Every year, America gives out $77 billion through a single tax break. Of these many billions, two-thirds go to the top fifth of earners, while the bottom fifth receives less than half a percent of this money. The more money you spend, the more money this tax break gives you, which is why research has found that it encourages wasteful spending and excessive debt. It exacerbates inequality, widening the gap between rich and poor and between white and non-white. And yet it is one of the most politically difficult tax breaks to remove, often ranked alongside the charitable donation tax credit and the deduction for employer-provided healthcare in terms of its invincibility.
What I'm talking about is the home mortgage interest deduction, America's worst handout. While many Americans may never have heard about it, the tax break is infamous amongst economists and policymakers. One poll of economists found 90 percent agreed that the tax break should be removed, and many major organizations across the political spectrum have called for its repeal, including the Washington Post, National Review, the American Enterprise Institute, the Brookings Institution, and countless others. The allies of the deductions, however, from politicians to lobbyist groups to a sizable slice of the voting public, all remain firmly behind it.
History of the Mortgage Deduction
To understand the fight over the home mortgage interest deduction, you have to understand the context behind it. The modern tax system was created in 1913, with the passage of the sixteenth amendment, which allowed the taxation of income by the federal government. Before this, the government had largely depended on tariffs and other dues to get by, often leaving the civil service underfunded. When creating the first income tax, Congress decided to make the interest on loans deductible from income—not as a way to help homeowners, since mortgages were practically non-existent at the time, but as a way to help farmers and business owners, who were much more reliant on debt.
It wasn't until after the New Deal that the government began thinking of homeownership as something that it should actually encourage. When the Federal Housing Administration (FHA) was created in 1934, its explicit goal was to make homeownership accessible to more Americans. The FHA did so by providing real estate companies with insurance for almost any home built, minimizing the risk these companies took—as long as they conformed to FHA guidelines. The FHA guidelines were extensive, but they elevated a certain type of living above all else. Large, expensive homes in sprawling, spread-out neighborhoods with little access to public transit were the ideal promoted by the FHA, and the ideal that came to define the American suburb. Meanwhile, people living in the dense, multi-use development pattern of America’s cities, including many of the country’s poor and nonwhite communities, were cut off from any sort of financing until as late as 2015. The home mortgage interest deduction only exaggerated this bias, rewarding those who could pay for large, extravagant homes and punishing those who rented or bought small apartments.
Of course, like much of the New Deal, the FHA was explicit in its exclusion of non-whites from its suburban ideal. Not only did it refuse to handle the loans of black residents, it penalized entire neighborhoods that it saw as “lacking homogeneity.” While homeownership became a core part of the American dream for white Americans, black Americans found it nearly impossible to buy homes. Real estate agents would lie to black home buyers, telling them that the only homes available to them were in certain neighborhoods. The process of forcing nonwhites into these neighborhoods was known as “redlining,” as the FHA would designate such areas as “red” to indicate their unworthiness. Real estate companies even weaponized this discrimination by “blockbusting,” which involved moving a few non-white residents into an area to drive down property values, then convincing the white residents to sell their homes for less than they were worth, fueling white flight to the suburbs. To this day, black homeownership lags behind white homeownership by almost 30 percent, and many black homeowners have much smaller and less expensive houses than their white counterparts, which means they receive less of the home mortgage interest deduction.
All this played a major role in creating what is known as the black-white wealth gap. Despite systematic disadvantages, black Americans have started to close the gap in average income. However, even among black and white families earning similar incomes, the white families tend to be far wealthier. The median white family had twelve times as much wealth as the median black family in 2017. For the average family, the value of their home makes up two-thirds of their wealth. Not only can they pass their homes onto their children, homeowning households can also take out loans against the equity of their homes, a method increasingly used to pay for the ballooning cost of colleges. Subsidies to homeownership like the home mortgage interest deduction drive up the equity of houses, and further penalize those who choose (or are forced) to rent their homes instead of buying them.
Defending the Indefensible
So why do people still defend the home mortgage interest deduction? For many, homeownership is still an integral part of the American dream, one that is becoming even more important as the middle class feels its economic prospects worsen. While it's true that homeownership has not always been accessible to all races and classes, they argue, it can be in the present, and “kicking away the ladder” by trashing the deduction would only solidify these divides. But does the home mortgage interest deduction actually increase homeownership?
