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Evidence Matters: Viewpoints: The Mortgage Interest Deduction

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Spring 2011   


        Informing the Next Generation of Rental Housing Policy
        A Spotlight on Rental Market Research
        Multibank Consortia Sustain Communities by Advancing Affordable Rental Housing
        Viewpoints: The Mortgage Interest Deduction

Viewpoints: The Mortgage Interest Deduction


      • Edward Glaeser finds that the mortgage interest deduction is poorly designed to encourage homeownership and incentivizes people to leave urban areas.
      • David Crowe contests that the positive externalities of homeownership justify the mortgage interest deduction.
      • Todd Sinai argues that broad reform of the tax code is necessary, but that changes to the mortgage interest deduction must take care not to disadvantage
        middle-class homeowners.

Edward L. Glaeser

The home mortgage interest deduction is a decades-old mainstay of American housing policy that badly needs reform. The deduction is regressive and artificially distorts behavior, including pushing people toward single-family detached houses. Moreover, the deduction is poorly designed to actually promote homeownership. A reasonable path forward is to lower the upper limit on the deduction by $100,000 per year over the next 7 years, and then perhaps replace the remaining deduction with a flat owner’s tax credit that does not scale up with the size of the home or mortgage.

In the wake of a great national housing crisis, the federal government should not be encouraging ordinary Americans to leverage themselves as much as possible to gamble on the vicissitudes of the housing market. Yet the mortgage deduction does just that. The U.S. government should avoid any suggestion that it sees investing in housing as being particularly lucrative, for such beliefs have played an outsized role in creating past bubbles.

The mortgage deduction is also problematic because it encourages people to buy bigger homes; even the poorest quintile of American households live in homes that are twice the size of the French or British average. We should not induce people to live in larger homes that are typically associated with higher carbon emissions.

A strong link exists between housing tenure and structure type; multifamily units are typically rented and singlefamily units are typically owner occupied. Renting apartments avoids the problems of coordinating owners, and owner occupancy provides strong incentives for maintaining single-family homes. But the connection between ownership type and structure type means that encouraging people to own homes pushes them away from the multifamily dwellings that are more common in cities. We should not be bribing people to leave our economically productive urban cores.

According to research by James Poterba and Todd Sinai, the home mortgage interest deduction provides benefits that are 10 times larger for the average family earning more than $250,000 than for the average family earning between $40,000 and $75,000.1 Anyone who wants more equality in the tax code should favor reform.

Homeownership has often been pushed as a path to middle-class prosperity, but in the wake of the housing boom this argument seems quite dubious. Homeownership is also correlated with a number of potentially desirable social outcomes, such as working to solve local problems. Yet the deduction is poorly designed to encourage homeownership because its benefits accrue mostly to the wealthy, who are likely to own their homes anyway. Many poorer households on the margin between owning and renting do not even itemize.

The housing market is still in distress, and eliminating the deduction overnight would be too extreme. But the upper limit on the deduction can be gradually decreased from $1,000,000 to $300,000 so that few households are immediately affected by the change. Eventually, policymakers could replace the deduction with a straight owner’s credit that provided some incentive for ownership (if absolutely necessary) but did not encourage extra borrowing or larger homes.

  1. James Poterba and Todd Sinai. 2008. “Tax Expenditures for Owner-Occupied Housing: Deductions for Property Taxes and Mortgage Interest and the Exclusion of Imputed Rental Income,” American Economic Review 98:2, 84–89.

Edward Glaeser, Ph.D., is the Fred and Eleanor Glimp Professor of Economics at Harvard University. Glaeser recently authored Triumph of the City: How Our Greatest Invention Makes Us Richer, Smarter, Greener, Healthier and Happier, which explores the benefits of urban living on cities, business, people, and the environment.


David Crowe

Homeownership plays a fundamental role in American society. A rich academic literature has consistently demonstrated the positive private and social benefits of homeownership, including improved educational outcomes for children, better health, reduced crime, and increased neighborhood concern and involvement. In the long run, homeownership is a path to wealth accumulation; the net worth of the average homeowner is more than 45 times that of the average renter.

For most homebuyers, homeownership is impossible without debt financing. The mortgage interest deduction (MID) provides parity with the tax treatment of interest expense associated with other forms of debt-financed investment, including financial assets and rental housing. The MID lowers the effective interest rate homebuyers pay, making homeownership accessible to more households. The MID is well justified as housing policy given the documented positive externalities associated with homeownership.

Critics often use misleading or incorrect arguments to attack the MID. One frequent claim is that few homeowners benefit from the MID because they take the standard deduction instead of itemizing their tax returns. In fact, 86 percent of all mortgage interest paid over the past decade is claimed as an itemized deduction.

The MID is often criticized as being “regressive.” Estimates from the Congressional Joint Committee on Taxation, however, indicate that approximately 70 percent of the tax benefits of the MID are collected by households earning less than $200,000.1 An analysis by the National Association of Home Builders (NAHB) also shows that these middle-class households earn the largest benefits from the MID, as measured as a share of income.2

Moreover, during the early years of a mortgage, interest charges make up the lion’s share of monthly payments. For younger, newly minted homebuyers, the MID offers significant benefits at a time when household budgets are at their tightest and wealth accumulation is just beginning.

Similar NAHB analysis indicates that families with children, who require larger homes, collect larger tax benefits.3 In this sense, the claim that the MID causes homebuyers to buy a larger home is backward; in fact, the MID helps growing households finance a larger home as needed.

