Comment December 2007

Housebound

Why homeownership may be bad for America

Glaeser and Shapiro point to other social costs. Communities of homeowners tend to act as cartels—calling for zoning rules, for instance, that suppress new development. At a minimum, the wider benefits of homeownership are not clear-cut.

The mortgage-interest deduction is the backbone of American housing policy. It exists, ostensibly, to encourage widespread homeownership. In its favor, it doesn’t actually do that. But it does have consequences: It’s been one of the quieter causes of the housing bubble. The mortgage-interest deduction deserves special recognition for the stupidity with which it subsidizes something that should not be subsidized in the first place. I challenge you to design a subsidy for homeownership that is as wasteful, as unfair, and as harmful to the economy in the long run.

The current deduction costs nearly $80 billion a year in forgone federal revenues. It is available only to the minority of households—typically affluent— that itemize their taxes. Households at the margin of choosing between renting and owning are not, for the most part, itemizers. The deduction has no effect on their choice, and thus does almost nothing to promote homeownership. What it does promote, studies show, is spending on housing—that is, people who would have been owners anyway pay more for their houses. Prices are higher than they would otherwise have been, and mortgages are bigger. As many owners have learned abruptly, this can worsen economic insecurity.

Heavy spending on housing, fueled by the subsidy, twists the pattern of economic growth as well. If investment in housing goes up, investment in things that would expand the economy and improve future living standards—such as commercial building and business equipment—goes down.

There are other problems. The value of the deduction, of course, is greater for those in higher tax brackets. And the code provides relief against home-equity loans up to $100,000, so that mortgagees, but not renters, can use tax-sheltered debt to buy new cars and televisions. None of this makes a shred of sense.

Is the mortgage-interest deduction untouchable? It may seem so. Ronald Reagan’s grand tax reform of 1986 was radical, but not bold enough to assault the tax break for mortgages. Homeownership, he affirmed, was part of the American dream. When George W. Bush convened a panel of experts in 2005 to revisit fundamental tax reform, he told them, in effect, to leave mortgages alone.

But Britain’s experience says otherwise. Under Margaret Thatcher—committed as she was to “popular capitalism,” her version of the “ownership society” that Bush would later champion—Britain’s mortgage-interest tax deduction began to be phased out. Some 20 years later, it’s gone altogether, with no ill effects. (Perhaps unfortunately, Britain’s rate of homeownership is still about as high as America’s.)

The tax-reform panel advising Bush in 2005—the one he instructed to leave housing out—went ahead and called for reform anyway. Its members accepted the case for subsidizing homeownership, but they said that the mortgage- interest deduction should go. In its place, they suggested a small tax credit (worth the same amount, for a given mortgage, regardless of a person’s tax bracket) capped at a maximum of a few thousand dollars a year. Whether even this much-smaller subsidy makes sense is debatable—but if such a plan were adopted, outright abolition would be but a small additional step. Mild as it is, this halfway reform would likely save tens of billions of dollars, which could be used to pay for other tax cuts—the sort that don’t badly distort the economy or encourage needless risk-taking. Presented as a whole, a package like this surely ought to be sellable.

Britain’s current housing-market troubles show that even without the extra spur of tax-sheltered borrowing, prices can get out of hand and then scare people witless when the mood shifts. Killing the mortgage-interest deduction does not guarantee a calm and steady housing market. And admittedly, this year is not the year to be curbing tax relief for mortgage borrowers. Falling house prices are risky enough for the economy already; the economic consequences of an outright collapse could be dire.

Still, when the housing market stabilizes, Congress and the next administration should ask how we got into this mess in the first place, and then embark on a phased reform. Its benefits would emerge only slowly. But a tax break that fuels speculation and overborrowing, that widens income inequality, and that fails to serve its own questionable purpose deserves a lingering death.

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