Arnold Kling  

A Tax Increase I Can Support

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Getting rid of the mortgage interest deduction. Subsidizing mortgage indebtedness is not a good thing.

I am not buying any "starve the beast" arguments. My personal starve-the-beast approach is to donate a lot of my income to charity. But the spending beast needs to be slayed directly. Get rid of the mortgage interest deduction, cut spending, then cut marginal tax rates.


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CATEGORIES: Tax Reform



COMMENTS (11 to date)
John Thacker writes:

I would love to get rid of the deduction. However, while I know that people always argue that it isn't the right time to get rid of it, maybe it isn't the right time to get rid of it. Personally, I would have loved to eliminate it while the bubble was going in order to slow the bubble down.

I think if it is to be eliminated, the only politically practical way to do so is to slowly reduce the debt limit at which it applies (currently $1M), or at the very least keep it the same and have inflation do its magic.

Foobarista writes:

Yup, this is one of those nasty "how do we get there from here" problems. This will obviously crater the RE market in relatively high-cost areas (even more than it already has fallen), and will have a secondary impact of driving down state and local tax revenues even more.

Sure, the interest deduction probably shouldn't exist to begin with, but this is the fun part about government policies, both good and bad: they're darn hard to change once they've been around a long time and have built up markets that have priced them in.

Gary Rogers writes:

Don't make it complicated. Arnold is correct. Just get rid of it along with all of the associated tax code.

Kevin writes:

You'd have to cancel the deduction way out in the future. Otherwise, this will bankrupt every lender who holds a non-recourse mortgage (and probably every one with recourse) day one. I guess if you don't believe the simultaneous failure of every financial institution is a problem and you think it's okay to transfer trillions of dollars from homeowners, banks, and bank creditors to people short housing and the government, then it's okay to do it immediately.

mulp writes:

Eliminate just the mortgage interest deduction, or just mortgage interest deduction on houses owned by individuals, or just the deduction on the house a person lives in??

If a person can't deduct the mortgage interest on housing he rents, then it doesn't make sense to allow a real estate corporation to deduct the interest it pays on mortgages.

If interest on income property can be deducted, then that means interest on a duplex with half rented out should be deductible.

If mortgage interest can't be deducted, then debt secured by inventory shouldn't be deductible.

I agree that interest deductions for taxes are bad policy because they distort things, but the tax treatment of interest on debt of corporations is as big a distortion as on homes. And as we move from mega corp to small corp to sole proprietor to home based business to rooming house to home, it isn't clear where interest moves from business expense to tax incentive - if a business can deduct it, then it is a tax incentive to the business.

GU writes:

Kling,

Yes yes yes! Far too many libertarians confuse politics with tax policy. The taxation system should be designed to raise enough revenue to cover spending in the most economically efficient (and perhaps "fairest") manner possible. Arguments about spending are entirely separate.

I wish the government spent a lot less. But this has nothing to do with designing taxation schemes. The mortgage interest deduction is distortionary (a.k.a. inefficient). There is no good reason for it; approximately zero tax policy experts are in favor of it.

Finally, Starve the Beast does not work. If it did, then maybe the "cut taxes no matter what" crowd would have a point. Since StB does not work, their arguments amount to screwing over future generations and increasing the probability of a truly dire fiscal crisis in the U.S.

Mulp,

If you really want to get technical, under the Haig-Simons definition of income, the universally accepted definition by economists and tax policy experts, both the imputed income equal to the rental value of your personal residence, and any appreciation in the value of your house should be included in your taxable income every year. If we're going to tax "income" we shouldn't make special exceptions. Even without the mortgage interest deduction, the government is actually giving homeowners a break by not taxing imputed income and appreciation (prior to sale) associated with private housing.

Thomas Boyle writes:

GU,

Of course STB works. It's working right now, in Greece, and soon it will work in CA.

Beasts always thrash about and grumble when they're starving - what do you expect?

But keep 'em hungry, and they will eventually starve. What's more, they learn how to diet. Ireland is cutting its spending with far less grumbling than might be expected, because the beast had to go on a diet once before, in the 1980s, with excellent results - and the population remembers that it worked out before.

There's nothing particularly bad about having a good fiscal crisis. That's what STB is designed to lead to. In fact, given that the population remembers, it's probably best to drive to fiscal crisis relatively often, so that the shock to individuals' expectations is less, and the fix easier.

Besides, what's the alternative - FTB? That just can't lead to a good outcome.

David N writes:

When the income tax was established in the US, all personal interest was deductible. It didn't matter what you borrowed the money for. It nicely avoided double-taxation of interest for businesses and individuals alike. Why can't we go back there?

If the MID is eliminated, I will start a company that will buy your house for $1. We'll borrow money and pay off your mortgage, then rent the house to you at a big discount to what you'd otherwise pay. We can afford to offer this discount because our corporation can deduct interest and you can't. If you ever want to buy the house back, there's an ever-declining price I can look up for you. After 20 years or so, you can have it back for $1.

GC, if you're going to tax homeowners for imputed income then they should be allowed to deduct depreciation and maintenance expenses like landlords can. No special exceptions, right?

Tom Grey writes:

Now, after a huge overbuilding housing bubble, is a terrible time to just eliminate the tax deduction on interest.

But it would be better, for home ownership support, if it was a 50% tax credit on house payments, both interest AND principal.
Plus there should be a lifetime maximum housing credit (e.g. 10*avg tax filer after tax income of prior year, so the lifetime average slowly increases).

Tax credit so there is less distortion and preference for the rich; lifetime limit so it disappears for many rich and upper middle class folk after 10, 20, 30 years. And a big credit now to boost the prices but with an expectation of much lower long term increases, so house ownership (=equity) is more supported than speculation.

The original US Constituion only allowed property owners to vote -- there was part of an excellent idea in there. The USA will, generally, be a better place to live when more people are buying their own home. In a sustainable, non-speculative way.

Peter writes:

Just a personal comment but should this get repealed I will be giving my house back to the bank. I am 25% under, house was on the market for 1.5 years and couldn't even short sell, and I am now renting it out at -20% my mortgage to prevent giving it back sacrificing my kids education in the process (I hold to my word and don't think its moral to just give up because you don't like how your bet worked out) but I simply can't afford this hit I would take if this was repealed nor am I the only person in this boat. Sure you can argue maybe I shouldn't have bought in the first place but the fact is I did and am still paying on that house through this entire recession even though rationally it doesn't make sense economically and I can't advocate a policy that will kill me :)

thebastidge writes:

Got to disagree: tax deductions and over spending have zero to do with each other. Cut government spending, cut taxes. Two issues, only circumstantially related.

Sure, I'd prefer to see a flat rate tax structure where there are no deductions, purely for simplicy's sake. It's not even really a fairness issue, except that it is virtually impossible to *guarantee* compliance in an overly compicated system such as we have now

Cut the taxes to a supportable low rate, and then you cna eliminate deductions, in my book. In the mean time, the mortgage interest deduction is undoubtedly a tax-based incentive, but I have to live somewhere. Having a mortgage interest rate deduction is no worse than excluding food from a sales tax, which my statre already does.

Your argument seems to assume that the government has some "right" to the money it is "losing" by "allowing" me to deduct my mortgage interest.

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