Thursday, October 06, 2011

My testimony to Senate Finance Committtee on Housing and Tax Reform

I testified today.  Here is how the written testimony opens:

Chairman Baucus and Ranking Member Hatch, I want to thank you for the opportunity today to present my views on the issue of housing and tax reform.  My name is Richard Green, and I am a professor in the School of Policy, Planning and Development and the Marshall School of Business at the University of Southern California.  I have published extensively on the issue of the Mortgage Interest Deduction, and in particular published a paper co-authored with Dennis Capozza and Patric H. Hendershott on housing and fundamental tax reform for the Brookings Institution[1].

My general philosophy is that the tax code should be as broad-based and efficient as possible, while maintaining vertical and horizontal equity to the best extent possible.  I find many of the ideas proposed by Robert Hall and Alvin Rabushka to be quite appealing, and to me, in an ideal world, we would have something quite similar to the tax code they propose, albeit with an earned income tax credit added.  That said, we are manifestly not in an ideal world, and issues of transition matter.  As I wrote in 1996, a rapid change in tax policy could have a traumatic impact on the economy, so it is important that congress phase in any major changes to tax policy involving housing.

That said, I have long thought that the Mortgage Interest Deduction is a residual of the 1913 tax code, accomplishes little that its supporters claim for it, pushes capital away from plant and equipment toward housing, and benefits high income (although perhaps not very high income) households more than the remainder of the country.

I will divide my remarks into 8 parts; (1) I will argue that the Mortgage Interest Deduction is a residual of the 1913 tax code, and was not created to encourage homeownership; (2) that those on the margin of homeowning get little-to-no benefit from the Mortgage Interest Deduction, and that the policy therefore does little to encourage homeownership; (3) that the Mortgage Interest Deduction does encourage those who would be homeowners anyway to purchase larger houses than they otherwise would; (4) that even in the absence of the Mortgage Interest Deduction, owner-occupants receive a large tax benefit; (5) that phasing out the Mortgage Interest Deduction would encourage households to pay down their mortgages more quickly, and would therefore encourage households to rely less on leverage; (6) household deleveraging would lead to greater market stability, but would also mean that the revenues generated by the elimination of the deduction would be smaller than static estimates suggest; (7) at a time when the housing market remains quite weak, it is important that the Mortgage Interest Deduction be phased out carefully; (8) that if we do wish to encourage homeownership via tax policy, a targeted, refundable credit would be more effective than the current Mortgage Interest Deduction.

[1] Dennis Capozza, Richard Green and Patric Hendershott (1996), Taxes, Mortgage Borrowing and Residential Land Prices in H. Aaron and W. Gale, ed. The Economic Effects of Fundamental tax Reform, Washington, DC Brookings Institution Press: 171-210


Gash said...

I love to read your articles. I failed to understand two main topics in your 8 points. I have couple of questions:
a) Mortgage deductions are one of the tax incentives to buy a house. If we donot have deductions, then overall tax benefits will be less. Can you please elaborate on why you consider tax benefits to be same with mortgage deduction removed?
b) Leverage is one of the main reasons first time buyers or most of the people can buy. Else, people will be unable to pay for complete price.
Also these proposals will also bring down the prices dramatically too?


JKH said...

Makes all the sense in the world. Canada has no such deduction.

John Thacker said...


a) He didn't say that the tax benefits of an owner-occupier would be the same, but that they would still be large. They would be large because in the case of an owner who rents to someone else, the owner must pay tax on the rental income. An owner-occupant is not taxed on inputed income from rent (though some have proposed that.) It's true that some repairs can be deducted by those who rent out a house, but on average owner-occupiers would have an advantage.

b) When he talks about reducing leverage, he means that people will no longer have as strong an incentive to get Home Equity Lines of Credit and take money out of their house to pay for other things.

And yes, on average these proposals should bring down the prices somewhat, which would help first time buyers.

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