Mortgage deduction helps housing lobby, but not homeowners

The battle lines are drawn between those seeking to protect the mortgage interest deduction (MID) and a legislative effort to greatly reduce the use of the MID. Hopefully, this is a battle that taxpayers will win over the housing lobby — the loudest supporter of keeping the deduction intact.

The housing lobby’s effectiveness is measured by its success at garnering subsidies. But the proposed House bill, the Tax Cuts and Jobs Act, would be a shot across the industry’s bow. The stage is now set for a crucial debate between two competing visions: the House plan — which would disincentivize the MID by raising the standard deduction and capping loans qualifying for the MID at $500,000 — and Senate tax reform legislation that effectively would leave the deduction intact.

From the perspective of taxpayer cost and federal budgeting, it’s no contest which plan is better. Since 1994, the cost of the MID, the separate real estate tax deduction (also downsized in the House plan), and other single-family tax subsidies has totaled over $2.5 trillion and in fiscal year 2017 were estimated to cost $141 billion. This does not include the many hundreds of billions in subsidies over the same period provided to or by Fannie Mae, Freddie Mac, the Federal Housing Administration, Ginnie Mae and others, and the $6.7 trillion in taxpayer mortgage debt guaranteed by these same agencies.

What did the U.S. taxpayer get for this massive level of rent-seeking? First, the U.S. homeownership rate today is 63.9% — statistically no different than the average rate of 64.3% since 1964 (excluding the bubble years). Second, these policies directly caused the 2008 financial crisis — a catastrophe for the U.S. and world economies.

True to their past positions, both NAR and the NAHB are opposing the House tax reform plan, favoring the Senate version. NAR had previously released a study it commissioned that found that a doubling of the standard deduction, elimination of the state and local tax deduction, and lower marginal tax rates would cause home prices to fall by 10.2%. On the other side are supporters of tax reform and lower marginal rates. Gary Cohn, President Trump’s head of the National Economic Council, stated in September: "People don't buy homes because of the mortgage deduction."

Before getting to the merits of these positions, it is worth noting the “man bites dog” nature of NAR’s admission that the MID drives home prices up higher than they otherwise would be. While this certainly explains the NAR’s past and current support for the MID, it is a damning admission for a group that purports to promote homeownership and “affordable housing.”

In terms of the merits, federal subsidies for homeownership like the MID get capitalized into higher prices, encourage the taking out of more debt, promote the buying of larger, more expensive homes, and price homes out of reach of lower-income buyers. Recent research at the Federal Reserve confirmed these points and found “when house prices are allowed to adjust in response to the elimination of mortgage interest deductions, the homeownership rate actually increases.”

One could end the argument here. However, this would leave NAR’s claim about a 10.2% price reduction unaddressed. First, a common sense reading of “a fall in home prices” is that prices would actually drop from current levels. This conflates a drop in price level and a slowing of the rate of increase. High-end home prices in 16 large metropolitan areas were up about 5% in July compared to a year earlier. A slowing of the rate of increase for high-end homes to the inflation level of 2% would, over three years, result in high-end home prices ending up about 10% lower than they otherwise would have been, but without an actual drop in prices.

Why is a slowing in the rate of increase, not an outright drop, the likely result? According to NAR, existing home sales have been in a seller’s market for 61 straight months and there are no signs of this abating anytime soon. A seller’s market is commonplace even at the higher price end of the home market. This includes San Francisco, where homes selling for more than $4.6 million have less than 2.5 months inventory along with similar conditions for the highest price points for metro areas such as Seattle and Los Angeles. Areas like Boston, Denver, New York City and Washington D.C. have a seller’s market except for price points in excess of $1.5 million to $2 million.

Jerry Howard, chief executive of the homebuilder assocation, told The Wall Street Journal that the House legislation is “a bad bill for housing.” In reality, it’s a good bill for American taxpayers and homebuyers.