The New Republic’s Jonathan Chait, admirably trying to make trouble, draws attention to a recent comment, which he probably already regrets, by the Secretary of Housing and Urban Development, whose name appears to be Shaun Donovan. Secretary Donovan spoke sympathetically about the idea of repealing the deduction for interest on home mortgages. This deduction is extremely popular with voters, for obvious reasons. About 80 billion obvious reasons a year, in fact. This deduction is also a perennial favorite target of tax reform types (a club to which Chait and I both belong). It exhibits all the flaws of tax subsidies. An $80 billion tax subsidy increases the deficit exactly as much as an $80 billion spending program. ($80 billion, to be exact). But because it operates through the tax code, it doesn’t get the kind of scrutiny that direct expenditures do. It is regressive, since richer people buy bigger houses, take out larger mortgages, and deduct the interest against a higher tax rate. Its rationale—that home ownership leads to good citizenship—is untested and dubious. And in fact the past couple of years have taught us that encouraging people to buy houses, or bigger houses than they can afford, is no favor to anybody.
Some people start to quiver at any talk of “tax subsidies” because they say this term contains the implicit assumption that all money belongs to the government except what little it allows us to keep. But whether you like your taxes low or high, you can’t design a sensible tax system if every current deduction or credit is considered sacrosanct and every effort to end it is considered to be a tax increase. The appropriate goal of liberal tax reformers and conservative flat-taxers alike is to close deductions and loopholes. Then we can lower tax rates or pay off the deficit or start new government programs as we wish.
The tax code is full of deductions and loopholes. How can you recognize a tax subsidy? You look to its ostensible purpose. There are deductions and credits in the tax code that are intended to make taxes fairer, and then there are deductions and credits that are intended to promote some other public purpose. The second category are tax subsidies. Sometimes it’s hard to tell. Take the charitable deduction, for example. Is this about tax fairness? (Someone who earns $150,000 and gives $50,000 of it away is more like someone earning $100,000 than like someone earning $150,000.) Or is it better seen as a tax subsidy to promote charitable giving?
There is no ambiguity about the home mortgage interest deduction: its purpose has nothing to do with the fair and efficient collection of taxes. That makes it a tax subsidy, which doesn’t automatically make it wrong. In fact, after years of railing against it, I’ve come to think that eliminating it might be unfair.
The problem is that home buyers, although they take the deduction, really get no benefit from it. That’s because the price they pay for the house takes the value of the tax break into account. Eliminate the break and current homeowners will be doubly hit: they will have to pay more taxes every year, and the loss of the tax break will reduce the value of their house when they sell it. The burden of a tax, or the benefit of a tax break, on real estate goes to whoever owns the property at the time the tax or break is enacted. The benefit of the home mortgage interest deduction has long-since been dissipated among past owners of real estate, but current owners will be stuck with the cost of repeal.
This is not a fatal flaw of tax reform—even of tax reform that involved eliminating the home mortgage interest deduction. Home ownership gets subsidized in all sorts of other ways. Any reform will produce arbitrary winners and losers. It’s just that when homeowners whine that they are the losers, in this particular case they have a point.
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