At the risk of sounding like a heretic, I must say that the sky - and most housing prices - will not fall if the tax deduction for mortgage interest is eliminated.
Yes, if the flat tax were to become law, some upper-end home prices may sag. The benefits of a more enlightened tax policy should, however, more than compensate.
Opponents of the flat tax, most notably the realty lobby, argue that the loss of the deduction will reduce the incentive to buy homes and send the housing market into free fall.
The Cassandras are correct that a tax deduction is an incentive to homeownership. The tax deduction, however, is not the only reason people buy houses. There are many countries that do not allow the mortgage interest deduction yet have higher homeownership rates than does the United States. So before we accept this argument, let us take a broader look at this complex issue.
Most economists favor a flat tax or a consumption tax as an alternative to our current system because it would favor savings and investment over consumption. This shift toward investment incentives should raise the pool of savings and thus reduce rates. In addition, as interest income would no longer be taxed, rates should tend to fall, thereby raising the value of all financial assets.
Another secondary effect of improved financial incentives should be an increase in job growth. Ultimately, the real drivers of home value are wealth and job creation.
Finally, upper-income consumers will see their disposable incomes substantially rise. This should also stimulate demand for upper-end housing. Keep in mind that even under our current system, no deduction is allowed on loans over $1 million. Therefore, the flat tax would have no effect on the carriage trade.
Now let's look specifically at just how much a disincentive the loss of the interest deduction would be. First, it is estimated that about 40% of all homeowners have no mortgage. Obviously the loss of the deduction will not directly affect them, not will it likely affect their demand for housing.
Second, many homebuyers, particularly first-time homebuyers, do not have enough total deductions to justify itemizing their returns and, therefore, reap little benefit under the current system. For many others, their marginal tax rate is already relatively low and a flat tax would not have a significant impact.
So who will be the big losers? Maybe a relatively small percentage of mostly upper-income homeowners. In fact, the National Association of Realtors believes that upper-end homes would be affected most.
Interestingly, the secondary effects of lower interest rates and rising values of financial assets might be sufficient to offset the reduced demand for housing caused by the loss of the deduction. And the same homeowners who receive the largest tax break would also be the largest beneficiaries of the wealth effect.
So, as you can see, the issue is not a simple one. I believe that if a flat tax were passed, we would see very little impact on lower-end housing and far less impact than the realty group is forecasting on upper end housing. There should also, therefore, be minimal impact on the mortgage banking business as well.
Two final thoughts. First, it will take a Republican President or a veto-proof Congress before anyone really has to worry about a flat tax.
Second, if you really want to lose sleep over housing prices, just look at our nation's changing demographics and monetary policy, not at the tax code. The loose monetary policy (and resulting inflation) of the 1970s, which fueled housing price growth, has been reversed. The current Fed chairman is committed to keeping inflation at bay.
In addition, the demographics of home purchasing, in an era of aging baby boomers, is not positive. These trends, and not the flat tax, will be the real culprits if homeownership is not the good financial investment it was in the 1970s.
Mr. Swedroe is vice chairman of Residential Services Corporation of America, Clayton, Mo.
