In which I am confused by conclusions about the mortgage interest deduction

My students currently are reading Triumph of the City by Ed Glaeser. In it, he echoes thoughts that many, many people seem to have: that the home mortgage interest deduction encourages sprawl and McMansions.

Now, I’m not a big fan of fiddling with the tax code, and I’m really not a fan of handing out tax breaks to people who have means, but I am confused by the way people have started discussing this particular policy–the consequentialist arguments in particular. For me, my first two reasons are enough to make the policy prima facie not a great idea. But the consequentialist arguments strike me as shakier than their very smart proponents, like Professor Glaeser, like to believe.

First off, it seems to me that unlike with any other tax policy, people (including economists, who should know better) assume that the incidence of the mortgage interest deduction falls entirely on the first group of beneficiaries–the home buyer. Really? With taxes, we know that they can be shifted: the example everybody loves to use is a tax on yachts. Yes, you’d like to soak the yacht-buyers by taxing yachts. But if the rich people look at the tax and suddenly decide to start buying handbags or trips to Wimbledon or botox injections or fur coats instead of yachts, the people bearing the cost of the tax are not wealthy people, but people who build yachts, including some low-wage labor. That’s shifting.

Maybe there is an empirical literature out there that Glaeser knows and I don’t–I hope Richard Green will pipe up and direct me to it–that estimates the incidence of the home mortgage interest deduction. Now, these incidence studies are difficult and subjective, but economists do them. And if these studies are out there for the mortgage interest deduction, I would like to see them. Because theoretically, I could see the incidence of the benefit moving far past the borrower to landowners (capitalizing the benefit in the price of land), mortgage lenders, and both labor and capital in the construction industry, not to mention those in the fancy-housewares and gardening industry (you get a break on your home costs, you use that buy fancy housewares). Then there’s the lifetime incidence questions that always change the calculation of incidence by a lot. Is it bad that we help young people buy homes when homes are seniors’ primary assets?

Second, it seems to me that while, yes, the mortgage interest deduction would cause you to overconsume credit, it’s not clear that, in the absences of consumer preference towards space, that cheaper credit would a priori cause you to overconsume space. So with the deduction, your mortgage credit is cheaper. Fine. But the mortgage interest deduction on $500,000 worth of mortgage is $500,000 of mortgage whether you spend that $500K on a lot of land/McMansiony house in the burbs or you use that to buy a fabulous loft in downtown. There’s nothing about the credit side of the equation that necessarily pushes you to that McMansion; it may be a supply issue (far too few high end lofts and far too many suburban homes), or, as I note, it may be a simple preference. In the the absence of that preference for space being strong and the political economy restrictions on multifamily development, wouldn’t subsidized credit just as likely yield more condos with jacuzzis and souped-up kitchens and bathrooms as it would McMansions?

Now, before you get all up my grill about being pro-sprawl and the other labels people like to throw around, I’m willing to concede that making this particular preference cheaper to indulge via the deduction is collectively bad for us. And I’m willing to believe that, given this preference, overconsumption of credit for housing leads to the marginal increase of home sizes across the board (from condos to McMansions) and that cumulatively sizes up housing in ways that are collectively not good. But…still. It doesn’t resolve the preference issue, which is relevant because a consumer preference can also be a democratic preference, which means we may have liked consuming space and thus made it easier for ourselves to do so via political economy. Which means we are looking at perhaps symptom rather than cause, albeit a symptom that becomes self-reinforcing and potentially causal over time?

But that incidence question throws in a wildcard for the above logic.

Perhaps without the deduction, wealth gains explain space consumption and we’d still have the spatial patterns we see here, only with different ownership structures. We see urban decentralization in places without the mortgage interest dedication, although not to the same degree. Sububanization has occurred worldwide even without the deduction. And we have different urban forms in the US, even though the policy is federal and it applies to all borrowers, from Portland to Atlanta. Why aren’t those places more similar in terms of housing delivery if the mortgage interest dedication is all that powerful a factor.

So leaving aside the desire to rip my throat out for daring to ask these questions, what’s the right way for me to reason my way through to the causal link between mortgage interest deducation and sprawl? Help me.