This report provides an economic analysis of the mortgage interest deduction. Although other tax benefits for homeowners exist, the deduction for mortgage interest is arguably the most well known tax benefit, and is the tax benefit most often associated with promoting homeownership. Due to recent changes enacted by P.L. 115-97, often referred to as “The Tax Cuts and Jobs Act” or TCJA, the size of the deduction, in terms of forgone federal tax revenues, has decreased significantly. For example, in 2017, prior to the TCJA, the deduction was estimated to cost $66.4 billion by the Joint Committee on Taxation (JCT). In comparison, the JCT estimated the deduction will cost $30.2 billion in 2020. Much of the reduced cost is the result of the TCJA’s nearly doubling of the standard deduction and limitation of the state and local tax (SALT) deduction, which made itemizing deductions less attractive to many taxpayers; the mortgage interest deduction may only be claimed if a taxpayer itemizes their deductions. Additionally, the cost of the deduction was reduced because the TCJA temporarily lowered the maximum eligible mortgage amount for the deduction from $1 million to $750,000 and changed the treatment of home equity debt.
The report begins by summarizing trends in homeownership and reviewing current and past versions of the mortgage interest deduction. Next, brief historical and international perspectives of the mortgage interest deduction are presented. The analysis then focuses on two dimensions of promoting homeownership and the mortgage interest deduction. First, the analysis focuses on the rationales commonly offered for providing tax benefits for homeowners, mainly that homeownership (1) bestows certain benefits on society as a whole,such as higher property values, lower crime, and higher civic participation, among others; (2) is a means of promoting a more even distribution of income and wealth; and (3) has a positive effect on living conditions, which can lead to a healthier population. Economists have been able to establish that a correlation exists between homeownership and a number of these outcomes, but have had difficulty determining the nature of the relationship (e.g., does homeownership lead to financial stability, or are financially stable households more likely to own their home because they have the resources to do so?).
The analysis then turns to examining the effect that the mortgage interest deduction has on the homeownership rate, housing consumption, and the economy. The analysis in this report suggests that the deduction may have a larger effect on the size of homes purchased than on the decision to become a homeowner. The possibility that attempting to p romote homeownership via the tax code may distort the allocation of capital and labor, which could hinder the economy’s performance in the short run and long run, is also raised.