The Downsides Of Mortgage Tax Breaks

Every year, homeowners deduct the interest paid on their mortgage from federal taxes, saving a combined total of more than $100 billion a year. Viral Acharya argues it's time to wean homeowners off of those subsidies because they favor the rich and encourage people to spend beyond their means.

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REBECCA ROBERTS, host: Every year, the federal government allows 35 million homeowners to deduct the interest paid on their mortgages from their taxes. These and other subsidies save homeowners lots of money, to the tune of more than $100 billion a year. But a group of economists are now arguing that these subsidies are doing more harm than good. Viral Acharya is one of these economists. He co-authored the book "Guaranteed to Fail: Fannie Mae, Freddie Mac, and the Debacle of Mortgage Finance."

In a recent New York Times op-ed, Acharya argues that we should end tax breaks for homeowners. He says that these subsidies favor the rich, encourage people to spend more than they can afford, and create a housing bubble. Do you agree? Why or why not? Our number here is 800-989-8255. Our email address is talk@npr.org. And you can join the conversation at our website. Go to npr.org, and click on TALK OF THE NATION. And Viral Acharya joins us now from our New York bureau. Welcome to the program.

VIRAL ACHARYA: Hi, Rebecca.

ROBERTS: So homeownership, it's always been sort of a central part of the American dream - the house with the picket fence and that you can call your own. But you're saying that these subsidies are actually making it more difficult for people to achieve that dream. How is that possible?

ACHARYA: The simple argument is as follows: The message that's conveyed to every individual, or every individual household, is that housing is cheaper for you. But the question is, is it cheaper for my neighbor? Is it cheaper for other people around me? And the answer is yes. Are we funding for it today, in some way? The answer is no. So what's happening through the homeownership subsidies is that everyone is borrowing more. Everyone is consuming housing more. As a result of which, everyone is demanding more houses. There's a construction boom, as we saw. The house prices went up.

So while on the one hand I was told I had all these deductions, my interest rates were lower because of government subsidizing them through Fannie Mae and Freddie Mac, however, all of these things made the house I wanted to buy more expensive than what it should have been. So that net net, in the end, didn't really produce substantial gains for most households - where really, the benefit scheme were for people who were buying second houses, people who can already afford housing on their own and therefore, rent and bought maybe a house of a size that was much bigger than they needed. Most of the benefits, according to economists' calculations, seem to have accrued to those who can already afford housing.

ROBERTS: So you're basically saying that house prices are artificially kept lower than a free-market price would be by these subsidies and therefore, people are consuming more housing than they need or can afford.

ACHARYA: Yeah. What I would say is that the interest rates for borrowing against houses are kept lower. The house prices are, in fact, getting higher. They're artificially getting inflated, absolutely.

ROBERTS: In The New York Times op-ed that you co-wrote, you say homeownership was untouchable because the programs were popular with voters and because of unrelenting lobbying efforts. The political rights sold them as part of its ownership society, where the left used them to fight rising income inequality, but the policies have turned into a major disappointment for both sides. What do you think has changed politically?

ACHARYA: Well, I think what has changed politically is that our ability to keep spending and keep borrowing is sort of hitting its limits. As the debt ceiling sort of - lets call it a debacle, in the sense of political risk that it created, as suggested; it's no longer possible to just continue spending and continue borrowing in external markets unconstrained. And I think this point is quite important, which is - what the message that has not been conveyed to the households - is, how are we paying for these subsidies?

We have not been raising taxes. We've actually been expanding all other kinds of entitlement programs at the same time, such as health care and, you know, we've had two sort of large walls on which we spend money. So in a sense, what is happening is that homeownership subsidies and these other entitlements, they are really a sort of a Ponzi scheme. We are going to generate money for this, somehow, in the future. Now, if I told you that I'm over-borrowing and my child is going to be spending for it when he grows up, most households would actually cut back on this over-borrowing and overspending on housing consumption.

But here, we have the subsidy coming from the government. So we feel oh, it's all fine, but not really. We have to ask the question: How is the government balance sheet funded? And if the government is not able to raise the right level of taxes or make transfers in order to pay for these subsidies, ultimately, it's going to be our future generations that are going to be paying for these costs.

ROBERTS: My guest is Viral Acharya, a professor of economics at New York University. You're listening to TALK OF THE NATION from NPR News.

