The Simpson-Bowles Breakthrough, Ctd

Adam Ozimek focuses on the mortgage interest deduction elimination proposals in the draft plan:

They present two possible plans for this deduction. One abolishes it entirely, and the other one eliminates it for second homes, home equity mortgages, and any mortgages over $500,000 in value. ...

I strongly believe that lower house prices right now cause significant externalities. Even if this deduction occurs five years from now, the value of a house today is in part determined by it’s expected future sales price, and thus expected future price declines will be factored into today’s prices.

The externalities associated with low house prices should be less of problem for high income households, since foreclosures and labor immobility are less likely outcomes for them. This suggests there will be less of a downside, but not zero, to the second approach proposed by Simpson-Bowles, which eliminates the deductions for 2nd mortgages, home equity mortgages, and mortgages over $500,000.  Alternatively, a slow decrease of the value of the deduction may limit the impact on prices.

In the long-run, the deduction should go entirely since a) it doesn’t increase homeownership, and b) it’s unclear whether we want to do that in the first place. In the short-run we should be very cautious, and make sure it is repealed it in a way that limits the impacts on home prices, especially in the relatively lower part of the price distribution where it is likely to cause externalities.