The simple explanation would be that the two are uncorrelated.
I see. You believe that the presence or absence of a tax break on the purchase of something has no effect on its price.
Got it. I give up.
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3. By far, the largest housing welfare program in the US is the home mortgage interest tax deduction. And it is surely welfare, just as much as taxing cap gains at a lower rate than income earned from working is, because every dollar of foregone taxes must be paid by someone else.
Not anymore. Very few people take the home mortgage interest tax deduction nowadays. When the standard deduction was raised a few years ago, the number of taxpayers using it dropped by nearly 60%.
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You believe that the presence or absence of a tax break on the purchase of something has no effect on its price.
I never said that. You are putting words in my mouth.
I give up.
I’m not going to, because I believe there are important macroeconomic issues here that many people, yourself included, don’t understand.
First off, of course taxation has an effect on prices. I’ve argued that many times here. That is why putting those words above into my mouth is offensive to me. So let’s see what I AM saying. And I’ll have to drag out some numbers.
I’ll admit up front that a couple of figures I’m going to use are very rough approximations of what I claim them to be. But absolute accuracy is not important here - understanding the concept is the important thing.
The topic is the mortgage interest deduction on US individual income taxes. So let’s start by calculating a typical interest deduction.
The median home price in the US is very roughly 400,000. I’ll use that as representing something close to typical. Let’s go ahead and use current mortgage interest rates. I was kind of shocked to see that a 30 year fixed mortgage is up to almost 6% now. I’ll assume that a 20% down payment is still standard. So let’s crunch the numbers.
20% down on a 400,000 house is 80,000. That makes the mortgage 320,000. 6% of that is (roughly and slightly overstated) the first year interest paid. Let’s call it 19,000. That’s the deductible amount for our hypothetical home buyer. Let’s ballpark the property taxes at 1.25% of the purchase price. That’s 5000 which can also be deducted.
Let’s give our home buyer 110,000 of annual income. That’s probably over the median income, but it’s also probably what you’d need to qualify for the mortgage. And let’s make this the income of a married couple.
So what do the income taxes look like for this couple?
Gross income, 110,000
Mortgage interest deduction 19,000
Property tax deduction 5,000
And let’s not forget their state income taxes - I’ll use a round figure of 6,000 for that. Just under a 6% rate. Some states will be higher, some lower. And those that live in a state with no income tax can deduct sales taxes. So we need to use something.
The total of these deductions is 30,000. Great. They’re saving 30k times their marginal rate, right? Not so fast.
The alternative to claiming your actual deductible expenses is claiming the standard deduction. For a married couple, that’s 25,900 for 2022. The actual benefit from all of these deductions is an extra 4,100 in deductions - the difference between their itemized deductions and the standard deduction.
Well, what does that work out to in actual dollars of tax saved? Glad you asked!
We have 110,000 of income and subtract 30,000 of deductions. So their taxable income is 80,000. Consulting the 2022 tax brackets, the first 20,550 of taxable income is taxed at 10%. That’s 2,055 of tax. The income between 20,550 and 83,550 is taxed at 12%. We have 80,000 of taxable income, so this is our marginal tax bracket. Subtract 20,550 from 80,000 and we get 59,450 taxed at 12% - that’s 7,134. Adding in the tax from the 10% bracket - 2,055 - and we get the total tax of 9,189.
What would their tax be using the standard deduction? 110,000 - 25,900 gives 84,100 of taxable income. We still have 20,550 at 10%, plus another 63,000 at 12%, and 550 dribbles over into the 22% bracket. If I’ve done the math right (far from a certainty, as I have a cat “helping” me) that tax is 9,736.
So the actual tax savings from buying the home is 9,736 - 9,189 or $547.
$547.
Let that sink in.
Paying 19,000 in mortgage interest saved you $547. I’m not going to deny that this is a tax saving. But I am going to strongly suggest it is immaterial and not going to have a noticeable impact on housing prices.
And let’s not forget that I’m using today’s mortgage interest rates. Back up just a couple of years and you could get a mortgage for 3.5% (or even less). At 3.5%, the first year mortgage interest is 11,200. Add in the same property tax and income tax and we have 22,200 of itemized deductions. That’s LESS than the standard deduction, so there would be ZERO tax saving from the mortgage interest deduction. You’d need to add in more than $3000 of charitable contributions to even begin to benefit from itemizing.
This is why I don’t think the mortgage interest deduction has any significant impact on the price of median-priced and lower homes. When there is a tax benefit from the deduction, it is minuscule compared to the rest of the dollars we’re talking about. It’s less than the rounding errors.
