Yet, that same subsidy also creates increased demand for housing among homeowners, some of whom consume more housing. Most notably, homeowners who increase their demand for housing increase the amount and quality of housing demanded. In this case, as the mortgage interest deduction subsidizes existing homeowners, it fails to increase homeownership rates.
It is, however, difficult to prove the mortgage interest deduction's efficiency, or lack thereof, because of its continued presence as a subsidy and availability to all home buyers for so many years. Some economists theorize the value of the mortgage interest deduction is capitalized into housing prices. Thus, the subsidy is perceived to have given homeowners a capital gain in the past, but new buyers entering the market face higher prices that offset the subsidy.
If the deduction is capitalized this way, it would not induce non-homeowners to become homeowners, though, a loss of the mortgage interest deduction might adversely affect housing prices. Some analysts have, in an effort to determine the effectiveness of the mortgage interest deduction, made comparisons to other countries.
In particular, Israel and Australia have homeownership rates well above those of the United States and yet they do not allow for the deduction of mortgage interest. However, since none of these nations had a mortgage interest deduction and then repealed the provision, their ability to provide comparative value to the United States is limited.
Few empirical studies have addressed this issue. One study found that the deduction for mortgage interest subsidizes housing consumption, but its impact on homeownership rates was minimal. The choice of homeownership, according to the authors, was influenced by variables other than the mortgage interest deduction, like house structure, house type, and family size.
To the extent that the mortgage interest deduction promotes homeownership, it can be criticized on the grounds that the provision yields too little return relative to its cost. Results of a recent study of mortgage rates and changes in homeownership provided evidence that direct spending programs and other policy options are more successful at increasing rates of homeownership. This increase equaled a 2 to 2. A different simulation, which examined tenure choices, indicated that reducing the amount that was required for down payment on the purchase of a home increased the probability of ownership by 4.
Home equity indebtedness supports homeownership by allowing homeowners to finance structural improvements, but home equity indebtedness is not limited to this kind of spending. For example, home equity indebtedness can be used to pay for vacations, reduce credit card debt, and other personal consumption expenses. Home equity financing used for purposes unrelated to homeownership does not serve the congressional intent of the provision to encourage homeownership.
Tax benefits such as those available for homeowners can result in individuals with similar incomes paying different amounts of tax. In particular, homeowners and renters who are equal in all other respects, are treated differently as a result of the tax incentives for homeowners. This differential treatment is a deviation from the standard of horizontal equity, which requires that people in equal positions should be treated equally. Another component of equity in taxation is vertical equity, which requires that tax burdens be distributed fairly among people with different abilities to pay.
Housing tax deductions, like all deductions, benefit those who have sufficient income to owe federal taxes, and the higher the income, the greater the benefit. The disproportionate benefit to individuals with higher incomes reduces the progressivity of the tax system, which is often viewed as a reduction in equity.
The tax benefit to the two differs if they are in different tax brackets. Thus, the higher income taxpayer, with presumably greater ability to pay taxes, receives a greater tax benefit than the lower income taxpayer. Besides renters, there are a few reasons why the mortgage interest deduction may not be available to certain homeowners. Some homeowners may not have mortgage debt on which they pay interest.
In the case of homeowners without mortgage debt, their net imputed rental income is relatively higher than those with mortgage debt. So as mortgage debt falls, along with mortgage deduction claims, the value of the exclusion of net imputed rental income rises.
Other homeowners may not claim the mortgage interest deduction because claiming the standard deduction is more advantageous. The mortgage interest deduction can be claimed only by those taxpayers who itemize. Itemizers tend to be primarily middle-and upper-income households.
When the value of the standard deduction is increased, the difference between it and the value of the mortgage deduction diminishes for lower income households. This effect reduces the incentive to purchase owner-occupied housing, but does not make the taxpayer worse off. For those households on the homeownership margin, the tax incentive's influence on their decision to own as opposed to rent depends on the amount by which the household's total itemized deductions exceeds the standard deduction.
