It's Time to Abolish the Mortgage Interest Deduction
The Washington establishment remains impregnable to the simple truths of responsible financial management. This fact is no longer a secret for the vast majority of Americans, who, unfortunately for their own financial wellbeing, now follow the political class in support of policies that will weigh us down for decades to come.
The inkling of what lies ahead is manifest in people's flagging expectations about their own future. The recent 2013 Retirement Confidence Survey, for example, found that the percentage of workers confident that they will have enough money in retirement remains at the all-time lows of 2011. Today, many workers are concerned about making ends meet, let alone contributing more to their depleted retirement accounts. Fifty-five percent of workers and 39 percent of retirees found themselves with too much debt.
And what, according to Federal Reserve data, is the source of nearly three quarters of current household debt? Decades of high-leverage housing policy, fervently endorsed by both left and right, have encouraged Americans to rack up a mountain of mortgage debt, accounting for $9.4 trillion of the more than $12.8 trillion we now owe as individuals. Not only have homes become an unreliable source of pension funding, but for many thinking about retirement, they are a burden and a liability.
There is, however, a systemic shift in housing policy that could change all this and return us to a nation of thrifty households that balance their books and expect the same of their politicians.
Here is how our current system works. Your neighbor, Bill, loads up on debt in what is effectively a 15-year rental agreement disguised as a mortgage - it requires a sizable deposit that substantially increases Bill's economic risk. His financial advisor encourages him to take it; after all, mortgage rates and inflation can only go higher. Then, the federal government lets Bill write the lender's profit off his tax return. Months later, an old friend offers Bill work with a startup that would double his pay, but he cannot relocate or take on the employment risk because of his mortgage. An important manifestation of the dynamism we need to jumpstart our economy is lost because of our mortgage burdens, one of the many shortfalls of the current tax system.
What's worse, Ted, another neighbor from across the street, who works hard to save and buy a home with cash, is punished by the IRS for his prudence. The interest on his savings is taxed as ordinary income because someone has to pay for the tax deduction on Bill's reckless borrowing. Adding insult to injury, Bill's ill-advised purchase makes houses scarcer and even less affordable for Ted.
Could anyone have come up with a better scheme to promote excessive long-term borrowing and labor-market rigidity, while effectively providing another subsidy to mortgage lenders - in addition to the trillions in taxpayer guarantees for mortgage loans?
We need action that in the short run is bold and in the long run is wise. It starts with ending the mortgage deduction. This highly visible act would demonstrate how seriously congressional leaders take both homeownership and tax reform.
Nowadays, paying more for a house means you get more from the public in tax deductions, which are effectively funneled to financial intermediaries such as mortgage lenders. But existing mortgages can be grandfathered into a system where new first-time homebuyers only receive a lump-sum tax credit from the Federal Housing Finance Agency. This fairer approach reduces the incentive to borrow because the amount of the subsidy no longer increases with the underlying leverage, and so excessive risk-taking isn't favored. If instead the credit is tied to the size and proportion of the down payment, it would entice homebuyers to take out a smaller loan, thus putting them on a firmer financial footing. With less leverage, there would be less speculative buying, milder housing bubbles and, ultimately, housing that is more affordable for everyone and an asset in retirement.
Taxpayers will also benefit. The one-time credit will slash the expenditure cost and make it more predictable because it would be limited to a single transaction that cuts out the middle man - the often irresponsible lender. The multibillion-dollar mortgage deduction now fluctuates with both new and refinanced mortgages, and goes exclusively towards interest cost. The homebuyer credit would actually go directly towards paying for the home, thereby reducing both overall interest cost and mortgage duration. The FHFA would match a percentage of the down payment for qualifying buyers, but from that point on, no more carving out deductions would be allowed.
The mortgage deduction is not only unfair, expensive and ineffective, but also helps consign many Americans to a retirement riddled by the angst of debt and poverty. What America needs now more than ever is a more honest system which does not play tax games that discourage the saver and urge on the spendthrift. We should have a mortgage system that does not subsidize the financial industry at the expense of taxpayers and debt-ridden retirees, but rather restores our homes and our nation's fiscal house to a surer and securer financial foundation.