Home ownership is commonly regarded as a big part of the American Dream. But most adults know that pursuing some dreams can be too expensive to justify. The mortgage interest deduction, a subsidy to homebuying, is one of those. Curtailing or abolishing it should a big part of any serious tax reform.
The real American dream is more about the broad prosperity and ample opportunity that derive from strong economic growth than it is about purchasing a house. Many Americans rent their dwellings, and the housing crash that helped cause the Great Recession made them glad they did. Some homeowners ended up in foreclosure. Many others found themselves trapped in homes that were worth less than they owed.
The deduction encourages home ownership by letting buyers deduct the interest they pay each year on their mortgages. But at this point, economists believe, it doesn’t have much net effect. That’s because the tax break has inflated home prices, largely if not entirely offsetting the benefit.
Economists generally oppose the deduction, because it gives Americans an incentive to put their money into houses rather than other investments that would yield higher returns. It encourages people to buy more expensive homes and to take on more debt than they otherwise would. It drains money from other sectors of the economy and maximizes the impact of housing downturns. Again, the crash of 2008 was an awful lesson.
The deduction also robs the Treasury of tax revenue — a gaudy $70 billion a year. This is money that could be used to finance a simpler, more efficient tax code with lower rates. If the deduction remains intact, any attempt at reform will be limited in scope and value.
Middle-class homeowners may bridle at the idea of losing their biggest tax break. But most Americans get little or no benefit from the mortgage interest deduction. About 70 percent of filers can’t make use of it, because they don’t itemize their deductions.
Among those who do, the rich gain far more than the average person. “For households making above $200,000 a year, the average benefit is $1,784 a year in tax savings,” wrote Bruce Katz of the Brookings Institution in The Wall Street Journal. “For households earning $65,000 a year, the deduction generally yields less than $200 a year in tax savings.”
The most reasonable argument against scrapping it is that the change would probably cause a one-time decline in home values. For Americans currently priced out of the market, any reduction counts as a virtue, not a vice, because it would make housing more affordable. But Anthony Randazzo, director of economic research for the Reason Foundation, calculates that “the direct influence on pricing of homes should be minimal.”
What would existing homeowners gain? They could expect to get lower rates, as well as a simpler tax code. They would probably also get a higher standard deduction, which would make it profitable for many to dispense with the headache of itemizing. President Donald Trump’s tax framework, which leaves the mortgage interest deduction alone, would double the standard deduction. But many members of Congress understand that lower tax rates would help Americans more than this deduction does.
They would reap the biggest potential payoff from a simpler, better tax code that pays the government’s bills: a healthier economy that boosts capital investment and creates more and better-paying jobs. If Congress and the president can agree on a plan that will do all that, the mortgage deduction won’t be missed.
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