Two researchers affiliated with the Mercatus Center at George Mason University have released a working paper entitled “Reforming the Mortgage Interest Deduction,” in which they analyze “two fundamental problems with the MID.” The first is that it is not an incentive for homeownership, but does incentivize greater debt. The second is that it is economically inefficient because it motivates higher income households to over invest in housing, “diverting resources from more socially valuable investments.”
James Fichtner and Jason Feldman examine the major economic literature on the MID for the last fifteen years and conduct their own calculations using IRS datasets. They assert that the MID could eliminated with little effect on low and middle income homeowners, but acknowledge that outright elimination is not politically feasible. They conclude that the second best reform would be to convert the MID to a non-refundable mortgage interest credit, and suggest such a credit would increase the homeownership among low and middle income households by as much as 5%.
Low and middle income households are generally those with incomes of $100,000 or less. Their analysis of IRS data shows that 75% of taxpayers in 2010 had adjusted gross income of $100,000 or less, and 50% had adjusted gross income of $50,000 or less.
The United for Homes campaign proposal to reform the MID and use the revenue raised to support rental housing affordable for extremely low income households calls for converting the MID to a 15% non-refundable tax credit, as well as lowering the cap on the size of a mortgage for which the interest can be deducted from $1 million to $500,000.
The authors detail several economic inefficiencies that the MID as currently structured creates. Because it incentivizing borrowing, people purchase homes that are 10-20% larger than they would without the MID. The MID also is capitalized into the price of housing and increases the cost of home buying by 10-15%. It also encouraged higher interest rates. One estimate is that between 9-17% of the value of the MID is lost to higher interest rates.
Fichtner and Feldman’s preferred design of a mortgage interest credit would be a fixed non-refundable $900 credit for all mortgages.