How a Widely Beloved Tax Deduction Really Just Benefits the Well-Off and Exacerbates Inequality


(AP Photo/Gene J. Puskar)

This May 2, 2012, photo, shows a new home under construction in Bridgeville, Pennsylvania.

Anyone who is concerned about the country’s growing inequality crisis should be pushing for reform of the feature of the U.S. tax code known as the mortgage interest deduction. Not only does this wasteful tax subsidy primarily benefit the richest Americans, it also costs the U.S. Treasury between $70 and $100 billion annually in revenue, making it the third largest deduction on the books.

National opinion polls indicate that between 60 and 90 percent of Americans support the mortgage interest deduction (MID), which allows taxpayers to deduct interest on $1.1 million in mortgages on primary residences, vacation homes and even yachts. And yet because of the way this tax subsidy is structured most U.S. homeowners receive very little if any benefit from it. Indeed, in its current form, the MID’s biggest beneficiaries are the real estate industry and its wealthiest customers—U.S. homeowners who have gross adjusted gross incomes of more than $100,000, and who in 2012 consumed a whopping 77 percent of the benefits. Homeowners from the top two percent of American taxpayers who earn more than $200,000 (or married couples who earn more than $250,000) annually fared the best: They gobbled up 35 percent of the subsidy.

The inequities and inefficiencies inherent in the MID are obvious to leaders of a wide range of groups advocating for its overhaul or elimination.

“What we are doing is over-subsidizing homeownership for higher income people, which is a choice that we have made,” says Sheila Crowley, president of the National Low Income Housing Coalition (NLIHC), “but we are also at the same time making a choice to horribly underfund housing subsidies for the poorest people in this country whose housing needs are getting more and more extreme.”

“It is not the homeowners or the consumers who are getting a lot of these [MID] benefits,” says Wayne Brough, chief economist at the Tea Party-affiliated FreedomWorks, which advocates for getting rid of the MID altogether in favor of a flat tax. ”It is the banks that get mortgage interest paid [by the government] and you have the homebuilders who sell bigger homes---all of this has distortionary impacts on the markets that are hard to justify.”


Urban Institute

From the Urban Institute report, How Would Reforming the Mortgage Interest Deduction Affect the Housing Market? by Margery Austin Turner, Eric Toder, Rolf Pendall, and Claudia Sharygin.

Making inequality a built-in feature in many American cities and suburbs appears to be the interest deduction's most profound effect. Studies indicate that this bedrock of U.S. tax policy has pumped up housing prices by 10 to 15 percent in certain real estate markets. Its use also is linked to the proliferation of McMansions and out-of-scale apartments in high-income areas throughout the country. In a 2012 paper published in the Journal of Housing Economics, Marquette University economics professor Andrew Hanson estimated that homes bought by owners who use the MID and other housing tax subsidies in the Washington, D.C., metropolitan area are, on average, 1,424 square feet larger than homes purchased without it. And in the New York City, Philadelphia, and Los Angeles metropolitan regions, he estimates that housing tax subsidies are tied to the purchase of homes that average in size to more than 800 square feet larger than those purchased without them. Basically, the MID encourages affluent homeowners to buy more extravagant homes than they otherwise would. There also is a grossly unequal distribution of the MID’s benefits between Red States and Blue States: The ten largest per-capita beneficiary states typically vote Democratic. 

But what makes overhaul of this tax subsidy especially urgent is the current nationwide housing crisis in the United States, where 76 percent of the 19 million people who qualify for housing assistance from the U.S. Department of Housing and Urban Development cannot obtain it because not enough federal funds have been made available to help them. The $70 billion to $100 billion that this country annually sacrifices for the MID dwarfs HUD’s $46 billion budget, the primary means of housing assistance for moderate and low-income people.


There is no shortage of proposals to reform the MID; these include plans from President George W. Bush’s 2005 Tax Reform Panel of Federal Tax Reform, President Barack Obama’s bipartisan National Commission on Fiscal Responsibility and Reform, and the 2013 Congressional Budget Office’s Options for Reducing the Deficit report. Some of the proposed overhauls would save the government billions of dollars in foregone tax revenue by imposing caps on the amount of mortgage interest that can be written off a homeowner’s bill, making home equity lines of credit ineligible and limiting the tax deductibility of mortgage interest to primary residences. Many of the proposals also call for converting the MID from a deduction tied to a homeowner’s marginal tax rate to a tax credit, which would greatly increase the number of low- and moderate-income people who benefit because they would now get a dollar-for-dollar reduction regardless of their tax bracket.

