One of the benefits of working in an office full of geeks is that my colleagues, rather than my spouse, bear the brunt of my obsessions over policy minutiae. A little while ago, for example, we had a rollicking debate about whether Sightline’s long-standing opposition to the Home Interest Mortgage Deduction—herein abbreviated as “HIMD”—still makes sense. (We’re wild and crazy here, I tell you!)
Here’s the rundown.
On equity grounds, the HIMD is crummy social policy. Most of the benefits go to people who own expensive homes, and whose incomes are high enough that they can benefit by itemizing their deductions. Worse, the biggest benefits go to the people in the highest tax brackets. So in essence, the HIMD is ginormous a housing subsidy for the well-off—and one that dwarfs all of the housing subsidies to lower income folks. This NY Times article lays out the case nicely: apparently, half the benefit of the deduction goes to the 12 percent of taxpayers who make at least $100 grand per year.
But theconventional wisdom is that the HIMD isn’t just crummy social policy, but crummy environmental policy as well. Allowing homeowners to deduct mortgage interest on their taxes gives people an incentive spend more of their money on housing than they otherwise would. And people with extra money to spend on housing tend buy larger homes on bigger lots—which, in theory at least, means that the HIMD primes the pump for low-density sprawl. (See, e.g., the photo.)
But not too long ago, we got an email from a guy who wanted to buy a condo in a neighborhood close to downtown—a modest place where he didn’t have to drive much. (In terms of greenhouse gas emissions, downtown living is about the best you can do, short of ditching your car and going off the grid.)
He argued that, condo prices being what they are, he simply couldn’t afford to buy close to the city center without the HIMD. Take away the interest deduction, and he’s got little choice but to stick with a bigger, more energy-hogging house in the ‘burbs (Several of the comments on this thread over at Matthew Yglesias’s house make the same point.)
So which is it: does the deduction accelerate sprawl, by encouraging homeowners to buy more land than they otherwise would? Or does it temper sprawl, by making homes in expensive, conveniently located neighborhoods more affordable?
I think the answer is both, or possibly neither.
Here’s my reasoning, for what it’s worth…
The mortgage interest deduction’s chief effect is to encourage people to spend more on their homes, and less on the things that they otherwise might want to buy. After all, for every $1000 you spend on mortgage interest, you can get $300 or so back on taxes—which is a deal you don’t get from, say, buying shoes, or going out to dinner.
Of course, there are a bunch of different ways to spend more money on a home. For example, you can buy…
- a bigger yard;
- a home in a more desirable neighborhood (where the definition of “more desirable” is left as an exercise to the reader);
- a more spacious home;
- a nicer home (e.g., fancier, or with better appliances or countertops or whatnot).
At heart, the first two items represent spending on land, and the latter two represent spending on the home itself.
But the thing is this: the supply of land is fixed(or, arguably, declining). So to the extent that the HIMD encourages people to spend more on land—either for bigger lots, or for better locations—home buyers aren’t actually getting anything extra for their money. They’re simply bidding up the price of land.
(That’s one reason the HIMD is such a sacred cow. Get rid of it, and land prices fall. Try selling that to a nation of homeowners.)
To me, this line of argument suggests that getting rid of the HIMD would have pretty minimal impacts on the affordability of land itself. Eliminate the interest deduction, and sure, people will have less to spend to on land. But as the cash available to spend on land declines, the land itself will become cheaper. On net, the two forces (less money to spend on land, cheaper land prices) will largely balance out, with roughly proportional effects in both surburban and urban locales—which means that the preference for urban vs. suburban living might not change much.
Now, I’m certain that a sophisticated economic analysis would find that this isn’t quite right—i.e, that eliminating the HIMD would have some effect on land affordability, preferred lot size, or the balance between urban and suburban housing demand. Still, I’d bet that the effects wouldn’t be all that huge. And if that’s right, it could mean that the HIMD is no longer the sprawl accelerator that it in the very early years, before the tax breaks had been fully capitalized into land values.
On the other hand, to the extent that people currently use HIMD subsidies to buy bigger, fancier homes, the deduction still has a major environmental downside. Larger homes—with cathedral ceilings, bonus rooms, and palatial master suites—consume lots of energy for heating, cooling, and lighting. Which means that even if the HIMD no longer does much to encourage low-density sprawl, it still promotes wasteful energy consumption.
BUT…high-rise condos are also expensive to build, especially on a square-foot basis. So the HIMD could help people cover the construction costs of condo, if that’s their preference—which would decrease average energy consumption. (Gosh, this is getting complicated.)
So let’s review. Getting rid of the HIMD would reduce housing subsidies to the wealthy; reduce the nominal price of land; have little effect on the affordability of land; and eliminate subsidies for expensive home construction, which could reduce both house size (a good thing) and the construction of high-cost condos (for energy efficiency at least, not so good). But on balance—given the market’s preference over the last few decades for big homes over conveniently located ones, I’d bet that maintaining the HIMD would still do more environmental harm than good.
However, perhaps the case for the HIMD being a sprawl-accelerator isn’t as strong as I thought it was. That doesn’t completely eliminate my concerns about the deduction, but it certainly makes me think twice about decrying the HIMD as a major accelerator of low-density sprawl.
(See—I told you we were wild & crazy!!)
