The Treasury Department views all income not taxed as a tax-expenditure loophole to be closed, and the biggest of these is the home mortgage interest tax deduction. The National Commission on Fiscal Responsibility and Reform reports Dec. 1 and is likely to find the estimated tax revenue of $130 billion a year too tempting to resist.
Most economists have long argued that the MID diverted too much capital away from productive business investments to less-productive housing, and the overbuilding during the recent subprime lending bubble is cited as evidence of the consequences.
Even if eliminating or scaling back the MID is good economic policy, the timing is bad, massive fiscal deficits not withstanding. And there are numerous reasons to believe this isn't as good an idea as its proponents would have us believe.
The Treasury never thinks it is a bad time to raise taxes by eliminating deductions. Back in 1982 when the entire thrift industry was technically insolvent due to the largely political and regulatory required policy of borrowing short and lending long, the Treasury recommended raising thrift taxes by eliminating the bad-debt deduction on the flawed theory that the survivors would then diversify out of mortgages.
The Garn-St. Germain Act of 1982 instead gave them the authority to invest in income mortgages to earn their way back to solvency, and the Accelerated Cost Recovery System, instituted by the Economic Recovery Tax Act of 1981, gave developers a huge incentive to build. Seven years later, as the budget deficit was soaring, the real estate tax benefits were modified by the Tax Reform Act of 1986. This is estimated to have wiped out $300 billion of income property value, and many thrifts along with it.
The MID didn't contribute to the subprime lending bubble, because most of those borrowers paid very little mortgage interest due to teaser interest rates and they didn't have sufficient income to warrant itemizing deductions in any event. Hence the mortgage market is much more stable at the higher end for those currently making their payments. The same is true for current home construction, which is focused more on higher-end and custom homes. But raising taxes for highly leveraged homeowners can't be good for mortgage lenders. Nor can raising taxes for the borrowers currently buying new homes be good for the construction industry.
Of course proponents argue that there has never been a good time to slay this sacred cow, and we need the money now. But the merits of eliminating the MID aren't what they once were, and the revenue estimates are likely highly inflated in any event.
Tax economists know all too well that the MID isn't a tax advantage — all businesses deduct interest expenses and homeownership is implicitly a business of renting to oneself. That's important for several reasons. First, removing the distortion to homeownership would require taxing imputed homeowner rental services, which no politician ever proposes. Second, most if not all those additional revenues from taxing the "rich" will disappear when they sell off their taxable bonds to pay off their mortgage.
Whether the tax code favors homeownership relative to rental is questionable. Whereas few if any subprime borrowers got any benefit as homeowners, they would have benefited as renters from accelerated depreciation and likely a plethora of federal, state and local tax credits for low-income housing as well. Businesses similarly have a plethora of tax "breaks" as the Treasury would define it.
Homeowners also get to deduct state and local taxes, which have approximately doubled as a share of GDP in the last half century.