Housing Tax Benefits Do Not Increase Homeownership

April 11, 2014

The tax code contains numerous benefits for homeowners. The largest is the mortgage-interest deduction (allowing homeowners to deduct interest paid on their mortgages from their taxable income). The idea behind these tax benefits is that they encourage homeownership. But in reality, they are regressive and expensive, and there is no indication that they actually do increase ownership, say Andrew Hanson, an associate fellow at the R Street Institute, Ike Brannon, a growth fellow at the George W. Bush Institute, and Zackary Hawley, an assistant professor of economics at Texas Christian University.

So what do these tax expenditures actually do? They lead to the purchase of larger homes and the greater use of debt financing.

  • The mortgage-interest deduction actually increases the size of homes purchased by people who would otherwise purchase smaller one, but it does not encourage owning rather than renting.
  • It is estimated that average home sizes increase by 11 percent to 18 percent due to the deduction. Basically, without the mortgage interest deduction, homeownership would not decrease, it would just mean that homeowners would be purchasing smaller homes than they currently purchase.
  • Moreover, the deduction applies to the portion of a home financed by debt, so it ends up encouraging greater debt financing than would otherwise be the case.

Why does the deduction not encourage homeownership? The deduction is poorly targeted -- it does not target those who are on the margin between purchasing a home and renting.

  • Because the mortgage-interest deduction is just that -- a deduction -- every dollar paid in mortgage interest is subtracted from an individual's taxable income. Higher earners, who pay higher rates, benefit more from this deduction than others.
  • Moreover, to benefit from the deduction, taxpayers must itemize their deductions. This is not something that low- and middle-income taxpayers tend to do, for two reasons. First, because it is simpler to take the standard deduction instead ($12,200 for married couples). Second, a taxpayer would have to do a lot of tax-deductible spending to itemize his deductions to the level of the standard deduction.
  • Furthermore, every dollar above the standard deduction reduces the tax bill by just 25 cents, maximum, for 90 percent of all households with incomes below $146,400.

If the government wants to encourage homeownership, the current housing benefits within our tax code are not the answer.

Source: Andrew Hanson, Ike Brannon and Zackary Hawley, "Rethinking Tax Benefits for Home Owners," National Affairs, Spring 2014.

 

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