If you’re young — and if you’re reading this, you probably are — the tax code hates you. Well, if you live in a dorm, the tax code probably doesn’t hate you, but if you rent it sure does. And if you’re like the 80 percent of people under 25 who rent, or if you’re going to be one of the two thirds of people aged 25-29 who rent, then the tax code really, really hates you. And even worse, this tax disadvantage for the young and renting population, the mortgage interest deduction, also has the negative side effect of favoring the rich — encouraging the building of bigger homes, driving up home prices and doing very little to encourage home ownership.
The mortgage interest deduction, which allows people to deduct the interest payments they make on their home mortgage loans from their stated incomes, is one of the most visible manifestations of America’s obsession with homeownership. And while owning a home is still part of the American Dream for many young people, the basket of policies pursued by the state, local and federal governments to encourage home ownership makes little sense and does more harm than good.
Beyond all the specific inefficiencies and harms associated with the tax, there is the basic fact that it benefits a certain demographic. The people who are most likely to rent are the young with low incomes, who are, not coincidentally, those who are least likely to have their interests represented in government. This younger population is also more likely to have most of their money in the form of income or wages, as opposed to stocks, bonds and dividends, which are all taxed at a lower rate. Basically, those who could most use a deduction on their incomes are the ones not getting it.
Economist Ed Glaeser of Harvard University has written that the deduction is ill-targeted, regressive, encourages the buying of larger and larger homes and does little to actually encourage home ownership. It’s regressive because it most benefits the people who buy the most expensive houses. Not only do they get the largest deduction, but since they are in the highest tax brackets, they get the biggest benefit from the deduction.
But helping the rich isn’t the only problem. Even worse, it encourages the wealthy to buy the most expensive house possible and it encourages everyone else to buy houses they can’t really afford. That’s because as long as home prices are going up (which, for most of the people who have mortgages, they were), the buyer can just sell the house if they ever fall behind on their mortgage payments. The reason the deduction encourages people to spend even more is because their tax benefit goes up with the amount of interest they are paying. And, as we know all too well, encouraging people to take out loans to bet on home prices going up indefinitely hasn’t exactly turned out well in the past few years. Not only is there massive human misery due to foreclosures when the prices go down, but the deduction also helps stoke the upward spiral in home prices, making the resulting crash all the more horrible.
One would think that assisting one of the worst asset price crashes in American history would be bad enough, but it turns out that little deduction also screws over the environment. Glaeser writes that the deduction makes it easier for people “to buy larger, single-family detached homes, and that increases carbon emissions and pushes people out of cities.” And since we all know that global warming is a problem, having government tax policy encourage environmentally unfriendly living arrangements hardly makes sense.
In many ways, the deduction is a perfect representation of what’s screwed up about our politics. Not only does it help those who need to be helped least, but it has just about zero defenders among those who seriously think about policy. And yet, because it benefits a powerful group in very visible ways while hurting everyone else more subtly, this nasty bit of our tax code is likely to stay around for a while.
So what should we do? Obviously, we can’t just get rid of the deduction right now. Home prices are already spiraling downward, so we hardly need to be encouraging their descent. Instead, we could phase it out over, say, 10 years. Still, the focus shouldn’t just be on this one tax deduction, but instead on the political system which produces policies that help those who need it the least.