One of the most progressive plans is from the NLIHC, and forms the basis of proposed legislation by  U.S. Representative Keith Ellison, Democrat of Minnesota. It calls for reducing the size of the mortgage on which interest can be deducted from the current $1 million limit to $500,000, and would also convert the MID to a 15 percent non-refundable tax credit. The NLIHC estimates that its proposal would the increase the number of homeowners who get a tax break for homeownership from 39 million to 55 million and generate $200 billion in new tax revenue over the next ten years. Further, the organization estimates that 99 percent of homeowners that would be newly eligible for their proposed tax credit would be from the very group currently getting shortchanged by the MID: households with incomes of less than $100,000.

The different political factions advocating for MID reform, of course, have different agendas. Under the Republican-dominated House Ways and Means Committee’s proposed Tax Reform Act of 2014, the projected savings from reforming the MID would be used to reduce overall tax rates. In contrast, the proposal from Ellison and the NLIHC calls for using the projected savings to help fund the National Housing Trust Fund, which provides funding for the building and renovation of rental housing for low and very low income people.

So what is standing in the way of reforms that would provide more housing assistance for more Americans, provide a more equitable distribution of tax revenue, and save the federal government billions of dollars?  The answer is the powerful special interest groups representing businesses that profit from serious inefficiencies in our economy. These “rent seekers” include the Mortgage Bankers Association, the National Home Builders Association and the National Association of Realtors, all of which make bigger profits on sales of larger more expensive homes than they do on smaller ones.

“You can see why Realtors would be opposed to a reform of the Mortgage Interest Deduction,” says Jason Fichtner, senior research fellow at George Mason University’s Mercatus Center, and co-author of a recent paper on the MID. “They would have to sell more houses to make for up the loss in commission.”

The real estate industry has been so successful lobbying and spreading myths that the MID often is referred to as the “Third Rail” of American politics. Among organizations that lobby Congress, spending by the Realtors' association is second only to the U.S. Chamber of Commerce this year. In addition, the National Association of Realtors (NAR) also operates the largest political action committee in the country.

In 2012, with tax reform looming on Congress’s agenda, NAR president Gary Thomas announced that he had secured 183 bipartisan cosponsors for a resolution that supportD preserving the MID. “If you are looking at why Congress has such a positive feeling for the Mortgage Interest Deduction,” says Russ Choma, a spokesperson for the non-partisan Center for Responsive Politics, it is because “the National Association of Realtors, when it comes to giving out money in Washington, is one of the biggest deals in town...they basically have the biggest influence operation.”

Many Americans still buy the myth that the MID increases homeownership. However, the reality is that the MID actually isn’t a deciding factor for most people trying to decide between purchasing a home versus renting one. Indeed, for the vast majority of American homeowners earning under $100,000, the tax deduction potentially available from the current MID does not outweigh the savings they can realize from taking the standard deduction ($6,200 for individuals and $12,400 for married couples) on their tax returns. Even in cases where it does make economic sense for moderate-income homeowners earning $50,000 to $100,000 to file for the MID, the dollar benefits they are eligible for are negligible compared to the windfalls available to high income households whose average tax benefit from the subsidy is close to nine times greater.

Another myth is that reforming the MID would roil housing markets and destroy trillions of dollars in wealth. However, many economists believe that in today’s low interest environment the potential effect on housing prices would be relatively modest and limited to high-end homes in areas that enjoy inflated values thanks to the use of the  MID. In addition, many of the proposed reforms call for phasing in the changes over periods of between five to nine years in order to keep prices stable in those markets. Further, reforming the MID actually is likely to improve housing prices in many neighborhoods that aren’t currently benefitting from the subsidy. According to a 2013 Urban Institute report, “proposals that shift the MID to benefit low- and moderate-income buyers could actually stabilize and increase prices of lower-priced homes, whose values continue to lag.” Clearly, elected officials and pundits have been doing a lousy job of explaining the need for reforming the MID. Sensible proposals for  its overhaul have gone nowhere. It also is astounding  that the American public appears to have such a poor grasp of who actually benefits from this subsidy. In an era when the gap between rich and poor is growing wider and an increasing number of Americans are struggling to afford housing, it is time for Congress to change this sorry state of affairs.


