When it comes to quotes about economists, there may be none more well-known than President Truman’s remark about the two-handed economist. Frustrated with what he perceived as the inability of economists to take a firm stance on an issue, President Truman famously said: “Give me a one-handed economist! All my economists say, On the one hand…. on the other.”
But for many people this neutrality is no laughing matter. Instead it is simply a by-product of economists being unable to reach a consensus regarding key economic issues. While this might paint a picture of economics as a field of widespread disagreement, there are many issues that economists from a wide variety of backgrounds find themselves in agreement on – whether that be the benefits of free trade, or the lack of a need to return to the gold standard. As such it’s often said that you can easily find an agreed upon consensus among economists – so long as you are asking the right questions.
An example of this can be found in tax policy reform. While economists would disagree with one another on the amount of revenue a government should raise, or how this revenue collection should be distributed up and down the income ladder, there is much less disagreement regarding the need for a simplified tax code. One reason for this is that the structure of a complex tax code is regressive by nature. The more loopholes there are to take advantage of, the better off those that can afford the best tax lawyers and accountants will be.
There are several methods of simplifying the tax code, but one that often comes at the top of many economists’ lists is the elimination of the home mortgage interest deduction that allows homeowners to claim the interest that they pay on their home loan as a tax deduction. Intuitively this may not make sense, home-ownership is a good thing, right?
However, there is a little evidence that the mortgage interest deduction has encouraged home ownership. In 2003, Edward Glaeser and Jesse Shapiro found that while there is evidence that home-ownership provides positive spillovers for nearby neighbors, there is little evidence that the mortgage interest deduction affected the rate of home-ownership over their period of analysis (1960-2000). Furthermore, there are many countries without similar deductions that possess higher rates of home-ownership, while there are others with similar deductions that actually have lower rates.
The home mortgage interest deduction also possesses considerable inefficiencies. In 2016, an estimated $77 billion was claimed under the mortgage interest deduction, the majority of which went to the top twenty percent of earners, making it a fairly regressive policy. This is a result of the tax-credit effectively subsidizing the purchase of bigger and thus more expensive housing, which grants larger incentives to higher-income individuals.
As the mortgage interest deduction subsidizes the purchase of expensive homes, it also grants these homeowners an additional tax break equal to the amount of rent that someone would pay to lease the home from a landlord. The reason for this is based on the idea of imputed rental income – or the theoretical rent that homeowners pay to themselves by virtue of being their own landlords. While rental income would normally be taxable for the typical landlord, the rental income that a homeowner receives from themselves is disguised and thus non-taxable.
Since low-income households are typically only able to rent, they effectively get 0% back on their mortgage interest. On the other hand, the holder of a million-dollar mortgage would see a tax break worth around $21,000 annually. Additionally, it’s likely that low-income households would fail to take advantage of the mortgage interest deduction as only about 30% of all taxpayers find it advantageous to itemize their deductions – the majority of which aren’t low to middle class homeowners.
Similarly, the mortgage interest deduction incentives individuals to purchase more expensive homes and to make smaller down payments. In effect, the policy offers an incentive for risky behavior by subsidizing mortgages that individuals may not be able to afford. Given the role of risky mortgage debt in the recent financial crisis, eliminating the deduction could make our financial system more resilient.
Another argument against the home interest deduction is that due to the nature of imputed rental income, it misallocates savings away from more productive investments that could encourage job creation and higher wages. Furthermore, as one of the largest tax expenditures, it makes lowering taxes overall much more difficult. So long as this $77 billion in potential revenue is declared off limits, lowering tax rates or federal expenditures will be much harder to accomplish.
Despite what seems to be an overwhelming consensus on the inefficacy of the mortgage interest deduction, eliminating this tax credit is hard to accomplish given its associated political difficulties. One of the more substantial political concerns is that the home mortgage interest deduction has raised the value of homes as the tax credit is now incorporated into the cost of housing – a concept known as capitalization. Eliminating the mortgage interest deduction thus risks lowering the value of homes, an idea many homeowners would have difficulty accepting despite there being some disagreement over the possibility of this occurring.
Ultimately, if eliminating the mortgage interest deduction proves to be too difficult, reforming it is always an option. The Center on Budget and Policy Priorities takes this approach by proposing to change the deduction into a credit and to lower the maximum amount of interest that it can cover. Doing so would trim subsidies for high-income households while providing additional help to middle and low income families. By re-gearing this policy towards the part of the population that has the most difficulty buying a home, we will be able to encourage home-ownership much more effectively.