Arnold Kling  

Economics of Home Ownership Subsidies

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Paul Krugman writes,


Why should ever-increasing homeownership be a policy goal? How many people should own homes, anyway?

It's a good question. Some of the subsidies to homeowners, such as the mortgage interest deduction, tend to go to more affluent people, so from a distributional perspective they are regressive.

From an economics perspective, the question should not be whether home ownership is good or bad for the individual (or family). The question should be whether there are positive or negative externalities.

If housing is a good investment, that is not a positive externality--it is a benefit to the owner. Conversely, if homeownership is risky, that is not a negative externality. If owning a home raises the cost of moving, that is not a negative externality.

Traditionally, one positive externality of home ownership is thought to be that owners maintain their properties better, and this helps maintain property values for others. Condominium associations sometimes will have rules against renting, based on that thesis.

Also, by raising the cost of moving, ownership helps stabilize a neighborhood. Seeing the same people year after year helps people feel more secure. Also, more home ownership might mean that more people will have an interest in long-term public goods, including roads and schools.

One point that is rarely recognized in these sorts of discussions is that renters benefit from the mortgage interest deduction. The owner of a rental property can deduct mortgage interest as an expense. This reduces the owner's cost, and in a competitive market this cost reduction gets passed along to renters. If markets were highly efficient, then high-bracket taxpayers would buy properties and rent them out to low-bracket taxpayers.

UPDATE: In response to a reader's comment, pointing out that imputed rent is not taxed. What that does is create a middle clientele, who own homes. The renters have low tax rates, so they don't care that they are paying rent in pre-tax dollars. The landlords have the highest tax rates, and they get the greatest benefit from being able to deduct interest as a business expense. In the middle are the homeowners, who get more benefit than the low-income renters from not having to pay tax on imputed rent. This is all in a working paper I wrote twenty years ago. Randall Pozdena of the SF Fed had a similar model.

In my opinion, government should never have gotten into the business of subsidizing homeownership. The externalities do not impress me.

However, this is a subsidy business that is difficult to get out of once you have gotten into it. The problem is that the value of the subsidy has been capitalized into the prices of existing homes. If you take away the subsidy, then people will take capital losses.

In this week's econtalk podcast, Richard McKenzie and Russ Roberts give other examples where government subsidies are capitalized into property values, making it difficult to reverse course. Crop subsidies are an example.

Once government establishes a cap-and-trade program to fight global warming, this will create subsidies that are capitalized into the value of assets. That in turn will make the policy very hard to reverse. Twenty years from now, the climate threat could be a new ice age, and yet changing policy would be as politically unthinkable as eliminating the mortgage interest deduction.


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TrackBack URL: http://econlog.econlib.org/mt/mt-tb.cgi/860
The author at The American Mind in a related article titled Economics Links–06.24.08 writes:
    A Federal Housing Administration program is letting home builders and sellers pay for down payments. This allows buyers to get mortgages with little of their own money down. The FHA says these “borrowers are two to three times as likely to defau... [Tracked on June 24, 2008 4:30 AM]
The author at Market Urbanism in a related article titled Subsidies and Taxes Favor Owning Over Renting writes:
    Paul Krugman asks a question that has been addressed at Market Urbansim: But here’s a question rarely asked, at least in Washington: Why should ever-increasing homeownership be a policy goal? How many people should own homes, anyway? Listening to pol... [Tracked on June 25, 2008 2:21 PM]
COMMENTS (41 to date)
John Jenkins writes:

Renters do not benefit from the mortgage interest deduction. Individuals are generally prohibited from deducting interest. Congress has elected to permit deductions for one's primary residence.

A person renting out a housing unit will not be using it as his or her primary residence, so the mortgage interest deduction will not apply. Instead, the general investment interest deduction will apply. These are two entirely separate and unrelated deductions.

ed writes:

I think raising the cost of moving could indeed be an externality, if it slows adjustments processes enough to exacerbate macroeconomic fluctuations.

ed writes:

Arnold is right that landlords benefit from an interest deduction. But the real difference is that owners do not pay tax on the flow of benefits that come from living in the house (often called "imputed rent,") while the cash rent received by the landlord is taxable.