And let's hear from Wayne(ph) in Santa Barbara. Wayne, welcome to TALK OF THE NATION.

WAYNE: All right. Thank you for having my call come in. I just want to say that when I borrowed money to buy my home - and I had worked very hard for about 20 years; I saved up a huge down payment, and I bought my property. The deal was - is I get to deduct that mortgage interest. If I had known midstream that the government would change the rules and tell me I no longer can deduct that mortgage interest, I never would've bought this house.

The middle class will be very badly hurt by such a move. People rely on that mortgage interest deduction, and if you take that away from them, their houses are going to have to be sold, and sold at a very bad time - when many people owe more than what their home is even worth at present time. If you take that mortgage interest deduction away from them, and they now have to pay thousands and thousands in additional income tax, they're going to have to sell their homes. Do you think that's going to be good for the economy?

ROBERTS: Wayne, thanks for your call.

ACHARYA: That's a great question, Wayne. It basically raises issues about how do we transition to a system where subsidies are not present or at least substantially reduced? Two points: One, we do not envisage that the subsidies would be taken away from those who have already made home purchases. Second, they will, however, affect those who are the new purchasers in the market. What's that going to do is, it's going to reduce everyone's consumption of housing. So if I was going to buy a three-bedroom, I might buy a two-bedroom.

So you can see that the demand is basically going to shift downwards. And the place where there's going to be, really, a gap left, as far as demand for housing is concerned, is going to be in the ultra large housing, maybe palatial mansions and so on. But property prices will probably take the biggest hit. Then maybe a property price decline in some other sectors as well.

Our recommendation to deal with that in the transition is to ensure that those whose principles are the most underwater as far as their mortgages are concerned, they be provided one-time, decisive write-down on their principals to soften the blow on them.

ROBERTS: This is Ned in San Antonio. Ned, welcome to TALK OF THE NATION.

NED: Hey, thanks for having me on. I buy and sell houses for a living. And for the last 10 years I've done that. And what I've found is a big disconnect. If you look at median income, which I believe is 48 or 49,000 - that's household income - 48 or $49,000 per year, and you looked at median household prices, which got up over $200,000 during the peak, there was no way that people who made the median income could afford the median house with a traditional mortgage. And basically, if they bought the house they could afford, it'd be something less than $90,000 or $100,000. And there's not enough interest for you to deduct on that type of house.

So I agree. Get rid of it. People will start buying houses that they can afford, that they could eventually own in 20 years, and that's basically my comment. And I'm curious to hear what your guest's comments are about that.

ACHARYA: Thanks, Ned. Thank you for clarifying this point. I think you made two important observations there. One is that the biggest effect of removal of subsidies is going to be that people will buy the houses they can afford. I think in the long run, that's got to be a good thing, especially given the kind of over-borrowing and over-consuming that we've sort of witnessed in the last 20 years.

I think the second important point you raised is that a lot of people, like the median income, don't actually get substantial benefits from the mortgage tax deductibility because they don't even itemize their deductions. So the primary benefits actually do accrue to those who are in the substantially higher income range. In fact, the calculations seem to suggest that compared to the median income household - say, it's a household that's earning $50,000 - if you went to someone who's earning more than $250,000, the ratio of the benefits is actually of the order of 10 is to 1.

ROBERTS: Millions of Americans are not homeowners at all. They're renters. Where do they fall into this?

ACHARYA: We would actually - we think, you know, renting is not such a bad thing. I think the ownership society, and the sustainable neighborhoods it creates, is quite important. But we are just not convinced that at the current level of sort of the state of the housing construction that is out there in the United States, that that's really a major factor for consideration.

I think sustainable housing is important, but that can't really compromise the extent of borrowing that happens in the economy. So we would support, sort of - some sort of subsidies for first-home buyers. Perhaps these subsidies could be counterbalanced through a rental subsidy, which would then sort of put rental and borrowing on equal footing so that people will still make the right choices. And the third point I would say is that, you know, one of these societies, which has the lowest homeownership rates, is Germany. Most of...

ROBERTS: I'm afraid we have to leave it there. We're out of time, Viral Acharya. You can see his op-ed on our website.

This is TALK OF THE NATION. I'm Rebecca Roberts.

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