Is Tax Deduction For Home Mortgages A Bad Idea?

GUY RAZ, host:

Now, in the midst of this month's health care debate, Congress has also made time to extend a program that offers an $8,000 tax credit to first-time homebuyers. The plan also offers tax incentives to people who want to trade up to a new house.

The idea was to ease the housing crisis, and the National Association of Realtors lobbied hard for it. But most economists think it's a bad idea, a very bad idea. In fact, many of them say an even worse idea is the tax break homeowners have gotten for the past 60 years, one we've come to think of as a birthright, the deduction we claim on our mortgage interest payments. But if these tax incentives help Americans achieve the dream of home ownership, what's the problem?

Well, Dennis Ventry, a law professor at the University of California-Davis, lays it out in a forthcoming article in the journal Law and Contemporary Problems.

And Dennis Ventry joins me from Berkeley. Welcome to the show.

Professor DENNIS VENTRY (Law, University of California-Davis): Thank you.

RAZ: You argue that the home-mortgage interest deduction actually raises the price of houses. How is that?

Prof. VENTRY: Well, any subsidy, in this case the home mortgage interest deduction, property tax deduction, various other forms of subsidies for housing, those get, over time, calculated and tabulated into the actual value and cost of the housing. Economists call this capitalization.

RAZ: So when people look to buy a home, they will spend more than they might be able to afford because they are assuming they're going to get this deduction?

Prof. VENTRY: That's precisely right. I mean, if you've ever bought a home, that's certainly what your real estate agent is telling you and what your mortgage broker is telling you. It gets budgeted in where you actually get some sort of schedule, showing that, in fact, all right, well, your mortgage interest payments might be X, your property tax payments might be Y, but at the end of the year, you'll get a tax benefit in the form of this mortgage-interest deduction and perhaps a property-tax deduction.

So to the extent that these subsidies get capitalized, it raises the cost. So some economists say that, in fact, the home mortgage interest deduction in combination with property tax deduction actually artificially raise housing prices by as much as 25 percent.

It also, I mean, economists tell us, does nothing with respect to raising rates of home ownership. So to the extent that raising rates of home ownership is a national policy goal, which it certainly was under both the Clinton administration and the Bush administration, it doesn't necessarily do even that all that well�

RAZ: You're saying that the deduction doesn't actually encourage more home ownership? I mean, that would sound counterintuitive.

Prof. VENTRY: Right, it certainly does. What it does, we're told, is rather than raise rates of home ownership, it actually, it just increases the supply of housing, so the housing stock. It encourages people to buy bigger, more expensive homes, just not more homes.

RAZ: I'm wondering what's so bad about it. I mean, we've been told that home ownership is the fastest way to accumulate wealth.

Prof. VENTRY: Right. Well, I mean, I suppose that there's three things. One, the distortive effects of these kinds of subsidies, and what things like the mortgage interest deduction do is they favor debt-financed purchases of things rather than equity-financed purchases of things.

From a fairness standpoint, and this gets a little bit away from the debt-to-equity discussion, but the fairness standpoint - I mean, it's the classic, upside-down subsidy, and what I mean by that is that it provides significantly more benefits to those folks in the upper income classes than it does in the lower income classes. In fact, it provides 10 times the tax savings for households with incomes exceeding $250,000 versus households with incomes between 40 and $75,000. It provides no tax benefits to the 65 percent of taxpayers that take the standard deduction. It provides no benefit to renters, no benefit to low-income households and only minimal benefits to middle-income households and to the elderly.

And this is to say nothing, by the way, of its cost. On an annual basis, it's estimated to cost, in tax year 2010, $110 billion, making it the second most expensive tax subsidy.

RAZ: If it were up to you, you would recommend that the federal government get rid of this deduction, right?

Prof. VENTRY: Right.

RAZ: Are there economists who would disagree with you and say actually, you're crazy?

Prof. VENTRY: Not any that aren't employed by the National Association of Realtors.

RAZ: Dennis Ventry, if virtually all economists agree that the tax deduction on mortgage interest is actually bad for the economy, why haven't politicians gotten rid of it or even proposed to get rid of it?

(Soundbite of laughter)

Prof. VENTRY: It just seems untouchable. It's just politically dangerous. I mean, it's very easy to portray this as taking something very fundamental away from folks: housing, home ownership, the American dream. The symbolism of that resonates. And over the course of 40 years, politicians and those interested parties, in particular, the housing industry has done a really good job of tying the value of homes, of tying your ability to achieve the American dream to the home mortgage interest deduction, when in fact, it actually might be preventing folks from getting into a home.

I mean, if in fact home ownership is our goal, then moving to something like a tax credit would get folks into homes who currently cannot buy homes. The tax deduction actually just, for the most part, helps folks that would otherwise buy a home with or without a tax subsidy. It just helps them buy a bigger house.

RAZ: Dennis Ventry is a law professor at U.C. Davis, where he specializes in taxes. Dennis Ventry, thank you so much.

Prof. VENTRY: Thank you.

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