Thus it's not generally true that "If markets were highly efficient, then high-bracket taxpayers would buy properties and rent them out to low-bracket taxpayers," because owner-occupiers benefit from the zero tax rate on imputed rent, while landlords do not. (I'm very surprised to see Arnold making this error.)

Mark Seecof writes:

Mr. Jenkins is partly right, in that homeowners and landlords deduct mortgage interest under two different income-tax provisions, but he's partly wrong, because the effect is exactly the same: interest on a loan secured by the housing is deductible, so the mortgage interest deduction does not subsidize owner-occupants compared to renters.

Krugman (who is supposed to be an expert) is flat wrong: the real subsidy to owner-occupants is the exclusion of imputed rental value from taxable income. As Prof. Kling pointed out (rather obliquely) the mortgage interest deduction does not favor homebuyers over renters since landlords also deduct mortgage interest and in a competitive market (across the USA, most housing markets are) renters get their share of that deduction.

Of course, as a policy matter it's awfully difficult to figure out how to tax imputed rental income. We would have trouble estimating the fair rental value of owner-occupied homes in many areas. Many homeowners (especially the little old lady from Pasadena) wouldn't have any actual cash to pay taxes on the rent they could theoretically collect if they just hied themselves off to live out of a stolen shopping cart under a bridge. Then if we did try to tax imputed rental income we would face the question of whether to tax other imputed income streams.

dWj writes:

The externality argument seems plausible to me, but suggests tax breaks by local government, not by the federal government. (The suggested externalities would not, by and large, flow very far.) The externality also would seem to have very little to do with how much of the cost of the property is being financed. Exempting the first $50,000 of owner-occupied property from local property taxes would make more sense to me than allowing the deduction of mortgage interest.

Dr. T writes:

I believe that the original justification for the mortgage interest deduction was to help move the economy from a wartime footing to a peacetime footing (no construction pun intended). It should have been phased out after ten years or so, but now will be with us for decades to come. Perhaps if the flat tax becomes a popular idea, folks will accept the need to kill the subsidy.

For some reason, I have an awful hard time believing that the mortgage deduction has zero distributional effects.

TGGP writes:

As Steve Sailer has pointed out, the if-they-own-it-they-won't-burn-it theory failed in L.A in 92, which had above-average rates of homeownership.

Lord writes:

Interest was deductible from the introduction of the income tax. It was considered income to the lender and an expense to the borrower, and the desire to tax income only once. Should we also make interest nondeductible for business? Why consider that an expense then? As for not taxing imputed income, this is what the property tax does. There are no subsidies that are not incorporated into to the price, so the only effect of a change is to induce a capital loss or gain and what would be point of that?

Market Urbanism writes:
Also, by raising the cost of moving, ownership helps stabilize a neighborhood. Seeing the same people year after year helps people feel more secure. Also, more home ownership might mean that more people will have an interest in long-term public goods, including roads and schools.

But this cuts both way. Look at Detroit or any city that suffered from loss of manufacturing jobs. When jobs leave an area, market frictions such as rent control, public housing, moving costs, and emotional attachment disincentivize people from relocating to where jobs are more plentiful, exacerbating the local economic problems.

giovanni writes:

The federal government subsidizes home ownership through the mortgage interest income tax deduction.

But doesn't property tax counteract that?

When I see one household paying $16K/year in property taxes on a somewhat modest $400K home vs. another household paying $8K/year in total rent (which property tax is a small part of), I don't see how government is subsidizing the home ownership.

Market Urbanism writes:
The federal government subsidizes home ownership through the mortgage interest income tax deduction.

But doesn't property tax counteract that?

When I see one household paying $16K/year in property taxes on a somewhat modest $400K home vs. another household paying $8K/year in total rent (which property tax is a small part of), I don't see how government is subsidizing the home ownership.

Rental property is taxed as well. In fact most cities tax rental property at a higher rate than owned homes. Chicago, for example, taxes commercial and income generating properties at a very high rate per assessed value, while owned homes at the lowest rate. If I recall an analysis I did, it's almost double.

These households you are comparing are obviously not in the same ballpark. I am willing to bet that the 16k/year home you are talking about is significantly larger, nicer, and more valuable than the extremely affordable 8k/year rental. If not, then you should rent it - now!

