The Mortgage Interest Deduction: A Tax Break for Low to Middle Incomes? Not so much . . .

The FAIRtax eliminates the income and payroll tax system and all of the special interest loopholes and deductions that come with it.  The chart below shows the top ten income tax system deductions.

Source:  Joint Committee on Taxation, report JCX141R-15.
Not surprisingly, given the high cost of healthcare, the deduction for employer paid health care, insurance and long term care insurance tops the list at a whopping $143.8 billion dollars. In second place is the tax reduction from lower tax rates on dividends and long-term capital gains to the tune of $134.6 billion.  We have to go half-way down the list to come to the Mortgage Interest Deduction (MID) for owner-occupied residences, probably the most touted tax deduction to help the Middle Class.
Much ado is made about the MID.  It supposedly helps low to moderate income families achieve the American dream of owning their own home.  The MID reduces the effective cost of housing by allowing households to reduce their taxable income by the amount of home mortgage interest paid.  For example, a household earning $50,000 and paying $8,000 in mortgage interest on their home is able to reduce their taxable income from $50,000 to $42,000.
If you ask most politicians, government officials or realtors, they will tell you that the MID, valued at $77 billion, is vital and without it homeownership would collapse.    In reality, it does little to expand homeownership:  the main reason being that most of its benefits go to higher-income households who generally can afford a home without assistance.  Fichtner and Feldmen from the Mercatus Center found that a whopping 64 percent of the benefits of this deduction—as measured by the effective tax reduction—go to households earning more than $100,000. 
In contrast, very few lower-income households can take advantage of the MID.  Of the 65 percent of taxpayers claiming income of $50,000 or less, fewer than 10 percent use the MID.  Those who did claim the deduction saved just $150 more than simply taking the standard deduction and not having to bother with filing the itemized deduction form, a sum most likely less than the amount they paid to someone to prepare their tax return.  [In 2013, the average tax preparation fee charged by H&R Block was $198 per return.]  In stark contrast, the average effective tax reduction for a filer earning between $100,000 and $200,000 is $1,420—nearly 10 times larger than the $150 saved by low-income taxpayers using the deduction.
                          Source:  Data from JCT Estimates of Federal Tax Expenditures, Aug. 5, 2014, p. 37.
Proponents will then say that the MID does increase homeownership and the demand for housing which is good for the economy.  Data on homeownership rates and whether or not a country has a MID, suggest otherwise.  The percent of household that own their own home in the United States is 65%.  However, Singapore (87%), Canada (68%), New Zealand (67%) and the United Kingdom (68%) have no MID yet have higher rates of homeownership than the United States.  In the case of the United Kingdom, which phased out the MID between 1975 and 2000, the homeownership rate rose from 53 percent in 1974 to 68 percent in 2001.
And because the MID is based on interest on debt, it discourages taxpayers from paying down mortgage balances when they have funds available to do so.  Larger mortgage balances in turn increase the risk that households will be unable to pay their mortgages if their incomes drop or that they will be left with negative equity (that is, with mortgage debt larger than the value of the home) if house prices decline.
If Congress intended to provide substantial benefits to the wealthiest 13% of our taxpayers, then the home mortgage deduction is working very well.  However, if the purpose is to promote homeownership for all Americans, then it is not doing a very good job.  A much better way to promote homeownership is to quit tinkering with the tax code for social engineering purposes and enact the FAIRtax.  The economy will boom.

Karen Walby, Ph.D.
Director of Research 
Americans For Fair Taxation