–Peter
PS - On review, I noticed that I failed to take the 10,000 limit on the deduction for state and local taxes into account. Bad, Peter. Bad. Sit in the corner and contemplate what you’ve done. I’ll leave fixing this error as an exercise for the reader. It does not have any affect on my conclusion. If anything, it means I have overstated the tax savings.
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Paying 19,000 in mortgage interest saved you $547. I’m not going to deny that this is a tax saving.
A quick followup to note that we agree. That said, this is the savings for a single year, as I presume you recognize, and not the total benefit. I didn’t claim it was a huge factor in affecting house prices. (Of course it isn’t: it’s a percent of a percent.) I do claim that, in aggregate, it’s a lot of money, even if it’s less in recent years than it used to be (as a % of the federal housing-related budget). I presume we can also agree that the benefit is greater for upper-income households and for more expensive homes (up to the cutoff).
In summary:
- It’s a government subsidy for housing, aka a “government handout” (to get back to the post that inspired by original response).
- It’s regressive.
- It makes homes more expensive than they would be otherwise, ceteris paribus, because (as dozens of studies as well as common sense, with which you agreed in your most recent post, show) the tax benefit is capitalized into the price.
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1. It’s a government subsidy for housing, aka a “government handout” (to get back to the post that inspired by original response).
Agreed.
2. It’s regressive.
Very much so, yes.
3. It makes homes more expensive than they would be otherwise, ceteris paribus, because (as dozens of studies as well as common sense, with which you agreed in your most recent post, show) the tax benefit is capitalized into the price.
This is what I do not agree with. At least not in any practical sense. I have demonstrated that for houses of roughly median price or less, the actual value of the benefit is vanishingly small, if it exists at all. And that is where the starter home or first home price point generally lies. So if there is any capitalization of tax benefits into the price of homes, it is going to be immaterial for a large fraction of home buyers.
Tell you what. I’ve put some numbers to my point. If you believe that the value of the tax benefit is capitalized into the price, how about you run some numbers to show how that happens and how much it might be. Convince me with some calculations. “Common sense” and fancy Latin phrases aren’t cutting it. (And yes, I know what ceteris paribus means.)
–Peter
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I have demonstrated that for houses of roughly median price or less, the actual value of the benefit is vanishingly small…
No. You demonstrated that, under the conditions you stated, it would be approx $550 for the first year. But of course the benefit continues over the life of the mortgage(s). I would not call the net present value of that benefit stream “vanishingly small,” but that’s a matter of taste, I guess.
I agree with you that the MID not the primary barrier to home ownership for low/moderate-income households. But it certainly isn’t any help. And the foregone tax revenues, which are substantial in aggregate, could be put to much better use if the goal is to provide decent, affordable housing for them.
Finally, I’m not going to replicate the large body of empirical research that already exists on the topic. You might start here, with a study that leverages variation in the mortgage subsidy both across states and over time: Hilber & Turner, THE MORTGAGE INTEREST DEDUCTION AND ITS IMPACT ON HOMEOWNERSHIP, Review of Economics and Statistics, October 2014. https://www.jstor.org/stable/pdf/43554944.pdf
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But of course the benefit continues over the life of the mortgage(s).
Not really.
Each year, the interest paid gets smaller. And the standard deduction generally grows larger. The two combine to pretty much eliminate any benefit after just a few years.
And let’s not forget that just a year or two ago, under the same conditions, there was no benefit at all. It is only the recent increases in interest rates that is giving any benefit at all to buyers of median priced homes.
As to the linked paper, it’s behind a wall, so I can only see the introduction. It uses data from 1984 through 2007. That was an unusual period of financial history, marked in particular by generally declining interest rates. And it ends at a peak in home values. It would be interesting to see how the results would change with data from 2008 to the present (or at least something closer to the present). It would also be interesting to see if the early years of the study period had any unusual impact on the overall study. Perhaps that information is already in the study, but in a part that I cannot access.
–Peter
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No. You demonstrated that, under the conditions you stated, it would be approx $550 for the first year. But of course the benefit continues over the life of the mortgage(s).
It will decline every year - slowly at first - reaching zero when the sum of itemizable deductions becomes equal to or less than the standard deduction.
Under the stated conditions the first-year interest is 19K - resulting in a $4100 increase in tax deductions. So when the interest gets down to just a bit under $15K, there is no increase in tax deductions and no tax savings.
It will take quite a bit less than the life of the mortgage (assuming it isn’t refinanced) to see the annual interest decline by 22%.
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There is a whole lot of cognitive dissonance going on in the heads of Americans.
Again, to save the rest of y’all the trip:
Cognitive Dissonance
https://www.bing.com/search?q=cognitive+dissonance&searc…