B.H. writes:

For a good illustration of the popular view that there are major positive social/cultural externalities associated with home ownership, see the movie "It's a Wonderful Life." Such a popular view, articulated while FDR was still president, explains institutions such as the FHA, Fannie, the income tax code, FHLB, and the peculiar structures of the late savings-and-loan industry.

It would be good if economists could join with other social scientists to test the theory of the social benefits of home ownership.

There are those who attibute some of the drop in the US crime rate to rising home ownership and more stable neighborhoods.

As for the property tax issue, while it is true that the negative effects of higher property taxes are capitalized in real estate values, so are the positive effects of local gov't spending, such as on roads, parks, police, fire, and schools.

Finally, in a theoretically perfect income tax system, aren't all interest expenses deductible and all interest received taxable? If so, the problem is not that mortgage interest is deductible but that all interest is not deductible.

dearieme writes:

"However, this is a subsidy business that is difficult to get out of once you have gotten into it." We got rid of it in Britain - Lord knows what our houses would cost now if we hadn't.

Working through it, one major distributional effect, as for any subsidy, would be to direct resources towards the real estate industry from all other industries. Government deciding which industries are more important than others is not a good thing. However, among the owners and tenants, I would have to consider that not everybody receiving the mortgage deduction is renting out their place to a tenant. Therefore, I fail to see how the tenants would be getting their "fair share" of the subsidy.

Although it would depend on the meaning of "fair share," I would think an economist would define it as high enough to make the economic costs of renting and buying equal. Which, of course, would be high enough to eliminate the added incentive for homeownership that was supposedly the purpose of the subsidy.

Market Urbanism writes:
However, among the owners and tenants, I would have to consider that not everybody receiving the mortgage deduction is renting out their place to a tenant.

I agree with you on the distributional effect, but can you clarify what you mean in the quoted statement? Who is getting a deduction who isn't using the land for as their home, business, or rental income? or speculation?..

Market Urbanism: can you clarify what you mean in the quoted statement? Who is getting a deduction who isn't using the land for as their home, business, or rental income? or speculation?..

Sorry, I'd neglected to quote what I was responding to.

Mark Seecof: As Prof. Kling pointed out...the mortgage interest deduction does not favor homebuyers over renters since landlords also deduct mortgage interest and in a competitive market...renters get their share of that deduction.

perfectlyGoodInk: ...I would have to consider that not everybody receiving the mortgage deduction is renting out their place to a tenant. Therefore, I fail to see how the tenants would be getting their "fair share" of the subsidy.

Hope that makes more sense now. A good portion of the subsidy goes to homeowners living in their homes and who do not pass any share of it to any tenant. Money flowing to them from taxpayer funds. So one distributional effect of the mortgage interest deduction is a transfer from tenants to homeowners, right?

Lord writes:

No, the landlord receives the deduction which the market then distributes to the tenant. Since an owner is both landlord and tenant he obtains the same deduction. Renting is cheaper than owning because of this. The owner incorporates the value of the deduction into his purchase. Disallowing the mortgage interest deduction would (eventually) lead to higher rents as it would increase the landlords costs greatly. Allowing business interest deductions but not real estate business interest deductions is favoring some industries over others. An owner merely has his own real estate business.

Market Urbanism writes:

Lord:

Renting is cheaper than owning because of this.

Yes, cheaper before accounting for all the intricate costs and benefit differences. I think that's what you meant.
If you calculate the total cost and value of deductions, capital appreciation, opportunity cost of capital, etc. and control for quality and location it's usually slightly cheaper to own in most places. Mostly because of the tax deductions and subsidized borrowing and lower property tax rates raises owned housing prices.

Otherwise, more people would rent...

I agree with everything you said except:

Lord: No, the landlord receives the deduction which the market then distributes to the tenant. Since an owner is both landlord and tenant he obtains the same deduction.

Not all owners are landlords. The ones that live in the place that they own only "pass on" the cost savings of the mortgage deduction to themselves (is that what you mean by an owner being a tenant?). They are pocketing 100% of the subsidy whereas tenants are only pocketing a fraction of the share of the subsidy that their landlord passes on (based on the relative elasticities, but clearly less than 100% of it).