Finally, some commentators have cited the MID as a cause of recent turmoil in the housing market. This claim is without merit. The MID has been a feature of the tax code since 1913 and an important policy for the middle class since the 1940s, with no evidence of having created a housing bubble. During the most recent recession, the homeownership rate in the United States began to decline more than a year before housing starts and prices fell, suggesting that speculation and poor underwriting were the leading causes of the crisis. If the MID were responsible, you would expect a positive relationship between the use of the MID and foreclosures, but none exists.

Homeownership remains the American dream, and the MID is a critical policy helping aspiring homeowners attain that dream. Homeownership confers social benefits to communities, including more than $200 billion in state and local property tax revenue each year. Given the macroeconomic damage that weakening the MID would cause, the MID must retain its place as a cornerstone of U.S. housing policy.

  1. The Joint Committee on Taxation. 2010. “Estimates Of Federal Tax Expenditures For Fiscal Years 2010–2014.” Washington, DC: U.S. Government Printing Office.
  2. Robert Dietz. 2010. “Housing Tax Incentives: Age Distribution Analysis,” National Association of Home Builders, Accessed 1 April 2011.
  3. Robert Dietz and Natalia Siniavskaia. 2011. “Who Benefits from the Housing Tax Deductions?,” National Association of Home Builders, Accessed 1 April 2011.

David Crowe, Ph.D., is Chief Economist and Senior Vice President at the National Association of Home Builders (NAHB), where he is responsible for forecasting housing and economic trends, survey research and analysis of the home building industry and consumer preferences, and microeconomic analysis of government policies that affect housing. Prior to joining NAHB, Crowe was Deputy Director of the Division of Housing and Demographic Analysis at HUD.


Todd Sinai

The current tax subsidy for owneroccupied housing offers little to like. Most academic research, including a 2010 paper by Christian Hilber and Tracy Turner, suggests that the subsidy has little to no actual effect on homeownership rates; instead, it induces those who already would have bought a home to spend even more on housing.1 The subsidy is also a highly regressive component of the tax code whose benefits accrue overwhelmingly to high-income households in areas with high home prices.

In times of fiscal distress, then, talk often turns to eliminating the mortgage interest deduction. And it should; according to the Joint Committee on Taxation, the mortgage interest deduction, at an estimated annual cost of $93.8 billion, constitutes nearly 9 percent of the 2011 budget deficit as projected by the Congressional Budget Office.

The mortgage interest deduction, however, is only one component of the total tax subsidy for owner-occupied housing. In an undistorted tax code, taxpayers would be allowed to deduct their expenses (mortgage interest) when they pay tax on their income (rent). Because the United States does not tax estimated rental income for owner-occupiers, the interest deduction should not be allowed. That the deduction is nonetheless available constitutes a subsidy. However, the tax code also does not permit many actions that could offset the effects of untaxed rental income, such as taxing the estimated return to equity invested in owner-occupied houses.

In fact, James Poterba and I recently estimated that in 2004 the total tax subsidy for owner-occupied housing was $330 billion, more than 4.5 times our $72 billion estimate of the cost of the mortgage interest deduction alone. Not only is the mortgage interest deduction not the biggest tax subsidy to owner-occupied housing, it isn’t even close.

Specifically, the mortgage interest deduction is just a subsidy that uses mortgage debt to finance home purchases. Curtailing it leaves behind a host of subsidies, the most important being a subsidy for using equity to buy a house.

Deterring housing leverage by making mortgage debt less subsidized than housing equity is not a bad thing. Many positive aspects of homeownership exist, but the inappropriate use of mortgage debt negated nearly all of them in the latest downturn.

However, one should not confuse eliminating the mortgage interest deduction with eliminating the tax subsidy for owner-occupied housing. Many high-income households have the financial wherewithal to substitute equity finance for debt, giving them the option to retain their housing subsidy. Older homeowners have little mortgage debt and would remain largely unaffected. In addition, most low-income households do not itemize deductions on their tax returns and therefore do not benefit from the mortgage interest deduction. Curtailing the mortgage interest deduction would have the biggest impact on middleclass families — those who have the least choice about using mortgage debt — and would discourage wealthy households from using leverage. Is a partial reduction in the housing subsidy worth these distortions to household capital allocation and progressivity? Because the government can change other parts of the tax code to restore progressivity, the answer is likely yes.

Even so, much depends on the implementation. Reducing the mortgage interest deduction for existing middle-class homeowners would require a corresponding reduction in their income tax burden to avoid the risk of financial distress. In addition, any changes would need to be carefully phased in to mitigate any adverse effects on home prices.

  1. Christian A.L. Hilber and Tracy M. Turner. 2010. “The Mortgage Interest Deduction and Its Impact on Homeownership Decisions,” Discussion Paper 55, Spatial Economics Research Center at the London School of Economics, U.K.

Todd Sinai, Ph.D., is Associate Professor of Real Estate and Business and Public Policy at the University of Pennsylvania’s Wharton School. Sinai is also Visiting Scholar at the Federal Reserve Bank of Philadelphia and Faculty Research Fellow at the National Bureau of Economic Research. Forthcoming research from Sinai explores the relationships between real estate and urban economics and risk, consumption, and the cost of consumption commitments. For a more detailed examination of the MID by Sinai and James Poterba, see “Revenue Costs and Incentive Effects of the Mortgage Interest Deduction for Owner-Occupied Housing.”


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The contents of this article are the views of the author(s) and do not necessarily reflect the views or policies of the U.S. Department of Housing and Urban Development or the U.S. Government.