Taxpayers would need to have itemized deductions, including deductible taxes such as real estate taxes, state and local income or sales taxes, or other deductions, that exceed the standard deduction amount to make itemizing worthwhile. Income tax and tax expenditure data indicate that high income households claim the majority of the deductions for mortgage interest and receive the majority of tax savings from claiming those deductions. While the IRS lists the amount of deductions claimed by households, the amount of tax savings received by households, or alternatively, the amount of federal tax revenue loss is calculated by the congressional Joint Committee on Taxation JCT.
The actual cost of the mortgage interest deduction is determined by the amount of federal tax revenue loss that results from taxpayers claiming the deduction. Tax revenue loss depends on many factors, which include the composition of the household i.
The tax revenue savings to individuals, thus tax revenue loss to the government, differs across households. As shown below in Table 2 , the JCT estimated that Source: U. The deduction of mortgage interest for homeowners contributes to the complexity of the tax code and raises the cost of administering the tax system.
Those costs, which can be difficult to isolate and measure, are often excluded in the cost-benefit analysis of the provision. The complexity of the tax code adds to the time cost of taxpayers in either learning how to claim various incentives and doing so, or an increased direct cost of paying tax professionals to perform the service for the taxpayer. Also, the more complex the tax code is, the more opportunity for tax evasion and avoidance exists.
Federal tax policy changes cause unintended consequences for housing subsidies enacted through the tax code. Several significant tax cuts have been enacted recently, all of which have affected the pool of potential beneficiaries of housing tax policy. In providing tax relief that was designed to stimulate the economy, a likely unintended consequence was to reduce the number of taxpayers claiming the housing tax deduction. For most households residing in the same home during that time period, mortgage interest was likely to be lower 45 such that some households who may have been itemizing on their tax returns began to claim the standard deduction.
Tax reform in the th Congress may have caused moderate or fundamental changes in the federal tax system. These changes could have been as far reaching as eliminating the current income tax system and replacing it with an alternative tax system, like a national sales tax. This change could have eliminated deductions and credits, including the mortgage interest deduction. Alternatively, Congress could have chosen to simplify the existing tax code by modifying or eliminating provisions, like the mortgage interest deduction.
Finally, tax reform could have occurred and the mortgage interest deduction could have been unchanged. In the absence of tax reform, Congress may or may not make changes to the mortgage interest deduction.
Congress may choose to modify or eliminate the deduction for homeowners for a variety of reasons, including revenue raising strategies to reduce the deficit or addressing the equity issues surrounding the provision. Alternatively, Congress may choose not to alter the mortgage interest deduction. Two possibilities can be examined in analyzing the elimination of the mortgage interest deduction.
The first case is that the provision is eliminated. The second case, which may be more likely to occur than the first case, is in the event of tax reform that fundamentally changes the federal tax system and eliminates the mortgage interest deduction. As mentioned previously, several tax reform proposals, if enacted, would have eliminated the mortgage interest deduction. There were, however, differences among proposals concerning the elimination of the mortgage interest deduction. In the th Congress, several bills were proposed to enact a flat tax.
A flat tax is levied on wages and earnings, but is not an income tax. The flat tax is considered a consumption tax because it does not tax savings and investment. The difference between a flat tax and a sales tax, both of which are types of consumption taxes, is where the tax is collected.
The flat tax is levied on income as it is earned and the sales tax is levied on income as it is spent. Two of the proposed flat tax bills H. In general, flat taxes would eliminate the three primary tax provisions for owner-occupied housing: the mortgage interest deduction, the deduction of state and local property taxes, and the exclusion of capital gains on sales of primary residences.
It is notable that the fundamental tax advantage of owner-occupied housing, the non-taxation of imputed rental income, would remain unless specifically addressed by legislation. However, the flat tax would eliminate the favorable treatment of owner-occupied housing relative to other assets because the returns to all new investment would be untaxed, not just the returns to homeownership.
Estimates of the effect of the eliminations of these tax provisions were made in the mid-to late s, when fundamental tax reform was last being considered. In CRS examined the effect of a flat tax on housing. Assets would shift from housing to business investment, which would improve economic efficiency. The report stated,. Economists would typically view this shift as a benefit of tax reform, because the current tax system encourages an inefficient overinvestment of funds in housing and consequent underinvestment in business assets.