When somebody is getting a bigger subsidy than others, that's a wealth transfer. Just like Social Security is a wealth transfer from young to old because the young will receive lower benefits.

Lord writes:

That subsidy does not accrue to the owner as such, but to the debtor. The tax system is designed to encourage borrowing for the creation of wealth. Renters don't undertake this risk so don't benefit from it unless they leverage their investments. Now they may want to avoid this risk, but it means foregoing the return as well.

Social Security is not a wealth transfer in your sense. A growing population requires a greater investment in uprearing children and building infrastructure. A stable population doesn't entail these investments. Social Security only appears to provide a higher return because these costs are not considered part of the system. The secondary reason it appears less is increased life expectancy.

There are two reasons owning ends up cheaper than renting in most of the country. Inflation works for the owner and against the renter over time, and the owner earns a return on his equity that the renter doesn't make. In expensive areas, one can rely on appreciation above inflation over time as well. Renting is generally cheaper than owning initially though, often substantially so in expensive areas.

Lord: The tax system is designed to encourage borrowing for the creation of wealth. Renters don't undertake this risk so don't benefit from it unless they leverage their investments. Now they may want to avoid this risk, but it means foregoing the return as well.

Alright. So you've moved from denying that there is a transfer to defending the transfer. I have less to say about this topic, except:

A) The free market already includes incentives for people to undertake risk and borrow to create wealth: a higher return. And yes, inflation as well. Why do you think these incentives are too low?

B) Isn't there a downside to encouraging risk-taking beyond its normal rate? Doesn't this run the risk of creating bubbles?

Lord: Social Security is not a wealth transfer in your sense. A growing population requires a greater investment in uprearing children and building infrastructure.

That made no sense to me. Social Security funds do not go towards uprearing children nor building infrastructure. They go towards retirees. Retirees who paid into Social Security at a much lower tax rate than younger workers. That's a transfer. Life expectancy doesn't just make this problem appear worse, it actually increases the transfer by increasing the benefits to people regardless of how much money they paid in.

Market Urbanism writes:
Inflation works for the owner and against the renter over time, and the owner earns a return on his equity that the renter doesn't make. In expensive areas, one can rely on appreciation above inflation over time as well. Renting is generally cheaper than owning initially though, often substantially so in expensive areas.

False. The expected growth in rental income is baked into the value of the rental property by what's referred to as a Cap Rate. The cap rate is the net-operating income of next year's income over the value of the property. In areas where income growth is expected to be high, cap rates are low, raising the property value relative to the rent. (or you could say lowering the rent relative to the property value)

r = y + g
total return = yield (cap rate) + growth

This applies to home ownership as well. Areas where appreciation is expected to be high, have higher home prices relative to the equivalent rent.

The kind of irrational myth you are describing is what causes bubbles.

Lord writes:

The taxation of interest was established with the origin of the income tax, reasonably to me. It could have been treated differently but wasn't. While it's intent is promote risk taking, or at least not discriminate against it, I don't think it actually does so. It only sets up the tableau in which to determine whether those investments are worthwhile. Businesses currently borrow a lot, but they could just as well rely solely on equity. It only determines the relevant interest spread and capital structure. So it doesn't increase the incentives for risk taking or take risk taking beyond any normal level. A change in policy however would do that until a new equilibrium was established. I see no benefit to that.

Retirees paid into Social Security at a lower rate because they could do so. They raised more children, build more infrastructure, made more investments, to make that possible. They died sooner as well. Newer retirees won't done this and may well have to pay more to make up for it unless they would prefer to die sooner. Earlier retirees may have had a higher return on Social Security but it was because they brought it about. Newer retirees return on Social Security may be lower but it will be through their own actions and needs.

Intergenerational transfers are largely fictitious. Finance likes to project what a dollar will be worth in the future. For a society though, it is the society through their actions that determines what that dollar is worth.

Market Urbanism:
I am glad we agree. You might want to reread what I wrote.

Lord: Retirees paid into Social Security at a lower rate because they could do so. They raised more children, build more infrastructure, made more investments, to make that possible.

Again, you have shifted discussion from whether there is a transfer to whether such a transfer would be fair.

And although what you said might have been true for some generations, it is not true for the one that is causing the biggest problems for Social Security: the Baby Boomers. They had fewer children, resulting in fewer workers paying retiree benefits, causing the (projected) shortful which was the reason that the Social Security tax rates were increased.

