The MID is a tax deduction that allows for homeowners to lower their taxable income base by the amount of the interest paid on the loan that is secured by their place of residence. The purpose of the deduction is to incentivize home ownership. While the MID had existed in the United States since 1913, it was not explicitly mentioned in the tax code until 1986 (more on the history of MID here). If it has been part of the U.S. tax code in one way or another, it makes me wonder how good of a job it has done, especially since the lost revenue from the MID accounts for 7 percent of total personal income tax payments.
Last week, a study at the National Bureau of Economic Research was released. The topic of this study (Gruber et al., 2017) was the MID in Denmark. Although this applies to the Danish market, it has some relevance because, as the abstract states, this is the "first comprehensive long-term study of how tax subsidies affect housing decisions." The study spans back to the late 1980s, which is when the Danish government slashed the MID for wealthy taxpayers.
This Denmark study had two main interesting findings, the first being that it did not increase home ownership. The other main finding of this study is that it made homebuyers purchase more expensive homes than they would have otherwise, thereby increasing indebtedness. This Denmark study is hardly the first study to find adverse effects of the MID:
- In terms of straight-up cost, the Joint Committee on Taxation found that the MID is going to cost the U.S. $350 billion in tax revenue from 2016 to 2020 (Table 1), which makes it one of the most expensive tax breaks out there. This same report also found that those who benefit the most are those making $100,000 or more (Table 3), which makes sense since you can't take the deduction unless you itemize on your taxes and those who itemize tend to be upper-income.
- Looking at data from 1984 to 2007, economists from Harvard and MIT concluded that the MID only helps higher-income households, and on the whole, the MID neither promotes home ownership nor improves social welfare (Hilber and Turner, 2014; Toder et al., 2010; Glaeser and Shapiro, 2002).
- Instead of encouraging home ownership, the primary effect of the MID is to artificially inflate housing prices, which makes housing less affordable for lower-income households (Landis and McClure, 2010).
- Repealing the MID would cause housing prices to fall. However, this would actually help with home ownership because the decreased in housing prices would help credit-constrained renters better afford a house. Also, since the MID disproportionately helps higher-income households, eliminating the MID would shift housing consumption more to lower-income households, thereby improving overall social welfare (Sommer and Sullivan, 2017, p. 37-39).
- A study from the Mercatus Center shows that the MID does not increase home ownership, and that the MID diverts resources from more socially valuable endeavors into more expensive homes (Fichtner and Feldman, 2014). As the Left-leaning CBPP points out, this non-optimal use of resources could potentially skew capital allocation, thereby lowering wages and living standards (also see Morrow, 2012).
- Another study found that while the home ownership rate did not increase, the square footage of the houses purchased did increase (Hanson, 2012).
There are some ways to reform the MID to improve the status quo. Replace the MID with a refundable credit would eliminate the artificially high demand for higher-end homes (Viard, 2013). Reduce the ceiling on the debt eligible for an interest subsidy (Lu, 2015) or cap the the income tax rate at which taxpayers can take itemized deductions (Katz, 2016). Personally, I am all for repealing the MID, especially since economists generally agree that removing the MID in exchange for lower taxes would be a more efficient use of resources. Plus, repeal would make conservatives happy by simplifying the tax code while making liberals happy since the MID is a regressive tax that arguably exacerbates income inequality. If Trump wants to make housing great again, and if Trump wants to cut taxes and simplify the tax code to improve economic welfare, Trump needs to add repeal of the MID as part of his tax plan.