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November 21, 2005

Crush That Mortgage Interest Deduction!

Writing from his huge villa on the hillside (three miles northwest of my 3400 square foot villa in the canyon) Hal Varian endorses the Tax Reform Commission's attempt to cut back on the home mortgage deduction. He is, of course, right:

Economic Scene: Certainly the panel's least popular suggestion is to limit the mortgage interest deduction. Under current law, homeowners can deduct interest on mortgages of up to $1.1 million... the panel proposed that this cap be significantly reduced and that the deduction be replaced with a 15 percent tax credit.

A change of this sort would probably have a significant impact on housing values.... But many economists would argue that the panel's proposal does not go far enough.... The truth of the matter is that housing is highly subsidized in this country and we would probably be better off if the tax treatment of housing were brought more into line with that of other assets. How is housing subsidized? Let me count the ways... the mortgage interest deduction... the deduction for property taxes... the capital gains exclusion... the deduction for points on mortgage loans... the deduction of up to $100,000 on home equity loans... home office deductions... homeowners are not taxed on the implicit rent they receive from their housing investment....

An excessive subsidy on one asset means that less will be invested in other assets. The money put into building those huge villas on the hillside could have been put into factories, office buildings and schools.... Given the huge subsidies to housing, it is likely that we as a country have overinvested in this area....

[T]his is unlikely to happen anytime soon.... The housing tax subsidy has been built into housing prices... cutting back could lead to painful capital losses on home values. If you give a lollipop to a baby, it may make him smile, but you will pay dearly for that smile if you try to take the candy away...

Posted by DeLong at November 21, 2005 08:03 PM