Lord: While it's intent is promote risk taking, or at least not discriminate against it, I don't think it actually does so. It only sets up the tableau in which to determine whether those investments are worthwhile.

Yes, the taxation is one of several things that "sets up the tableau," if by tableau you mean all the conditions affecting economic decisions. The interest rate itself is one of them. Any policy that raises or lowers the interest rate or the taxation rate on the interest changes risk/reward ratio and thus the amount of total investment. To choose to treat interest income differently from other income changes the risk/reward ratio in the new "tableau", creating incentives for people to attempt to make money by assuming more risk than they otherwise would have in the old "tableau."

Lord: The taxation of interest was established with the origin of the income tax, reasonably to me. It could have been treated differently but wasn't.

According to this excellent 2006 New York Times piece, the history isn't that straightforward. To summarize, the evidence indicates that Congress did not intend to create incentives for homeownership, because most homeowners at the time didn't have mortgages. Congress probably had business interest in mind instead. The rise of credit cards caused Congress to close the loophole, but the incentives created by that tax break had, by that time, created a real estate mortgage industry too large for lawmakers to do anything about the mortgage deduction.

The quote to take away from all this:

Since 1986, there have been some 15,000 amendments to the tax code, always to help some interest or other but each time distorting free-market incentives. To an economist, when someone invests for profit, that's good. When they invest to take advantage of a tax break, that's bad. "It's a standard canon of economics," Poterba says. It means that capital is being diverted from its best use, and the economy suffers as a result.

Emphasis mine. In addition, the article notes that the transfer from tenants to owners doesn't even create incentives for tenants to become owners because most tenants don't make enough money to itemize deductions.

I found the link via the Tax Foundation's Tax Policy Blog, which had this to add:

The article is right – the mortgage interest deduction essentially treats individuals’ housing expenses like a business expense, allowing them to deduct it from taxable income. But the big difference between a business deducting interest and an individual deducting housing-related interest is that the business must pay taxes on the net income for which that expense was incurred, whereas no one pays tax on the imputed income they earn from owning a home.
Market Urbanism writes:
Market Urbanism: I am glad we agree. You might want to reread what I wrote.

I guess I must have interpreted the word "cheaper" differently than you had intended. Sorry for that. Then let me clarify:

Renting is usually cheaper than owning in high growth areas, if by "cheaper" you mean initial monthly housing payments.

Owning is usually cheaper than renting in slow/negative growth areas, if by "cheaper" you mean initial monthly housing payments.

My previous comment got stuck in moderation, probably because it contained a couple of links. Am attempting to repost without those links.

Lord: Retirees paid into Social Security at a lower rate because they could do so. They raised more children, build more infrastructure, made more investments, to make that possible.

Again, you have shifted discussion from whether there is a transfer to whether such a transfer would be fair.

And although what you said might have been true for some generations, it is not true for the one that is causing the biggest problems for Social Security: the Baby Boomers. They had fewer children, resulting in fewer workers paying retiree benefits, causing the (projected) shortful which was the reason that the Social Security tax rates were increased.

Lord: While it's intent is promote risk taking, or at least not discriminate against it, I don't think it actually does so. It only sets up the tableau in which to determine whether those investments are worthwhile.

Yes, the taxation is one of several things that "sets up the tableau," if by tableau you mean all the conditions affecting economic decisions. The interest rate itself is one of them. Any policy that raises or lowers the interest rate or the taxation rate on the interest changes risk/reward ratio and thus the amount of total investment. To choose to treat interest income differently from other income changes the risk/reward ratio in the new "tableau", creating incentives for people to attempt to make money by assuming more risk than they otherwise would have in the old "tableau."

Lord: The taxation of interest was established with the origin of the income tax, reasonably to me. It could have been treated differently but wasn't.

From what a fascinating New York Times piece by Roger Lowenstein from March 5, 2006 entitled, "Who Needs the Mortgage-Interest Deduction?" (which you can find by Googling the terms "mortgage deduction history" and clicking the link from the Tax Foundation), the history isn't that straightforward. It used to be that all interest was deductible. Furthermore, Congress most surely did not intend to use the tax code to create incentives for homeownership, because most homeowners at the time of the deduction's creation didn't have mortgages.

