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Tax Reform Must Not Keep Tax Breaks for Real Estate

Ike Brannon

As the House Ways and Means committee proceeds with the markup
of its landmark tax reform proposal, one change that seems
inevitable is the curtailment of the modest reforms of the myriad
home ownership tax breaks contained in the original legislation.
These included capping the deduction for mortgages below $500,000,
limiting the deductibility of property taxes to $10,000, and
eliminating the deductibility of state and local taxes
altogether.

While the realtors, homebuilders, and mortgage bankers howled at
the original proposal and look as if they will soon get their way,
mostly, the reality is that no tax reform worth its name can keep
these expensive and economically unproductive tax breaks and still
manage to lower rates and boost economic growth—the
ostensible goals of the entire exercise.

The tax writers’ acquiescence is politically expedient, of
course: The realtors and home builders are angry because the
proposed doubling of the standard deduction, combined with
curtailing the deductibility of state and local taxes, would result
in most taxpayers ceasing to itemize and thus foregoing the
mortgage interest and property tax deductions. Should that come to
pass, the pretense that these actually boost home ownership would
be exposed as the bald faced lie it actually is.

The whole thing becomes
pointless unless we reform the mortgage interest
deduction.

The partial cave-in to Big Housing has not diminished its
outrage one bit and sets a lamentable precedent for when we need to
eliminate even more tax breaks for reform to succeed. Other losers
from tax reform will be agitating for a similar appeasement as
well, and the more tax breaks that remain, the less we can cut
rates.

But the larger problem this surrender creates is that deductions
for home ownership are costly and economically harmful. Under
current law, the deduction for mortgage interest and property taxes
alone will reduce tax revenue by over $1.3 trillion in the next
decade, which would finance a sizeable reduction in tax rates.
Keeping both around, even in diminished form, would significantly
reduce those potential savings.

The various deductions for home ownership also happen to be
amazingly regressive, since only 30 percent of all
taxpayers—pretty much the wealthiest 30
percent—currently find it worthwhile to eschew the standard
deduction and deduct mortgage interest as well as state and local
taxes. And since the savings from these deductions go up sharply
with a homeowner’s income and home value, the benefits increasingly
accrue to the richest homeowners in the most expensive homes.
Marquette University professor Andrew Hanson discovered that the
average household in well-to-do Redwood City, California, receives
fifty times the tax savings from the mortgage interest deduction as
a household in Mossville, Illinois, a blue-collar community in
Central Illinois that happens to be my hometown.

The tax breaks for housing would become even more regressive
under the Ways and Means plan: The doubling of the standard
deduction would result in just five percent of households
itemizing. For reference, the 95th percentile for income starts at
$225,000.

The staggering regressivity of the deduction for mortgage
interest and property taxes—both before and after the
proposed reform—means that in neither scenario does it do a
whit to boost home ownership, since the tax breaks don’t go to the
middle class families who might need help to afford a house. In
fact,
research
by Federal Reserve economist David Rappoport suggests
that the mortgage interest deduction actually boosts home
prices at all price levels, even homes likely to be bought by
people who can’t avail themselves of the mortgage interest
deduction. In short, the home ownership tax breaks probably
reduce homeownership rates in the aggregate.

The tax deductions for homeownership also reduce economic
growth. Encouraging the well-off to buy or build bigger, fancier
homes, which are economically unproductive assets, results in them
putting less savings into their banks or retirement accounts, where
it could be lent to businesses to invest and expand.

To be sure, getting rid of the deduction for state and local
taxes, along with the mortgage interest deduction, might hurt some
homeowners: Rappoport’s
research
estimates housing values would decline by 6.9 percent
if the mortgage interest deduction disappeared. But to put that
into perspective, that happens to precisely equal the average price
increase
for a home in 2016.

If we want achieve a tax reform that is constrained to be
progressive, boosts economic growth and does not grow the deficit
then there cannot be any room in the tax code for regressive,
growth-reducing and costly provisions that do not even accomplish
their ostensible purpose, even if their supporters happen to be
politically powerful. If Congress feels compelled to make sure no
one loses from reform, the answer is not to maintain costly tax
breaks for well-to-do homeowners but to lower tax rates for all
households to the greatest extent possible.

If that is insufficient then we may as well dispense with the
entire exercise.

Ike Brannon is
a visiting fellow at the Cato Institute.