Let's Kill the Mortgage Interest Deduction and Replace It With This

Instead of letting the rich deduct their mortgages, what if the government created savings accounts that made it easier to make a down payment?

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The mortgage interest deduction probably isn't going anywhere soon. Voters are far too fond of it, and politicians are loathe to nix a popular sort-of-kind-of-middle-class entitlement. But while the tax break might be beloved by the people who actually show up on election day, it's also a highly regressive giveaway to the top 20 percent of American households, who reap 75 percent of the benefit, as my colleague Matt O'Brien wrote yesterday.

So let's say policy wonks could wave a magic wand and make the mortgage interest deduction disappear. How could we replace the thing? Even though everyone has sobered up a bit about it thanks to the housing bust, home ownership still has a lot of economic virtues we should want to encourage. For instance, it's one of the few ways a large portion of this country actually saves. And we really don't want Americans saving any less than they already are.

One interesting solution: a proposal from the Progressive Policy Institute to create "HomeK" accounts -- or 401Ks for home buyers. Workers could shift a portion of their retirement savings into a sub-account meant for purchasing a house, which they could then withdraw either tax-free or at a low rate when it came time for a down payment. The PPI would cap the amount at $50,000 to be spent on a first house. (Important to note: The institute's researchers weren't themselves proposing that we get rid of the mortgage deduction. But I think their idea is interesting in that context).

Without getting too much into the nitty gritty details, what's broadly neat about this concept is how it flips the incentives for home buyers in a much needed way. Interest deductions encourage borrowers to take out larger mortgages, and perhaps buy too much house, since they're delaying the impact of their spending decisions. Tax free savings accounts encourage workers to make larger down payments, since that's where they'd find the savings. On the one hand, the swap might delay home ownership for some families. On the other, it would make it a safer, more responsible investment for many of them once they got there. You could always try to reconcile the two by limiting mortgage deductions and introducing savings accounts to try and get the best of both worlds.

One other potential downside to this idea: not every worker has a 401K. But given what we know, those workers probably aren't taking advantage of any mortgage tax breaks anyway.