While everyone is looking forward to Christmas tomorrow, let’s sneak in one last article this year on the MID, this from the Reason Foundation:

http://www.mortgagenewsdaily.com/12232013_mortgage_interest_deduction.asp

Here are excerpts:

The mortgage interest deduction (MID) is never left alone for very long.  In Unmasking the Mortgage Interest Deduction: Who Benefits and by How Much? Economists Dean Stansel and Anthony Randazzo lay out their arguments for eliminating the popular deduction from the tax code.  Written for the libertarian Reason Foundation, the article examines the history and reasoning behind MID, looks at the financial impact on individuals, the housing market, and tax collections, and presents alternatives which they say would more evenly distribute tax benefits and help the economy.

“The least distortionary income tax system is the one with the broadest possible tax base and the lowest possible marginal tax rates. Consider that if the tax base was broadened to include the $1.2 trillion in itemized deductions for 2011, the average tax rate could be reduced by nearly one-fifth, from 17.3 percent of taxable income to 14.2 percent.”

Stansel and Randazzo say such a reduction in marginal tax rates would directly increase the reward for productive (income- generating) activity. As a result, closing loopholes such as the MID and lowering overall rates would likely lead to a more prosperous economy with higher economic output and incomes.

One defense of MID is that is helps increase homeownership which is usually viewed as a societal good.  But the authors maintain the MID fairly ineffective at this.

Renter households that would prefer to own “if they had just a bit more financial flexibility,” tend to be low income and thus less likely to itemize their deductions.  So, instead of increasing the homeownership rate, the MID increases the amount spent on housing by consumers “who would choose to own anyway, subsidizing spending on housing rather than homeownership.”  If the MID had a significantly positive effect on homeownership, they contend we would expect to see a faster and continuous increase in homeownership, rather than a gradual increase and subsequent decline.

The MID encourages consumers to use debt rather than their own assets to finance home purchases.   This creates a distortion in how financial capital is allocated, which leads to greater amounts of mortgage debt.  The paper frequently quotes economists James Poterba and Todd Sinai who estimate taxpayers could reduce their mortgage debt by nearly 30 percent by using other financial paper assets, (savings or brokerage accounts) to pay off loans.  If all non-housing assets, such as retirement accounts, trusts, and annuities, were liquidated to pay off mortgage debt, Poterba and Sinai estimate that the reduction could be 70 percent.

Furthermore, the marginal effective tax rate for owner-occupied housing in 2003 was only 2 percent, compared to 18 percent for noncorporate investment and 32 percent for corporate investment.  By creating favorable tax treatment for housing compared to other investments, the mortgage interest deduction encourages individuals to over-invest in housing, contributing to housing bubbles.   The Federal Reserve Bank of Philadelphia estimate that government incentives for homeownership, including the MID, have skewed distribution of resources so much that the American housing stock is 30 percent larger than it otherwise would be.

This over-investment means less capital is put toward productive assets in the rest of the economy, like machines and equipment used to produce goods and services. If there are fewer productive assets, there will be less economic growth and a lower standard of living.

In 2011, only about 32 percent of income tax returns filed with the IRS contained itemized deductions and about 21 percent of itemizers do not take the MID.  The percentage of taxpayers claiming a MID has been relatively stable at between 21 and 26 percent since 1991.

Read the full article with solution ideas here:

http://www.mortgagenewsdaily.com/12232013_mortgage_interest_deduction.asp