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.

7 thoughts on “In which I am confused by conclusions about the mortgage interest deduction

  1. You’re forgetting Glaeser’s other argument: the collective action problems inherent to owner-occupied multifamily housing mean that, c.p., people who want to own their dwelling will prefer a single-family fee-simple unit over one with collective ownership. The mortgage interest deduction therefore amplifies this preference, and subsidizes something that is already desirable.

    • But that doesn’t mean that the single family fee-simple housing would necessarily have to be McMansion sized. So ok: not condos with jacuzzis, but bungalows with jacuzzis then.

    • You should come out to Fairfax County sometime. There are quite a few townhouse developments here with McMansion-sized units (3 stories, 50-60′ deep, 20′ wide) that probably have a few gold-plated cherubim in them.

  2. Isn’t there a greater proportion of rental units in urban areas? In that case, a mortgage deduction, favoring ownership over renting would promote suburbanization.

    If the mortgage interest deduction has a causal role, it doesn’t mean that it’s the only cause. So places without the deduction have experienced suburbanization, but not as quickly, as you said. And different cities in the US have different forms because they are affected by many other policies.

    That doesn’t mean that the deduction is insignificant. If each US city was just slightly more urbanized than it is now, that could have large-scale, self-reinforcing national impacts.

    Maybe people exhibit a strong preference for space, but what’s the marginal utility of square feet 2,000 to 2,500 in a house? Is that worth the costs associated with an altered city form? Or if you don’t like that comparison, is it worth $573 billion in federal tax revenue between 2009 and 2013 (CBO estimate, http://outofthestormnews.com/2011/01/13/on-the-much-loved-little-used-mortgage-deduction/)?

    • 1. Isn’t there a greater proportion of rental units in urban areas? In that case, a mortgage deduction, favoring ownership over renting would promote suburbanization.

      Suburbanization isn’t strictly the issue I take up in the post; it’s possible to have lower densities/sprawl without suburbs. And you can have suburbs with multi-family housing in them. The question I take up is lot and house size, and whether the interest deduction really exerts a significant causal influence on what’s happening there. Sure, land on the urban fringe tends to be cheaper and there are more rentals in the city, and that might explain why there are more owners on the fringe with the deduction, but in a world where nobody preferred space, you could still own a small house on the urban fringe with the mortgage interest deduction. You don’t have to use the cheaper credit towards more space: you could use it towards more built-in bookshelves, fireplaces, and oak floors, all of which will drive up the cost of the house and mortgage.

      2. If the mortgage interest deduction has a causal role, it doesn’t mean that it’s the only cause. So places without the deduction have experienced suburbanization, but not as quickly, as you said. And different cities in the US have different forms because they are affected by many other policies. That doesn’t mean that the deduction is insignificant. If each US city was just slightly more urbanized than it is now, that could have large-scale, self-reinforcing national impacts.

      In fairness to me, I didn’t say it was the only cause, but I was asking if it was an important cause, and you seem to be saying that it’s both significant and insignificant. If the deduction is eclipsed by other policies, which results in different forms, why should we get our undies in a bunch about the deduction rather than just implement those other policies? And if other policies can trump the deduction, it might not be particularly important. And finally, if low-density development would be slower without the deduction, is it enough slower for that different rate to really be policy relevant? (I don’t know.It’s an empirical question; papers about lower density development in Europe suggest no).

      3. Maybe people exhibit a strong preference for space, but what’s the marginal utility of square feet 2,000 to 2,500 in a house? Is that worth the costs associated with an altered city form?

      Ok, but I don’t understand what this argument has to do with my original set of questions, so I’m chalking this up to a non sequitur. Just because some people have a preference for something doesn’t mean it’s pro-social–I’m pretty sure I covered that in the original post.

      But let’s deal with the non sequitur: would we really gain all that much in saving on the “costs of sprawl” or in altering urban form from going to 2000 down from 2500 square foot houses? I’m pretty sure that 2500 square feet is not in the McMansion realm, since my loft downtown was 2100 square feet. Perhaps the proper example is 8000 square foot to 2,000 square foot lots? It’s an empirical question.

      4. Or if you don’t like that comparison, is it worth $573 billion in federal tax revenue between 2009 and 2013 (CBO estimate, http://outofthestormnews.com/2011/01/13/on-the-much-loved-little-used-mortgage-deduction/)?

      Interesting enough, but this point has nothing to do with my original questions; another non sequitur. Tax deductions are terrible idea if you are worried about revenues. However, I’m not sure whether I should be outraged by this or not, simply because I don’t know the answer to the incidence questions I raised. If the deduction helps people build a wealth base they then use to increase their financial security later in life, I’m not sure $538B is out of line, and more importantly, I’m not sure it wouldn’t be more expensive to provide greater levels of supplemental senior pensions to folks who hadn’t saved via their homes. Now, homes have proven to be volatile investments in recent years, but still.

      How about this? What if the *only* way housing remains affordable over the long term under urban growth boundary regimes is with tax breaks for both ownership and renting? Wouldn’t getting rid of the deduction be bad for cities if you got rid of it under those conditions? WHY ARE YOU AGAINST HOUSING AFFORDABILITY? (Hey, two can play ad hominem).

      • And the link you sent us to just confuses me more. If the deduction is ineffective and not that many people get it, then how can it be an important factor in urban form?

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