The Sacred Cow of Real Estate

With the nation's finances in dire shape, elected officials will have to make tough choices in the coming years.  Federal spending is at its second highest nominal dollar amount (2009 being the highest) in the face of two wars and the "Great Recession," tax revenues have plummeted as a result of massive tax cuts and a sluggish economy, and the gap between the two continues to escalate.

These are the kind of tough choices that make politicians wince.  But unfortunately, we've got into this mess and something needs to be done to get out of it.

Numerous deficit-reduction proposals have begun emerging and the Mortgage Interest Tax Deduction, long-held as the "sacred cow" of real estate investing, is increasingly coming under the chopping block.  With home ownership a central theme to the American dream, I felt it would be a good idea to investigate these potential changes and how they might affect homeowners. 

First, it is important to note that of all the advanced economies in the world, only 4 allow personal debt interest to be deducted from their taxable income.  These countries are:

1)  The United States
2)  Sweden
3)  Switzerland
4)  The Netherlands

Perhaps homeowners in the United States have taken for granted their ability to write off mortgage interest.  As you can see, very few countries have laws that allow such a practice.

There are some important rules that govern that ability of homeowners to write-off mortgage interest.  First, mortgage interest deductions are only allowed on primary and second-homes.  Investment properties are not often allowed the deduction.  Also, only the interest paid on the first $1 million of debt is permitted.  These might seem like strict rules, but the reality is that very few Americans own multiple homes, and even fewer have over $1 million in mortgage-related debt.

Currently, the mortgage interest deduction is one of the largest subsidies operated by the federal government.  On average, the federal government spends about $100 billion annually to continue the subsidy.  But does it that important?  Does the mortgage interest deduction really improve the level of homeownership in the United States?

Politically, yes, it does.  Defending the mortgage interest deduction has become commonplace for legislators.  Can you imagine what the FOX News' and the MSNBC's of the world would have to say about a politician that "supports taking more money away from you"?  Of course not, because legislators from both parties have been more than reluctant to call for anything other than a continuation of the status quo.

The real question becomes, who does the mortgage interest deduction benefit most and is it achieving its stated goal of preserving and increasing the level of American homeownership?

Although politicians say one thing, economists (you know, the ones who actually analyze the data and attempt to give unbiased, logic-based conclusions/recommendations!) are almost united in their opposition to the full subsidy.  As it turns out the data shows that, although the interest deduction appears to be a good deal for everybody, the winners are those at the very top of the income distribution.  And those at the bottom rungs of income?  They see the least of the benefits.  In fact, in some areas with particularly strong land-use regulations (think urban areas) the mortgage interest deduction actually HURTS homeownership, particularly among lower-income individuals.

So what should be done?  It seems both legislatively unfeasible and economically irresponsible to do away with the entire deduction.  It has become a way of life for Americans and a major disruption would undoubtedly do more harm than good.  I think an effective compromise would be to roll back some of the subsides for the highest-earners (those that need the deduction least) and use the saved revenues to encourage broader home-ownership for lower-income levels.  These incentives could be something similar to the $8,000 First Time Home Buyer's tax credit of 2008/2009, or they could be in the form of down-payment assistance.  Regardless of the form the incentives take, a well-targeted program would benefit those at the bottom and would start to bring the housing market back to rosier days.