out many of the pluses and minuses. Having spent more than 40 years in housing, most in the private sector, I can tell you that I was never a policy wonk until I spent 9 years as head of the Multifamily Division of the old MCDA (now Dept. of CPED) in Minneapolis from ’86-’95 and saw what a penalty poor and mistimed policies can exact (in this case housing ones) and have been on a tear against them since. Let me share some observations, thoughts and suggestions with you concerning housing subsidies in general and the MID specifically:

    1. The last time I saw a decent pie chart on all housing subsidies was about 10 years ago from President Bush’s own Millennial Housing Commission and it showed that about 84% of all federal housing subsidies were indirect (MID, capital gains exemptions, low-income housing tax credits, etc.) and about 16% are direct (CDBG, HOME, Section 8, Public Housing, etc.) About 2/3rds of the indirect subsidies went to those who really didn’t need them (say, the upper 20% of wage earners) whereas almost all the direct ones went to those who did. This disparity increased even more significantly with the increase of the capital gains exemption for a house sale by 2 people from $250,000 to $500,000 a few years ago, though now its impact is certainly less than it was because of the housing bubble bursting. However, it goes to show that you and I as average homeowners are still subsidized much, much more than any public housing tenant and I don’t think that’s fair or prudent housing tax policy.

    2. Whether it’s an indirect tax credit or a direct expenditure, it’s still a dollar lost and spent to the U.S. Treasury. Isn’t it interesting, however, that almost all the housing subsidies for poorer folks are the direct ones and almost all of the housing subsidies for you and I are indirect (and thus are usually not even viewed as “subsidies”?) It’s politics, of course, and that’s fine to a point.

    3. The Tax Reform Act in 1986 did to rental properties and their owners what the busting housing bubble just did to homeowners, but did it by policy, and it took about 10 years for that sector to come back, especially with it’s overly-quick transition period. The disparity between subsidies that renters get and homeowners get is still terrific. Your average neighborhood or suburban apartment is still, by far, the least subsidized form of housing in the Country.

    4. I would pare back the Capital Gains exemption to $250,000. Any more and, I’m sorry, but you’d have to pay some taxes.

    5. The MID sounds great in theory – to promote homeownership – however there are almost no restrictions on it, generally, other than you must occupy a house, declare it as your homestead and have a mortgage of $1,000,000 or less. There are no design limits, no locational limits, i.e. being inside the MUSA (Metropolitan Urban Service Area) line, no income limits, no cost cutting restrictions imposed, no nothing. (You ought to see what you and I might have to do someday as seniors to qualify for affordable rental housing as a condition for getting “subsidized”. Or different types of assisted living or nursing homes. Get ready to dance.)

    6. I would suggest following the advice of the one writer who recommended phasing in a reduction of the MID over time. I’d then limit it to a mortgage of, say, no more than $250,000 – $300,000. I’d further only allow the MID on a new, refinanced mortgage if the extra proceeds were going into the rehabilitation of the house and not for equity stripping.

    7. This savings (from #4 and #6 above) would further provide funds for more homeownership if that’s what you want, however just for those that need it, say, more first-time homebuyers tax credit programs to allow for all the vacant and foreclosed houses to be absorbed, sold quicker and get reoccupied.

    Housing bust or not, we need to reform the MID to assist those that need it.

  13. Submitted by Mohammed Ali Bin Shah on 02/05/2011 - 11:17 pm.

    “and the MID costing the treasury an estimated $131 billion in 2012”.

    The MID is not a COST to the treasury. It is less taxes paid by citizens. There is a difference. And when you use the language that you did people immediately understand where you stand.

  14. Submitted by Bill Toppson on 02/06/2011 - 12:40 am.

    Excellent analysis of the MID.
    I have one more tax item I would like to see comments on.
    In 1997 the tax law changed from a once in a lifetime exclusion for capital gains on your home to allowing an exclusion from capital gains taxes of up to $250,000 (for a single) of profit for any home in which you reside for just 2 of the past 5 years. I believe this tax law change affected the buyers philosophy from that of someone buying a long term home into a short term investor. People began to buy houses with the idea of an investment rather than for the ideal of home ownership.
    And how much does this cost the government in lost taxes? Not only from stretching the occupancy rules but also lost from people putting a building on an appreciated lot.

  15. Submitted by David Greene on 02/07/2011 - 08:21 am.

    Dave T.: “Even with two incomes, they couldn’t have done it without the first-time homebuyer’s credit AND the MID.”

    Then you go on to decry people purchasing homes beyond their means. If your son and his wife truly could only afford the home due to the MID, they bought too much home.

    The MID _is_ a transfer of wealth to the rich, despite what y’all say here. Just as I am amazed at how fact-deaf Republicans can be, so too am I equally amazed how fact-deaf Democrats can be if a change impacts their bottom line.

    Can’t we actually look at the studies and do the right thing based on what they tell us?

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