Congress probably had business interest in mind instead of the subsidizing of consumer purchases. Therefore, the rise of credit cards caused Congress to close the loophole. However, the incentives created by the tax deduction had, by that time, attracted enough people into the real estate and mortgage industry, making it too large and influential for lawmakers to do much of anything about the mortgage deduction. So it stayed.

The quote to take away from all this:

Since 1986, there have been some 15,000 amendments to the tax code, always to help some interest or other but each time distorting free-market incentives. To an economist, when someone invests for profit, that's good. When they invest to take advantage of a tax break, that's bad. "It's a standard canon of economics," Poterba says. It means that capital is being diverted from its best use, and the economy suffers as a result.

Emphasis mine. In addition, the article notes that the transfer from tenants to owners doesn't even create incentives for tenants to become owners because most tenants don't make enough money to itemize deductions.

The Tax Foundation's Tax Policy Blog had this to add:

The article is right – the mortgage interest deduction essentially treats individuals’ housing expenses like a business expense, allowing them to deduct it from taxable income. But the big difference between a business deducting interest and an individual deducting housing-related interest is that the business must pay taxes on the net income for which that expense was incurred, whereas no one pays tax on the imputed income they earn from owning a home.

My previous comments got stuck in moderation, probably because it contained a couple of links. Am attempting to repost without those links.

Lord: Retirees paid into Social Security at a lower rate because they could do so. They raised more children, build more infrastructure, made more investments, to make that possible.

Again, you have shifted discussion from whether there is a transfer to whether such a transfer would be fair.

And although what you said might have been true for some generations, it is not true for the one that is causing the biggest problems for Social Security: the Baby Boomers. They had fewer children, resulting in fewer workers paying retiree benefits, causing the (projected) shortful which was the reason that the Social Security tax rates were increased.

Lord: While it's intent is promote risk taking, or at least not discriminate against it, I don't think it actually does so. It only sets up the tableau in which to determine whether those investments are worthwhile.

Yes, the taxation is one of several things that "sets up the tableau," if by tableau you mean all the conditions affecting economic decisions. The interest rate itself is one of them. Any policy that raises or lowers the interest rate or the taxation rate on the interest changes risk/reward ratio and thus the amount of total investment. To choose to treat interest income differently from other income changes the risk/reward ratio in the new "tableau", creating incentives for people to attempt to make money by assuming more risk than they otherwise would have in the old "tableau."

Lord: The taxation of interest was established with the origin of the income tax, reasonably to me. It could have been treated differently but wasn't.

From what a fascinating New York Times piece by Roger Lowenstein from March 5, 2006 entitled, "Who Needs the Mortgage-Interest Deduction?" (which you can find by Googling the terms "mortgage deduction history" and clicking the link from the Tax Foundation), the history isn't that straightforward. It used to be that all interest was deductible. Furthermore, Congress most surely did not intend to use the tax code to create incentives for homeownership, because most homeowners at the time of the deduction's creation didn't have mortgages.

Congress probably had business interest in mind instead of the subsidizing of consumer purchases. Therefore, the rise of credit cards caused Congress to close the loophole. However, the incentives created by the tax deduction had, by that time, attracted enough people into the real estate and mortgage industry, making it too large and influential for lawmakers to do much of anything about the mortgage deduction. So it stayed.

The quote from the Lowenstein piece to take away from all this:

Since 1986, there have been some 15,000 amendments to the tax code, always to help some interest or other but each time distorting free-market incentives. To an economist, when someone invests for profit, that's good. When they invest to take advantage of a tax break, that's bad. "It's a standard canon of economics," Poterba says. It means that capital is being diverted from its best use, and the economy suffers as a result.

Emphasis mine. In addition, the article notes that the transfer from tenants to owners doesn't even create incentives for tenants to become owners because most tenants don't make enough money to itemize deductions.

The Tax Foundation's Tax Policy Blog had this to add:

The article is right – the mortgage interest deduction essentially treats individuals’ housing expenses like a business expense, allowing them to deduct it from taxable income. But the big difference between a business deducting interest and an individual deducting housing-related interest is that the business must pay taxes on the net income for which that expense was incurred, whereas no one pays tax on the imputed income they earn from owning a home.