CRS found much smaller effects than private sector reporting, which had suggested that the elimination of the mortgage interest deduction would cause larger, more adverse effects on housing prices and on the economy. The higher these two variables were found to be, the greater the percentage decline in house prices. High-priced metropolitan areas in California, as an example, would be hardest hit, while low-priced metropolitan areas in the south would experience the smallest degree of house price decline.
Movement to a sales tax system from the current income tax system would eliminate existing tax subsidies to owner-occupied housing, including the mortgage interest deduction and would also eliminate the significance of the net exclusion of imputed rental income. A national retail sales tax would repeal the personal and corporate income tax code and replace it with a tax on all final sales of goods and services to consumers.
A national retail sales tax would impose a tax on newly built homes, which would cause existing homes to enjoy a tax advantage. Under most concepts of a national retail sales tax, the sale of an existing home would be categorized as the sale of used property and would not be taxed. In this context, the value of existing homes, relative to newly built homes, would rise. If rental payments for housing were taxed, owners of existing homes would also enjoy a tax advantage over renters.
Generally, eliminating the mortgage interest deduction separate from tax reform would harm itemizing homeowners with the highest amounts of mortgage debt and, in particular, those homeowners who could not easily replace that debt with equity. Homeowners with mortgages would be expected to reduce their debt and new homebuyers would incur less debt than they would have previously.
For some, homeownership would no longer be an optimal choice. A study examined the possibility of eliminating the mortgage interest deduction, noting that the benefits of the mortgage interest deduction accrued overwhelmingly to young households and to high income households.
For the higher income households, the loss of the deduction would lead these households to use financial assets to reduce or eliminate their mortgage debt. This alternative, however, is not available to households without financial assets. Some economists theorize that the loss of the mortgage interest deduction separate from tax reform would adversely affect housing prices because the value of the subsidy is capitalized into housing prices. Buyers of housing, it is thought, bid up the price of owner-occupied housing to the point where the price of owner-occupied housing, including tax benefits, is equal to the cost of renting.
The full economic implications of eliminating the mortgage interest deduction depend upon whether or not the subsidy is capitalized into real estate prices.
If it is fully capitalized eliminating the subsidy would not affect the cost of owning but many owners would experience significant changes in wealth. In particular, they found there were more than 40 metropolitan areas, including many densely populated ones in and around Boston, New York City, Washington, D.
That would be more progressive and less expensive than current policy and, most important, would actually help some middle-class families become homeowners. William G. Related Topics Taxation U. More on U. The Avenue The monthly jobs report ignores Native Americans. How are they faring economically? Gabriel R. Actively scan device characteristics for identification. Use precise geolocation data. Select personalised content. Create a personalised content profile.
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The mortgage interest deduction is a common itemized deduction that allows homeowners to deduct the interest they pay on any loan used to build, purchase, or make improvements upon their residence, from taxable income.
The mortgage interest deduction can also be taken on loans for second homes and vacation residences with certain limitations. The amount of deductible mortgage interest is reported each year by the mortgage company on Form This deduction is offered as an incentive for homeowners. Introduced along with the income tax in , the mortgage interest tax deduction has since become the favorite tax deduction for millions of U. Home mortgage interest is reported on Schedule A of the tax form.
The mortgage interest paid on rental properties is also deductible, but this is reported on Schedule E. Home mortgage interest is quite often the single itemized deduction that allows many taxpayers to itemize; without this deduction, the remaining itemized deductions would not exceed the standard deduction. Interest from home equity loans also qualifies as home mortgage interest.
But it also nearly doubled standard deductions , making it unnecessary for many taxpayers to itemize. As a result, most went on to forgo the use of the mortgage interest tax deduction entirely. There is no evidence, however, that Congress thought much about this provision. The people paying taxes — Andrew Carnegie and such — did not need the deduction to afford their homes or their yachts.
There is another reason Congress could not have had homeownership in mind. The great majority of people who owned a home did not have a mortgage. The exceptions were farmers.
But most folks bought their homes with cash; they had no mortgage interest to deduct. When Congress made interest deductible, it was probably thinking of business interest.
In a nation of small proprietors, basically all interest looked like business interest.
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