Unmasking the Mortgage Interest Deduction

The deduction of mortgage interest from federal income taxes subsidizes homeownership, making it more affordable to become a homeowner. Or so we’ve been told. It is a highly popular tax break, yet one that is not without criticism. For example, it turns out the mortgage interest deduction (MID) primarily benefits those who would choose to own homes anyway while encouraging them to simply buy bigger and more expensive homes. Those who are on the margin between renting and owning tend not to itemize deductions, thus they cannot benefit from the MID. As a result, if the goal is to increase the homeownership rate, the MID is an ineffective tool. Furthermore, it creates a distortion in the choice between financing owner-occupied housing with debt or other assets, and in the choice between investing in residential real estate or other assets.
Despite its popularity among voters, the mortgage interest deduction has long been a target for elimination. Most recently, President Obama’s deficit reduction commission (Simpson-Bowles) had it in its sights. While there is general sentiment among voters that the mortgage interest deduction is a good idea, there is little understanding of its impact. In order to understand the potential impact of closing this loophole, this study examines specifically who benefits from the MID and how much they benefit. It also provides an estimate of how much tax rates could be reduced if the deduction were eliminated but revenues were held constant as well as a discussion of other possible changes to the mortgage interest deduction.

Anthony Randazzo

Reason Foundation

July 28, 2011

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