The Inefficiency of the Mortgage Interest Deduction

Matthew O’Brien over at The Atlantic had a piece up yesterday with the bold headline: “Why the Mortgage Interest Deduction is Terrible.” What he means (and does a solid job at explaining in the piece) is that the mortgage interest tax deduction primarily benefits homeowners in the top fifth of income earners. O’Brien writes, “We spend $100 billion every year -- that's the annual cost of the deduction -- subsidizing bigger houses for the upper middle class. This should be among the lowest of low-hanging fruit when it comes to tax reform. It would be nice to end welfare for the well-off.” He notes that the top 1% of earners (those making over half a million dollars a year) receive more benefit from the mortgage interest deduction than the entire bottom 56% of earners combined.

If you read our 2012 Assets Report, you’ll already be familiar with the skewed nature of the mortgage interest deduction and federal spending to promote homeownership more generally. As our infographic shows, people earning below $40,000 filed fewer than 2 million returns claiming the mortgage interest deduction (out of roughly 14 million taxable returns). Meanwhile, those earning above $100,000 filed over 18 million returns claiming the deduction (out of nearly 28 million taxable returns). This means only 14% of households who earned less than $40,000 and had taxable returns received the deduction, while over two-thirds of higher income households received it. The deduction is unfair both due to its take up rate and the dollar value of the benefit. The average value of the deductions was much higher for the wealthy and upper middle class. Households earning over $200,000 received an average deduction nearly ten times that of households in the $30-40,000 range ($6,370 vs.  $664).

If policymakers view homeownership as a valuable goal, wouldn’t it make sense to shift the subsidization of home mortgages from high income to lower income people? Presently, we have a system that rewards behavior that would be happening anyways and subsidizes larger homes for the upper middle class and wealthy. Low- and middle-income homeowners are left with a tiny fraction of the benefits and renters are left out of the picture entirely.  

Unfortunately, high-income people have a hefty financial stake in keeping the tax code exactly as it is. As Matt Yglesias pointed out, Mark Zuckerberg (the CEO of Facebook and the 40th wealthiest person in the world) recently refinanced his mortgage and now has a 1.05% interest rate (considerably lower than most average homeowners). Why would a billionaire even need or want a mortgage? As Yglesias explains, “[mortgage] interest payments are tax deductible, which is a very big deal if you have a very high income and live in a high-tax state like California. That of course raises the question of why we do this as a matter of public policy. The deductibility of mortgage interest is often described as a "middle class" tax break, and it's of course true that middle-class people use it. But richer people have more expensive houses and pay higher tax rates, so the scale of the benefit is much larger to rich people.” Zuckerberg and his high income, high wealth counterparts are benefiting enormously from a feature of the tax code that rewards them for owning homes, while doing next to nothing for the bottom half of the income distribution. That’s a serious inequity that we’ve built into the tax code. Policymakers, advocates, and academics are all working on possible ways to address parts of this problem.

In a 2010 CNN editorial, Dorothy Brown* makes the case that the mortgage interest deduction unfairly penalizes renters for their personal housing choices. In doing so, the mortgage interest deduction places an undue burden on Americans of color because 1) they rent at higher rates than white Americans and 2) even when people of color do own homes, they are disproportionately represented among the low and middle income households who claim fewer and less valuable deductions. As our Aleta Sprague wrote recently federal housing policy is currently doing very little to mitigate the racial wealth gap. When we deliver billions of dollars in homeownership-oriented benefits through the tax code, we systematically exclude certain groups and perpetuate a structural inequality.

The Center on Budget and Policy Priorities' recent paper “Renters’ Tax Credit Would Promote Equity and Advance Balanced Housing Policy” addresses some of the key concerns with the existing preferential treatment given to mortgage interest. The report explains: “Congress could further improve the effectiveness and fairness of the nation’s housing expenditures by directing a modest share of the savings from reform of homeownership subsidies to address part of the unmet need for housing assistance among lower income renters, in the form of a federal renters’ tax credit.” The devil is in the details of course (and the report does go into more depth) but this type of creative thinking is exactly what is necessary to move forward with sustainable reforms of homeownership tax subsidies and broadening access to savings and asset building for all Americans.

*Thanks to Professor William Darity from Duke University and PhD candidate Tressie McMillan Cottom from Emory University for pointing out via Twitter the great work Professor Dorothy Brown of Emory has done in this arena already.