Tag: mortgage interest deduction

Bank Tax Is Wrong “Fix” for Too-Big-To-Fail

Chair of the House Ways and Means Committee Dave Camp is soon to roll out a plan for comprehensive tax reform. He is to be commended for doing so. Our tax code is an absolute mess with incentives for all sorts of bad behavior. Early reports suggest, however, that Congressman Camp will also include a “bank tax” to both raise revenue and address the “Too-Big-To-Fail” (TBTF) status of our nation’s largest banks. While the evidence overwhelmingly suggests to me that TBTF is real, with extremely harmful effects on our financial system, I fear Camp’s approach will actually make the problem worse, increasing the market perception that some entities will be rescued by the federal government.

Bloomberg reports the plan would raise “would raise $86.4 billion for the U.S. government over the next decade…would likely affect JPMorgan Chase & Co, Bank of America, Citigroup, Wells Fargo, Goldman Sachs and Morgan Stanley.” The proposal would do so by assessing a 3.5 basis-point tax on assets exceeding $500 billion.

While standard Pigouvian welfare analysis would recommend a tax to internalize any negatives externalities, TBTF is not like pollution, it isn’t something large banks create. It is something the government creates by coming to their rescue. I don’t see TBTF as a switch, but rather a dial between 100 percent chance of a rescue and zero. By turning the banks into a revenue stream for the federal government, we would likely move that dial closer to 100 percent–and that is in the wrong direction. For the same reason, I have opposed efforts to tax Fannie Mae and Freddie Mac in the past. The solution is not to bind large financial institutions and the government closer together, as a bank tax would, but to further separate government and the financial sector. Just over a year ago, I laid out a path for doing so in National Review. Were we to truly end bailouts, limiting government is the only way to get that dial close to zero.   

If we want to use the tax code to reduce the harm of financial crises, then we should focus on reducing the preferences for debt over equity, which drive so much of the leverage in our financial system.  I’ve suggest such here in more detail. There are also early reports that Camp’s plan will reduce some of these debt preferences. Let’s hope those remain in the plan.

Federal Homeownership Policy: Money for Nothing

Earlier this week, the Los Angeles Times ran a column repeating the simplistic notion that since homeownership is “good” then subsidies for homeownership must therefore also be “good.” Never asked, or apparently even contemplated, is the question of whether all our various homeownership subsidies actually deliver homeownership. Let’s start with the ever popular mortgage interest deduction (MID). The chart below, reproduced from Glaeser and Shapiro, shows the value of the MID and the homeownership rate. Hard to see any relationship there, probably because there isn’t one. I discuss the MID in more detail here.  

 

Next would be Fannie Mae and Freddie Mac. The chart below shows the homeownership rate and the Fannie/Freddie share of the mortgage market. What should be immediately obvious is that the long run homeownership rate steadied out in the mid-60 percents when Fannie & Freddie were bit players, having a market share in the single digits. In no way can we say that Fannie & Freddie have increased the long-run trend rate of homeownership.   So even if one believes homeownership is worthy of subsidy, a questionable proposition on its own, it should be beyond question that our current system of homeownership subsidies has not delivered long run gains in the homeownership rate.

End, Don’t Cap, the Mortgage Interest Deduction

The housing market is soft, so this is the worst possible time to get rid of the mortgage interest deduction, right? Well, it’s not that simple.

1.) The deduction is not a subsidy to homeowners. It’s a subsidy to people who have mortgages, and then only if they itemize their taxes. Those claiming the standard deduction can’t take advantage. Paying cash for a home won’t qualify you for the deduction, either. Following a great recession fueled by would-be homeowners borrowing more than they could afford, it’s well past time for the feds to get out of the business of subsidizing home debt.

2.) Borrowing to own a home now costs homebuyers less in interest than it has historically, which means that the cash value of the mortgage interest deduction is lower than it will be under higher (future) interest rates. In other words, this particular tax-code goodie is at a historically low value to taxpayers, so why not get rid of it now?

Mitt Romney has nibbled around the edges of this idea. He would cap the mortgage interest deduction. In delivering a bit of a backhanded compliment, Yonah Freemark and Lawrence J. Vale write in the New York Times that “while Mr. Romney’s tax proposal overall may not be fair or sensible—or even mathematically logical—Democrats shouldn’t be so quick to attack any change to the mortgage interest deduction.”

Freemark and Vale would use the boost in federal revenue from ending the deduction to fund new housing programs. However, ending the mortgage interest deduction could also be used to lower overall tax rates. Mark Calabria and I chatted about the mortgage interest deduction this week for the Cato Daily Podcast.

End the Mortgage Interest Deduction

The mortgage interest income tax deduction is popular among homeowners (read: likely voters) despite its role in distorting housing and related markets, its contribution to the housing bubble and its enabling of additional household debt. Never mind that there isn’t much evidence that the deduction boosts home ownership in the United States. Consider also that the tax break largely benefits affluent homeowners living in expensive urban areas.

As Mark Calabria notes in today’s Cato Daily Podcast, it’s well past time for the mortgage interest deduction to be replaced by lower marginal tax rates for all earners.

Now Is the Time to End the Mortgage Interest Deduction

If there is one, almost universal, point of agreement on drivers of the financial crisis, it is that our financial system simply had way too much leverage.  Much of that discussion has focused on financial institutions, leading many to suggest increased capital standards, so that banks have more equity and less debt.  Often lost in the mix is the excessive leverage on the part of home owners.

We know, for instance, that the number one predictor of mortgage default is whether the borrower has equity or not.  And while that should lead us to debate appropriate downpayment requirements, at least when the government backs the mortgage, we should not forget that our tax code encourages excessive leverage on the part of home buyers.  And there’s no bigger incentive to get a bigger mortgage than the mortgage interest deduction.

Some might say we can’t risk removing any props from the housing market.  My friends at the National Association of Realtors, for instance, have in the past argued that full removal would decrease home prices by up to 15 percent.  Such an estimate depends on the level of interest rates (the higher are mortgage rates, the higher the value of the deduction and the greater the impact on house prices).  With the current low level of mortgage rates, the negative price impact should be around 5 percent.

Given the already close to 30% national decline in prices, a further 5% would be less noticeable now than at a time when prices start to rise again.  In addition, a 5% decline would attract more buyers into the market.  Housing is just like any other good – when there’s too much, the best way to clear the market, perhaps the only way, is to drop prices.  Getting rid of the deduction would make housing all the more affordable.  And given current low mortgage rates,there would be far less distortions to do so now.  Of course, all of this should be done in a budget neutral manner, lowering marginal tax rates across the board, which would have its own benefits to the economy.