Ugh. Seems like the comment moderation didn't like the quote I was trying to make from the Lowenstein piece. Anyway, it points out that someone investing for profit is a good thing. Someone investing to take advantage of a tax break is a bad thing, because it means capital is being diverted from its highest valued use.

In addition, the article notes that the transfer from tenants to owners doesn't even create incentives for tenants to become owners because most tenants don't make enough money to itemize deductions.

The Tax Foundation's blog had this to add:

The article is right – the mortgage interest deduction essentially treats individuals’ housing expenses like a business expense, allowing them to deduct it from taxable income. But the big difference between a business deducting interest and an individual deducting housing-related interest is that the business must pay taxes on the net income for which that expense was incurred, whereas no one pays tax on the imputed income they earn from owning a home.

In case the moderation wasn't due to the links, here's the Lowenstein piece I found via the Tax Foundation's Tax Policy Blog.

[perfectlyGoodInk--Eek! Sorry about the moderation. I think I've now figured out what was triggering it and fine-tuned the spam software a little, so I don't think you'll get moderated now. (It wasn't the links last night, though that was my first thought, too. I think the Lowenstein quote purely by happenstance used a word that coincidentally included a series of letters that had gotten marked for moderation because that series had recently appeared in a lot of spam. No wonder it was driving you crazy! It was a challenge for me to find it, too.) I'll keep an eye on it to be sure. Please email me at webmaster@econlib.org if it happens again and I'll get on it right away. I don't enjoy the time involved with my moderating any more than you enjoy the delay of being moderated, so the fewer moderations, the better. I've also removed a few of the duplicates you submitted as experiments, but I've left in some track records so as not to expunge your clever efforts to figure it out. Good going, but next time, don't stay up all night! Just email me.--Lauren Landsburg, Econlib Ed.]

Lord writes:

I'll try to make this simple. The parents create a large vibrant fast growing economy and retire on the bounty of it for a short period of time. Their children, try as they might, only produce a slow growing economy. They come crying to their parents saying we tried our best but we won't end up with as much and will have to live longer as well. The parents try to comfort them. No, it isn't your fault you will end up with less, that you only managed to create a slow growing economy, or that you will live longer. No, it isn't fair, not fair at all. Alas, life isn't fair. Sometimes we have to make the best of it.

No, it is not a generational transfer. Retirees created the economy they retired on. Future ones will as well. Current retirees are not boomers, and won't be predominately boomers for another decade or two. Boomers have paid more and are still paying more and this will help. It will be necessary under slower future growth and longer lives to continue paying more. That will not end with the boomers unless we see a renaissance in the economy.

The entire reason to change tax laws is change how people behave. More changes just lead to more tax directed changes. People do pay on their imputed income, they just do it through property taxes rather than income taxes. My main concern is not with mortgage holders but bond holders. It is certainly possible to favor equity and denigrate debt. I have serious doubts this would be any improvement.

Most tenants can not afford to buy but they still need housing which means they need someone to provide it for them. That is what exactly what this transfer does. Landlords are businessmen. Homeowners are landlords, all of them, even the ones that only rent to themselves.

Lord: Retirees created the economy they retired on.

No, I think it would be more accurate to say that they played a role in creating the economy that they retired on. Who created the economy would be the sum of the efforts of the retirees, the previous generations, and the generation of people who are currently working.

The answer to the complicated question of how exactly to weight the contributions constantly changes, and these changes do not propagate themselves to the separate question of how to fund the benefits of current retirees from the incomes of current workers. That separate funding question is determined mostly by how many children each generation bears, as well as advances in life expectancy. Those two factors certainly do not correlate very well with the amount of productivity gains from technological progress. Note that as an economy develops, birthrates traditionally go up before they go down even though technological and economic progress is continually made.

Lord: The entire reason to change tax laws is change how people behave.

And as I've mentioned, economists know that any distortions in the tax code will divert capital flows from their most efficient uses. So an equally valid reason to change tax laws is to remove such distortions. Please read the Lowenstein piece. For an article in the New York Times, it actually does a decent job fairly depicting the economist's point of view.

Lord: It is certainly possible to favor equity and denigrate debt. I have serious doubts this would be any improvement.

