Tax Reform's Third Rail: Mortgage Interest

Policy Backgrounders | Taxes

No. 139
Friday, February 16, 1996
by Bruce Bartlett

Rates of Home Ownership Where Interest Is Not Deductible

Figure II - Home Ownership Rates and Mortgage Interest Deductibility%2C 1992

Even without a decline in tax rates and interest rates, international data suggest that the loss of mortgage interest deductibility would not devastate housing. Figure II shows that home ownership rates in other countries are not sensitive to deductibility. Israel and Australia have home ownership rates significantly higher than the United States and no mortgage interest deductibility. Rates in Canada and Japan are about the same as in the U.S., also without deductibility. By contrast, France and the Netherlands have much lower home ownership rates despite mortgage interest deductibility and higher tax rates.

The states also provide a laboratory: 18 states either have no income tax or do not allow mortgage interest deductions from state taxes. States with income taxes and no mortgage interest deductions are Connecticut, Illinois, Indiana, Massachusetts, Michigan, New Jersey, Ohio and Pennsylvania.

"Home ownership rates in other countries are not sensitive to interest deductibility."

One might expect that states that do not allow such deductions would have lower home ownership rates than states that do. One also might expect that the higher a state's tax rate, the higher the home ownership rate would be because the aftertax cost of housing would be lower. The data show the opposite.

In 1993, the 18 states without an income tax or mortgage interest deductibility had an average home ownership rate of 64.8 percent - slightly higher than the national average of 64 percent. Three of the five states with the highest home ownership rates - West Virginia (73.3 percent home ownership), Michigan (72.3 percent) and Pennsylvania (72 percent) - do not allow mortgage interest deductions.

By contrast, the 12 states with the highest statutory tax rates, and the District of Columbia, have an average home ownership rate of just 61.8 percent. Of the six states with the lowest home ownership rates, four are among this group of 13. For example, California's top tax rate is 11 percent - tied with Montana for the highest in the nation - yet its home ownership rate is among the lowest at 56 percent. New York, Hawaii and the District of Columbia also have high tax rates and home ownership rates well below average.

Further, according to the Bureau of Labor Statistics, about 40 percent of homeowners have no mortgage on their homes and thus no mortgage interest to deduct. Finally, any flat tax passed by Congress likely would allow homeowners to deduct interest for the life of their existing mortgages, losing deductibility only with a sale or refinancing.

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