The Presiden't Commission on Tax Reform and Housing

Andy Reschovsky and I just wrote a paper on this. Here is part of the conclusion:

The United States government currently spends about $175 billion per year to subsidize homeownership. The lion’s share of these subsidies operate through the tax system, with the largest single tax subsidy being the mortgage interest deduction. Despite these subsidies, ho-meownership rates for certain groups of Americans, notably African Americans, Hispanics, and households with modest incomes, are substantially below the average homeownership rate. For several decades now, economists have argued that the use of a mortgage interest credit instead of the current deduction would both encourage homeownership and more equitably distribute ho-meownership tax subsidies across the income distribution. In fact, in their final report, issued in November 2005, the President’s Advisory Panel on Federal Tax Reform recommended eliminat-ing the mortgage interest deduction and replacing it with a non-refundable 15 percent mortgage tax credit.

In this paper, we estimate a model of housing tenure choice and housing expenditures using data from the one-percent PUMS from the 2000 Census. The model allows us to determine the impact of alternative tax policies on the user cost of owning relative to renting. Because of our large sample size, we are able to estimate quite precise effects for individual racial/ethnic groups. Our results are very robust, with the tax variable proving to be highly significant in re-gressions using data for both 1990 and 2000, for recent movers, and for various racial/ethnic groups. The results of our housing model are used in a tax simulation model that we have con-structed based on 2004 federal and state tax law. Our simulation model allows us to calculate federal income tax liabilities of all taxpayers under existing tax law and under a variety of alter-native tax policies aimed at increasing the rate of homeownership.

Specially, we simulate the impact of the housing credit proposal made by President Bush’s Advisory Panel on Federal Tax Reform. Because we are convinced that the elimination of the mortgage interest deduction is politically impossible, we also simulate a plan that involves a refundable mortgage interest tax credit that provides every household with the option of utilizing the credit or the existing mortgage interest deduction, whichever one provides the largest tax savings.

The striking thing about the housing proposals of the President’s Tax Reform Panel is how little they do beyond redistributing the homeowner tax subsidy. The net result of replacing the mortgage interest deduction with a credit would actually be a decrease in the overall ho-meownership rate (by half a percentage point). This decrease would occur because the additional homeownership among low- and moderate-income households would be insufficient to offset the decrease in homeownership among middle- and high-income households, some of whom would choose to rent in response to a reduction in the size of the mortgage tax subsidy they would re-ceive, Although a credit is more beneficial than a deduction for low- and moderate-income families, its impact on the homeownership rate is limited because the proposed credit is non-refundable, and therefore provides no homeownership incentive to households who pay no in-come tax.

On the other hand, because many homeowners who are not itemizers become eligible for the credit, the Tax Reform panel’s proposal does not do very much to increase federal income tax revenue. Much of the benefit of the proposed plan flows to households who are already owners in the form of reduced housing costs. We estimate that if there were no changes in how households finance their housing, the Treasury would gain $4.9 billion in revenue, about 1.6 per-cent of total 2004 income tax revenue. However, if there is a substantial shift away from debt toward equity for the financing of homes, the net revenue impact of the proposal will be much smaller.