Friday, August 27, 2010

Is the mortgage tax deduction worth it?

My partner and I own a nice little house in Berkeley, CA. We bought a house for many reasons. Vanity was one—we were in our forties when we bought our house, but many of our younger friends, even people in their late 20’s, had already bought homes or apartments. We had to keep up! Plus the prevailing wisdom was that mature people own homes and certainly we think of ourselves as reasonably mature. If you can buy, you should buy. The shortest distance from the working class to middle class was home ownership, etc. And, of course, there was the mortgage tax deduction which makes home ownership even more attractive. In the 1990’s everyone believed all this and bought if they could, many taking on what turned out to be sub-prime loans.

So, imagine my surprise when I realized two things:
  1. The mortgage tax deduction is a very regressive tax break as it benefits high income earners far more than low income earners, and the size of the deduction is much higher for more expensive homes (although it does cap at $1 million).
  2. Many developed countries do not have a mortgage tax deduction and have just as high rates of home ownership as the USA. Canada is a good example of this.
Even the right-leaning Tax Foundation is against the mortgage deduction, calling it a subsidy for the real estate industry (who, understandably, is in favor of keeping it) and a boon to wealthy people. They debunk the claim that this deduction helps middle class people in any significant way. Further, if you take out a home equity loan (a loan based on the amount of equity you have in your home), you can deduct the interest on that even if you use the money for something other than your home, such as a vacation, a car, or a wedding. People who don’t own their homes have no access to such a deduction.

But the bigger problem with the mortgage tax deduction is that it is a subsidy of debt, and it makes debt (and investment in debt) profitable. This, I admit, I never understood until I came upon an old (Nov 2009) article by the very clear writer, James Surowiecki, in the New Yorker. Surowiecki himself pulled from another source, the iconic John Kenneth Galbraith, who said that financial crises are the result of “debt that, in one fashion or another, has become dangerously out of scale.” Surowiecki points out that we have a tax system that subsidizes borrowing (what economists call a “debt bias”) and claims, “Debt didn’t get dangerously out of scale because the system was broken. It got out of scale, in part, because the system worked.”

For example, if a corporation wants to expand, it is cheaper for it to borrow the money than to reinvest profits or sell more shares. Business is allowed to deduct all the interest they pay, which gives highly indebted companies more deductions than those which are more profitable and debt free. And now, of course, the government is bailing out these very companies that were over leveraged!

So back to my house. It is true that we had a nice size tax deduction when we first bought the house. The longer we own it, the less interest and more principal we pay, so the savings go down every year. The total amount we will save over our current 15 year loan (we just refinanced) is about $26,000, or a little over $2,200 per year ($6.00 per day/ $42 per week) When I think about how people talk about the mortgage tax deduction, I would have predicted saving much more than that. It is less than I spent last night taking my nieces to the movies. Would I give that up for a fairer tax system? In a heartbeat.

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