The research almost unanimously points to “no.” Most first-time homebuyers, to whom a subsidy might make a difference, either pay few taxes or do not itemize their taxes, and thus do not receive any benefit from the deduction at all. Studies into the effects of the deduction have found that it in fact encourages people to buy larger homes and go deeper into debt than they otherwise would. Even without the in-depth studies, we can see that there is little relationship between homeownership and granting these sorts of deductions. Australia, Britain, Canada, and New Zealand have higher homeownership rates than the United States with no deduction, while Switzerland, which has a deduction for home mortgage interest, has nearly half the homeownership rate that American does.
Destroying the home mortgage interest deduction, then, is not “kicking away the ladder.” Instead of enabling people trying to own homes and fulfill the American dream, the subsidy punishes those who aren’t able to earn homes, and rewards to those who can afford them. Rather than acting as a conduit for opportunity, the deduction reinforces the gap between rich and poor.
Special Interest Interference
So what grants the deduction its aura of invincibility? The answer lies in the deduction's structure, which would be considered pure political genius if it weren't a complete accident. Instead of giving out money to the rich over the poor, it instead exempts money from taxation, which has the same economic effect with none of the bad optics. And despite the fact that it rewards mainly the ultra-rich, millions of middle-class Americans claim the deduction each year. All those voters would be frustrated to see such a large deduction disappear from their tax bill, even if they aren't the main recipients of the payout.
The recent Republican tax bill tried to sidestep this gut reaction by pairing it with a tax cut. One of the plan's biggest objectives was to shrink the long list of tax deductions in our code, as well as to reduce the number of taxpayers who take specific itemized deductions by increasing the standard deduction. In practical terms, this meant that most Americans saw their taxes fall, even with deductions like home mortgage interest under fire.
However, the cut to the deduction was modest. Whereas the cap for deducting home mortgage interest in the past had been $1 million dollars, the GOP tax bill slashes this down to $750,000 dollars, a mere quarter reduction. Because this change will be grandfathered in so that it only affects new mortgages, combined with the still high cap to the deduction, some estimate that only 1.3 percent of new mortgages will actually be hit by the adjustment in the law. In fact, the most significant change that the bill makes is that it completely eliminates deductibility for second homes. Until the new tax bill, anyone who owned a second home in Aspen could get rewarded by the government for doing so. And even this reasonable change to the deduction brought forth a flurry of articles bemoaning the fact that it would become harder for middle-class Americans to own vacation homes.
Even a hint of a threat to the home mortgage interest deduction is enough to set off the special interest lobbyists who jealously guard the deduction. For realtors and home builders, the deduction is a steady cash cow, nudging home buyers into purchasing much larger houses than they otherwise would. The National Association of Realtors condemned the bill in the strongest possible language, and the National Association of Homebuilders joined them, complaining that the removal of any subsidy to homeownership could lead to “a tax system that suddenly favors renting over owning in a big way.” In California, with some of the most expensive houses and wealthiest homeowners in the nation, realtors’ associations are attacking specific congressmen, taking out full-page ads in papers and threatening to force lawmakers out of their seats over the issue.
Unfortunately, these special interests won out. While the mortgage interest deduction does not emerge unscathed, the changes made to it are small, and could easily be reversed in future legislation. The worst thing is that elimination of the deduction would have solved many issues the bill had. The GOP tax bill received wide criticism from economists and even other Republicans for its substantial debt burden, but by eliminating the deduction, the GOP could have recovered millions of dollars that would have mitigated the added debt. On top of this, eliminating the deduction achieves a philosophical goal held by Democrats and Republicans alike: a firm statement that the tax code of the United States exists to fairly collect money for the government to run on, and not to reinforce inequality, aid special interests, or give handouts to the rich.The image featured in this article is used under the Creative Commons license. The original can be found here.
Sam Owens is a second-year Economics major. This past summer, he worked at the Immune Deficiency Foundation, a patient advocacy group for individuals with primary immune deficiencies. On campus, he is communications director for the College Republicans, volunteers for New Americans, and participates in the Writer's Workshop.