You lament the supposed revenue losses, and then proceed to detail the increases in property value attributable to those same policies. Municipal and state governments are getting 15% more revenue than they would with the policy changes you call for, and as you point out, the properties that are built are much larger, more valuable, and generate far more property tax revenue than would be possible if you did away with the mortgage deduction. It looks to me like the program is working rather well. After all, it's also generating a higher level of property ownership versus rentals, and we all know owners vote differently than renters. The only advantages I see to abolishing the deduction are that it accedes more revenue and power to the central government, and thrills the environmentalists who believe they have the right to determine how the rest of us live, choosing out light bulbs, our toilets, our cars, and desperately want to force most of us into urban apartments. Because it's cheaper for our government to control us, oh yeah, provide services when we're all crammed into anthills.

Like any other form of government tax intervention, it causes market distortions. Yes, these distortions cause property values to be higher. Removing the MID wouldn't necessarily make homeownership more unattainable for new homeowners since the loss of the deduction would likely be offset by the lower purchasing price and lower property taxes. It shouldn't really hurt the rate of new homeownership and force people to live in apartments (which seems to be your claim). Who it would hurt was existing homeowners who paid the distorted price, who'd see the value of their property decrease as the gov't market distortion was removed.

Simply put, it's a government intervention that distorts market prices. When that distortion causes the value of something people own to increase, they don't like the idea of getting rid of that distortion. All prior convictions about government intervention and the distortionary effects of tax policy that may have played a large part in political ideologies are often so strangely shrugged off.

Shrugged off is the wrong phrase. It tends to create cognitive dissonance that manifests itself as anger and rage at those who point out the ideologically contradictory beliefs. That is to say, people get mad when you make them realize they're a hypocrite.

What makes you believe property taxes would be lower? Property tax revenue is the lifeblood of local government, and the chances of any local government giving up revenue are slim and none. Note: slim just left town.

Finally, someone sees through the lie of this abominable deduction. But you missed one of the ugliest consequences of the MID, the opportunity cost of job immobility and debt slavery. Does society really benefit by burying its most productive citizens under intimidating debt? Will you really be able to maintain stable employment for at least 20 years to sustain the payment? Or will you be stuck with a house you can't sell, in a town without jobs, and a debt you can't pay? Renters can move to opportunity, owners are anchored.

Flat taxes, no subsidies, no writeoffs, no shenanigans. Transparency in costs and benefits. Let the customers decide, without federal bribery and corrupt dealing.

great to see the trolls hit first - way to earn that bonus, guys!

Anyway, I fall into the above category of making just enough and having a house value low enough so that we take the standard deduction instead of the mortgage/tax write off. The only way we could benefit is if we bought a house that was more expensive - or a vacation home. (not going to happen...)

Although Ellison's idea is good, I'd rather see the elimination of the interest deduction from the income tax, and just allow the addition of local, state and real estate taxes to the standard deduction. This way, renters and homeowners are treated the same way.

However, this article doesn't mention the other real estate tax loser - the loss of capital gains tax from selling the house - during upturns in the real estate market, many individuals made a non-taxed fortune by being wise (buying low/selling high) and then paying no tax at all on the gain. Perhaps a standard 10% tax credit could be allowed to account for selling expenses, but then capital gains rates should apply.

Why do wealthier taxpayers get not one but TWO mortgage-interest deductions if they can afford a "second home" like a cabin cruiser, a RV, a beach cottage, a mountain cabin, etc.., yet the poor working stiffs can't even deduct apartment rents for their only dwelling and, therefore, must be content with the Standard Deduction?

Total crap!

H. Watkins Ellerson
PO Box 90
Hadensville, VA 23067

Never tell a MID-utilizing Tea Party homeowner that they lived in government subsidized housing. Or do. It all depends on whether or not you want to watch the tantrum, excuses, and denial that follows.

Capital gains tax is still in force, but it only affects those who make around 250-300k in gains. Anything below that not taxed.

Realtors and property taxing gubmints are the only ones who benefit from the MID, they get a % of the gross, and all it does is inflate property values. I expect all those homeowners who owned before the windfall have died by now, much like all the early FICA payees. All that's left is the bill.

As far as this progressive Democrat goes, Ulam got this one dead wrong. Reduce debt limit from 1.1 to 1 million? Eliminate the benefit for boats? Fine. But a million dollars in mortgage debt is not an extravagant amount in real estate markets like New York, San Francisco, or Boston where I live. And the idea that earning over 100,000 makes you wealthy is just nuts. Especially with parents and kids who may need help in a very tough economy. Those who confuse middle class wage earners and small investors with the wealthy elite risk the allegiance of middle class activists and donors to the Progressive cause.

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