Eliminating or curtailing mortgage interest deduction would have modest long-run effects on economy

Jan 16, 2013

Eliminating or curtailing the mortgage interest deduction (MID) would initially result in declines in housing prices and investment but would have only modest aggregate macroeconomic effects in the long run, according to a new paper from Rice University's Baker Institute for Public Policy.

The MID is the second-largest individual income tax expenditure, according to the congressional Joint Committee on Taxation. Given the severity of the fiscal problems currently faced by the U.S., many recent tax reform proposals have included measures that would curtail or eliminate the home MID.

"The MID is, of course, an extremely popular and thus highly politically sensitive provision," said John Diamond, the Edward A. and Hermena Hancock Kelly Fellow in Public Finance at the Baker Institute. "It was one of the few provisions that was deemed to be untouchable during the deliberations preceding enactment of the landmark Tax Reform Act of 1986, a highly successful effort at fundamental tax reform that is widely believed to be the most sweeping reform of the income tax since its enactment." Diamond co-authored the paper with George Zodrow, the university's Allyn R. and Gladys M. Cline Chair of Economics and a Baker Institute Rice Scholar.

The study uses a developed by Diamond and Zodrow to simulate both the short-run and long-run dynamic aggregate macroeconomic effects of several plans that propose eliminating or curtailing the MID. The model is a dynamic, overlapping-generations, computable general equilibrium model of the U.S. economy.

The most dramatic reform the authors analyze is complete elimination of the MID. In this case, they find that GDP decreases slightly in the short run, due to the adjustment costs incurred in reallocating the capital stock, and increases slightly by 0.1 percent in the long run. Overall investment increases by less than 1 percent and reflects the expected reform-induced increases in investment in the nonhousing sectors and the rental sector, coupled with a decrease in investment in the owner-occupied housing sector, of about 6 percent initially and 3 percent in the long run. Asset values increase in the nonhousing sectors by less than 2 percent and by 3.5 percent in the rental housing sector and are coupled with a decline in the value of owner-occupied housing of roughly 4 percent.

The effects of the other two reforms analyzed—replacing the MID with a 12 percent nonrefundable credit subject to a $25,000 interest cap and limiting the MID to primary residences—are qualitatively similar but significantly smaller. For example, for the capped credit, housing investment in the owner-occupied sector declines by 2.6 percent initially and by 1.5 percent in the long run, and the value of owner-occupied housing declines by roughly 2 percent. By comparison, the effects of the far more modest reform of limiting the to principal residences are quite small, with investment in owner-occupied housing falling by 0.7 percent initially and by 0.4 percent in the long run, and the value of owner-occupied housing falling by only 0.5 percent.

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More information: "The Dynamic Effects of Eliminating or Curtailing the Home Mortgage Interest Deduction," paper: bakerinstitute.org/publications/TEPP-pub-DiamondZodrowHomeMortgageInterestDeduction-120712.pdf

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User comments : 9

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AWaB
5 / 5 (1) Jan 17, 2013
That's right, give the housing sector another hit. This is just another reason for rents to rise, housing prices to fall, and home ownership to fall. This will have a direct negative affect on the middle class. IF these discussions are to be made, do it when the economy isn't struggling, not when it's having tepid growth, at best.
rwinners
5 / 5 (1) Jan 17, 2013
Why eliminate this boon to home ownership? Do eliminate the deduction for second or vacation homes. Do put a cap on the deduction so that those buying trophy homes do not get a helping hand from the US Treasury.
But DO NOT eliminate the mortgage deduction for first time and low income buyers.
NO, I'm not one of those who fit into these categories.
ryggesogn2
2.1 / 5 (7) Jan 17, 2013
Let's eliminate the income tax.
'Progressive' tax policy punishes those who earn more and rewards those who earn less.
The FAIR tax should be the one the 'progressive' anti-capitalists should support. The more one consumes the more tax they pay. Punish consumption and reward savings and frugality.
kochevnik
5 / 5 (2) Jan 17, 2013
'Progressive' tax policy punishes those who earn more and rewards those who earn less.
Russia has a 13% flat tax, ryggie
ryggesogn2
2.3 / 5 (6) Jan 17, 2013
'Progressive' tax policy punishes those who earn more and rewards those who earn less.
Russia has a 13% flat tax, ryggie

What's wrong with that?
VendicarD
4 / 5 (4) Jan 17, 2013
"Why eliminate this boon to home ownership?" - Rwinners

To pay for tax cuts for the wealthiest Americans and corporations.

It is the Republican way.
VendicarD
3.7 / 5 (3) Jan 17, 2013
There is nothing wrong with the concept of a flat tax in my view.

However I note that every flat tax proposal made by Republicans includes provisions to exempt capital gains from all taxation.

"What's wrong with that?" - RyggTard
VendicarD
5 / 5 (2) Jan 17, 2013
RyggTard is wrong from the very first statement.

"Progressive' tax policy punishes those who earn more" - RyggTard

Taxes aren't punishment, but the price of living in a civilized society.

If RyggTard thinks that the price is too high, then he can move to the Libertarian Paradise of Somalia.

He doesn't of course, because he knows how good he has it in the U.S. and how horrible life is in his Libertarian paradise.
rwinners
5 / 5 (2) Jan 18, 2013
The wealthiest among us also benefit the most from living in an open and free society. I say, pay for what you get.

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