The U.S. housing market continues to recover. The number of homeowners who are newly delinquent on their mortgages has fallen to pre-2007 levels. Housing prices also rose 9.3 percent in February for the biggest year-to-year advance since May 2006. To top it off, Fannie Mae, the government-owned mortgage financier, today said it is returning $59.4 billion to taxpayers after a record quarterly profit.
This newfound strength creates an opportunity to address two tax breaks that are expensive, distortive and unfair: deductions for mortgage-interest payments and local property taxes.
Together, these tax expenditures transfer about $120 billion annually to homeowners. More than 70 percent of that goes to people in the top fifth of the income distribution.
The mortgage-interest deduction subsidizes excessive borrowing, encourages speculation and increases the chance of default. Subsidized borrowing also makes housing more expensive than it otherwise would be. Meanwhile, the property-tax deduction exacerbates educational inequality because wealthier areas collect more property taxes and generally offer better schools as a result.
Right now, anyone borrowing money to buy or improve a home can deduct the interest payments on the first $1 million of debt. The deduction can be used to purchase vacation homes or investment properties, as well as primary residences. Interest payments on as much as $100,000 in home-equity debt are also deductible.
If all this sounds like a benefit targeted toward the well-to-do, it is: According to the U.S. Census Bureau, the median sales price of new single-family homes in the U.S. was only $247,000 in March 2013. In addition, because wealthy homeowners are in higher tax brackets, they get larger tax benefits from deducting $1 of mortgage interest and property taxes than middle-class households get.
To begin winding down subsidies in the U.S., we would immediately limit the mortgage-interest deduction to primary residences and lower the mortgage cap to $700,000 from $1 million. Each year, the cap could be lowered by $25,000. At this rate, the subsidy would be gone in 28 years.
At the same time, we would cap the value of the mortgage-interest and property-tax breaks at 28 percent, so everyone who claims $1 of deductions gets the same 28 cent benefit. This would reduce the subsidy to the highest earners while protecting the middle class. Taxpayers in lower brackets would get a slightly more generous break than they do now. The value of the deduction could be reduced by one percentage point per year, also ending it completely after 28 years.
These changes would raise taxes on tens of millions of households. Congress could use the extra revenue to trim the deficit, although we wouldn’t recommend that — the economy needs more, not less, stimulus right now. We would prefer offsetting the fiscal drag from the tax increase by giving a refundable tax credit to everyone, including those who don’t currently claim either deduction.
Some might say that these reforms could hurt both the housing market and the recovery. There are good reasons to think otherwise. Residential construction hasn’t contributed much to economic growth or to employment in the recovery. More important, the U.S. economy is much less dependent on house prices than in the past.
Wealthier homeowners with higher credit scores are less sensitive to changes in house prices. They didn’t alter their spending during the boom years — and aren’t doing so now.
All of which is to say that a simpler, fairer tax code will not devastate the housing market and the broader economy — as long as the U.S. proceeds gradually.
Bloomberg News (May 10)