This means you believe there was an efficiency gain from choosing to favor debt and denigrate equity. A tax code that is neutral to behavior would treat all income equally with zero deductions or credits. A tax deduction for interest income influences market players towards debt. This increases the amount of risk taken on by the overall market. In addition, the choice has an opportunity cost, as the tax code is creating incentive for players to deviate from what would have been the most efficient behavior.

Unless you believe the free market's existing incentives for people to assume risk were somehow too low.

Okay, to be sure, a tax code perfectly neutral to behavior would be at a rate of zero. But an income tax code that is most neutral to behavior would be flat with no deductions or credits.

Lord writes:

Growing population eases the retirement burden but increases the working burden, so it isn't easy either. Among the best analyses of Social Security available is http://bruceweb.blogspot.com/

Making interest payment nondeductible would definitely be a bias against debt to me. Debt already pays through taxation of interest. Double taxation of it would not be neutral in my opinion and likely wasn't either to the original designers.

Lord: Growing population eases the retirement burden but increases the working burden, so it isn't easy either.

Never said it was easy. I'm actually arguing that it is difficult, and that there's nothing in the calculation of SS taxes and benefits that even attempts to cause it to match or even correlate with the productivity of a generation. So it's extremely unlikely for the generational transfers to start out or remain fair.

Lord: Making interest payment nondeductible would definitely be a bias against debt to me. Debt already pays through taxation of interest.

I don't understand your point. Debt doesn't pay if the interest is deductible, which means the deduction creates a policy bias towards debt.

Keep in mind the policy's effect to change the behavior of people on the margin. This would be somebody whose comparative advantage is slightly in favor of earning income working for someone else rather than taking out a loan and starting their own business. With the deduction, the return is increased by taxpayer funds, altering the risk/return ratio and tipping the incentives for this person to start their own business.

Thus a tax code with an interest deduction diverts this person's behavior from their most productive and efficient activity. Unless you believe the free market incentive for assuming risk is somehow too low.

Lord writes:

Interest is taxable to the recipient. Making it also taxable to the payor taxes capital twice. There is no difference in efficiency between these two because tax is still collected on the interest earned. Now if you want to discourage saving and lending I can't think of a better way.

I'm not really a fan of double taxation arguments. Arguably, money is taxed infinitely. I pay income taxes on my income. I use it to buy stuff. This money gets taxed again for sales taxes, then taxed again for payroll taxes, and when it goes to someone else's income, the income gets taxed again, and when that person spends it, the whole cycle repeats itself. Perhaps I'm misunderstanding the argument, but that's my take on it.

The important thing is not how many times the money gets taxed. Because that's just a question of how you want to count it, and money does not make economic decisions. What really matters are the the tax's incentives on the market players.

Now, a tax policy that everybody can agree causes no distortion on behavior is a tax rate of zero. People can then decide based purely on market incentives whether to trade their labor for income or invest capital for a return or borrow money and become an entrepreneur. Adding an income tax that does not treat interest income the same as labor income will cause some people on the margin to switch from working to investing, even though they would have been most productive working. Likewise, adding an income tax where interest expenses are deductible will cause some people on the margin to switch from working for somebody else to borrowing money and starting their own business, even if that's not what they would be best at.

A tax code that is truly neutral will not alter incentives for behavior from what it would have been had the tax rate been zero. And if you're going to have an income tax, this means taxing all possible sources of income at the same rate with no deductions.

Lord writes:

The way to think about this is the lender becomes a silent partner with income passed through to the partners in the proportion of interest to remainder. Therefore elimination of the deduction can be circumvented simply by filing. It essentially just drives lending to internal sources.

I'm not sure I understood you fully, but if lending to a partner (silent or otherwise) is treated differently by the tax code compared to lending to anybody else, then that causes another distortion of incentives.

If you are saying a tax on interest income creates an incentive to not report the loan and thus the income, then yes. Any tax increases transaction costs and thus creates incentives to avoid it, including the income tax (e.g. hiring of illegal immigrants). But that's just another reason to simplify the tax code and lower the rate as much as possible.

Daeah Luz writes:

Home ownership is a good investment unlesss you invest in a good investment firm. The government must also inspect those investment firms anually.

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