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Breaking Down The Concept Behind The Mortgage Interest Deduction


People across the country who are thinking of buying a new home may have heard about a proposed change to something known as the mortgage interest deduction. Currently, homeowners can deduct interest they pay on mortgages of up to $1 million. House Republicans have proposed capping that at $500,000. That's one of many changes to the tax code that they put forward in their tax bill. Senate Republicans are expected to unveil their bill as early as tomorrow. Well, for help understanding the concept behind the mortgage interest deduction and what this change would do, we've called on economist Ben Lockwood. He's with the University of Pennsylvania's Wharton School. Welcome to the program.

BEN LOCKWOOD: Hi there. It's nice to be here.

SIEGEL: You study, among other things, the use of taxes to change behavior. Is it fair to say that the mortgage interest deduction is supposed to encourage people to buy or own homes?

LOCKWOOD: That's typically the sense you usually hear in arguments for the mortgage interest deduction about the benefits of homeownership and the stability that homeownership entails. And the thought is that mortgage interest deduction encourages that sort of thing.

SIEGEL: Well, in your mind, has the mortgage interest deduction accomplished what it's designed to do? And who has benefited from it to be able to buy a house or a bigger house?

LOCKWOOD: So I don't think it's achieved the goal of raising homeownership. There doesn't seem to be a strong systematic relationship between the mortgage interest deduction and homeownership rates. A lot of the people who are benefiting from it are the ones who are likely going to buy houses regardless. And instead, you'd like to design it so that it's really people who are on the margin of whether to buy or not who would be the - seeing the largest incentive to go out and purchase a home.

On top of that, the benefit of the deduction basically scales with your marginal tax rate. It's a larger benefit for people who have a very high marginal tax rate. And that tends to be very high income earners. So that's another reason that it really ends up benefiting the people who are probably not on the margin of making these decisions in the first place.

SIEGEL: So let's assume that there is a social good in broad homeownership. Let's assume that people take care of their residences more if they own it and neighborhoods full of properties owned by the people who live in them will tend to be nicer neighborhoods than those where everybody's renting. If that's a social good, what is a provision of the tax code or something the government could do to encourage it?

LOCKWOOD: So I think this is one reason that a lot of economists are skeptical of the mortgage interest deduction because they feel - we feel that there are other, better sorts of policies to accomplish those same goals. So you could, for instance, have a credit for homeownership itself rather than a deduction that scales with the size of your mortgage debt. A mortgage interest deduction really encourages taking out large loans and, in its current iteration, loans on second homes. That's something that the current bill might eliminate, but those are things that are not the same as just the benefits of homeownership more generally.

SIEGEL: I guess if all of a sudden nobody could deduct their mortgage interest anymore, then I assume the value of every property would go down somewhat. Do we have any idea by how much it might go down, how much house prices might go down if nobody could deduct?

LOCKWOOD: Right. So this is a reason that economists feel that although the mortgage interest deduction itself is probably not an ideal policy - it's a tax expenditure that cost the government on the order of $70 billion a year - scaling it out immediately would probably cause a pretty big change in the real estate market. And so although it should probably be phased out in the long run, doing it more gradually over time is probably a better approach than just capping it or eliminating it entirely all at once.

SIEGEL: So if I understand you, you'd say that as far as measuring a tax provision by how well that it encourages a particular behavior, you'd say the mortgage interest deduction is not a raving success. Are there other tax provisions that stand out as much better incentives to a particular kind of desired behavior?

LOCKWOOD: Yeah. I think there are other deductions that do a much better job of achieving their desired ends. So one that I find very interesting is the earned income tax credit, which both provides income support for families in poverty, especially families with children, but it also provides an incentive to work and increases employment. And that is one policy that has achieved great success. The thought is that raising the credit by, say, 10 percent often seems to raise employment by around a couple of percentage points. So I think that is something that could merit greater focus and potentially greater expansion than the mortgage interest deduction.

SIEGEL: Ben Lockwood is an assistant professor of business economics and public policy at the University of Pennsylvania's Wharton School. Thanks for talking with us.

LOCKWOOD: My pleasure. Thanks, Robert. Transcript provided by NPR, Copyright NPR.