Michael
Yes, clearly some kind of Friday freak-out, Clark. I kept reading this going, “Oh no, HE WENT THERE!” Hopefully, you’ll all come down to earth again over the weekend. 😉
Sungsu
Canada has no HIMD and plenty of sprawl and large houses.
cmarque2
You may not be aware of another traditional point in the debate—that anything that encourages home equity ownership also encourages better citizenship and more law-abiding property behavior. Having ownership “roots” supposedly creates more interest in long-term community benefits, less graffiti, etc.
Alan Durning
Sungsu,Our data suggests that Canada has dramatically less sprawl than the United States. It also has smaller houses than the United States—or less residential floorspace per capita, which is the important measure. There are many other differences in policy and history that may explain this different result, but the mortgage interest deduction is one possible explanation.cmarque2,I believe that home ownership has big community benefits (“positive externalities”) and, therefore, deserves subsidy. But the mortgage interest deduction is an incredibly expensive way to increase home ownership. Most of the benefit goes to those who would buy a home anyway, and very little of the benefit goes to those who need help. Canada and several other countries that have no mortgage interest deduction have similar rates of home ownership as the United States.If the mortgage interest deduction weren’t already in place and almost impossible to dislodge (politically speaking), a better alternative would be a refundable home-ownership tax credit of perhaps $1,500 (and rising with inflation). A tax credit provides the same absolute financial benefit to all home owners, whether they pay a lot for their home or a little. This means that those with less expensive homes receive a benefit that’s much larger, as a percentage of their home price (and mortgage payments). It’s a progressive, as opposed to regressive, tax policy.The general principle? You get more of whatever you subsidize. If you subsidize mortgage loans (as the mortgage interest deduction does), you’ll get more and bigger mortgage loans. A variety of indirect effects may follow, including possibly some increase in home ownership and certainly an increase in debt-financed spending on housing in general. You probably also get higher land values, as the value of the deduction is capitalized. You may get more sprawl. You probably get bigger houses. You almost certainly get higher levels of personal debt. You may get more personal bankruptcies. You probably get a bigger mortgage lending industry, and more home equity loans.If instead you subsidize home ownership directly, you’ll get more home ownership, probably without all the other side effects.Last point: the political opening around the mortgage interest deduction is probably the cap. You’re allowed to deduct interest paid on loans for first and second homes whose combined principal is about $1 million. (This figure may have changed since I last researched the matter. Anyone know the latest?)Lowering the cap—or simply holding it steady and letting inflation erode it—will gradually decrease the value of the deduction to the richest home owners.
Arie v.
I agree with Alan that is is a battleship that can’t be quickly turned around. Capping the deduction may be the best way to edge in without destroying trillions of USD in equity. HIMD encourages us all to spend a greater proportion of our income on housing. Perhaps 30-40% of monthly income. This means we build both more equity and that all that equity is in one egg basket. Good and bad. As for encouraging home ownership, thus good citizenship, that is a valid argument as well. More would opt to rent without it.The rub for me is for some it doesn’t make financial sense *not* to own an expensive home – they need the tax break. There is still maintenance, depreciation and energy costs on large homes, but ideally this encourages investments in higher value per sf investments like condos or in energy efficient homes.Does this push up land prices? Probably. Other construction costs are largely fixed so much of the increases we we are due to land values and to some degree regulatory costs.
Dan
The HIMD should be slowly taken away and replaced with a deduction for superinsulating your home: e.g. walls greater than R-25 and ceiling/roof greater than R-32, low-e windows, etc. As Arie points out, our investments tend to be in our homes in this scheme. Folks act to protect their major investment rather than to foster community when this happens.
payton
Homeownership might be a good thing—it’s correlated with higher levels of social capital, but correlation does not equal causation—but in the words of Robert Reich, “you couldn’t design a more regressive housing policy [than the HIMD] if you tried.” It doesn’t even benefit 2/3 of Americans, those of us (principally earning <$50K) who don't itemize deductions.One of the few “good ideas” to come out of the Bush administration was its tax reform commission’s recommendation to replace the HIMD with a standard 15%-of-HIM* tax credit, thus moving it from Schedule A to the 1040. Such a credit would improve housing affordability for lower- and middle-income Americans who currently don’t itemize, thus perhaps relieving the pressure to build new, “affordable” housing in the cheap, “drive ’til you qualify” exurbs. At the same time, it would take some of the wind out of the million-dollar-home market and thus out of McMansion sprawl.Of course, while I’m fantasy-reinventing housing tax law, look at something along the lines of the municipal-bond funded Mortgage Credit Certificates that many housing finance authorities offer. Such credits (typically restricted to first-time buyers) have price and income limits that are relaxed for buyers in low-income “target areas,” in order to promote reinvestment (a/k/a gentrification) in poorer neighborhoods. However, a municipality could attach other conditions: perhaps a city could reward homebuyers who choose “location efficient” (e.g., high Walk Score), or Energy Star rated houses. Like any other incentive, this could create market distortions—bidding up house prices—but mostly what it does is broaden the market for such houses.Of course, I’ve heard several urban developers agree (off the record) that removing or relaxing the zoning codes’ parking requirements would be the #1 way to make housing more affordable. Just sayin’ that incentives can come from the supply side (relaxed zoning) and the demand side (like tax credits for buyers).* up to a ceiling, max. about $400K in high-price coastal markets