NCPA - National Center for Policy Analysis

The Home Mortgage Interest Deduction Is Inefficient

January 17, 2013

As the largest explicit tax deduction for households, the home mortgage interest deduction allows taxpayers who own their homes to lower their taxable income by the amount of interest paid on loans for a principal residence or a second home. While politicians believe this deduction greatly increases middle-class home ownership, reality proves otherwise, say Jeremy Horpedahl and Harrison Searles of the Mercatus Center.

  • The deduction is aimed at encouraging home ownership and increasing future taxable income.
  • Most middle-class taxpayers do not benefit at all.
  • Only taxpayers in the upper income brackets receive a large benefit from this deduction.

With growing federal deficits, the existence of deductions in the tax code necessitates a tradeoff between different government services and higher taxes. With a skewed distribution of beneficiaries toward the wealthy, most households would not be significantly harmed by removing the deduction.

  • The Office of Management and Budget estimates the deduction resulted in $72 billion in lost tax revenue in 2011.
  • For a household in the $40,000 to $50,000 income bracket, the average tax savings amounted to only $111.
  • By comparison, for households earning above $200,000, the average tax savings amounted to $1,784.

These statistics negate the argument made by defenders of the deduction who claim that it makes housing more affordable and accessible to middle-class families. In fact, an examination of the period from 1960 through 1997 shows that homeownership rates varied only slightly, between 62 percent and 66 percent, despite the deduction. Additionally, the mortgage interest deduction has negative economic impacts that further render it inefficient.

  • The deduction alters the natural allocation of resources toward high-income residential housing construction.
  • This misallocation skews the structure of the economy and distribution of income in favor of the wealthy, who also waste resources supporting lobbying efforts to defend the deduction.
  • The subsidy inflates the prices of high-income housing.

To fix these problems, the deduction could simply be eliminated, replaced with a tax credit for purchasing a home, or eliminated and offset by a decrease in the general level of income taxation.

Source: Jeremy Horpedahl and Harrison Searles, "The Home Mortgage Interest Deduction," Mercatus Center, January 8, 2013.


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