Editor’s note: An error has been identified in the piece below. A correction is being prepared and this page will be updated with a revised version of the piece when available.

The two largest tax policies that promote homeownership in the United States under the current tax code are the Home Mortgage Interest Deduction and the Real Estate Tax Deduction. The two deductions are expensive— together they’re expected to cost the federal government more than $100 billion annually from 2013-2017.1 The congressional Joint Committee on Taxation estimates that in the absence of reforms, the cost of the mortgage interest deduction and the property tax deductions will continue to increase. (See Figures 1 and 2.)

Figure 1

Figure 2

Both these policies tilt the economics of housing toward owning and away from renting, favoring higher-income households who are more likely to own than to rent, and more likely to own a more expensive home than households with lower incomes. Yet proponents of the home mortgage interest deduction and real estate tax deductions contend that homeownership, which has long been considered the key to realizing the American Dream,2 serves as a path to greater equality as it promotes wealth accumulation,3 and contributes to stronger communities,4 lower crime,5 and thus higher home values.

President George W. Bush summed up this belief earlier this century: “The more ownership there is in America, the more vitality there is in America, and the more people have a vital stake in the future of this country.” But economic research suggests that these programs appear to do little to achieve the goal of expanding homeownership. In fact, research finds that mortgage innovation, not tax policies, have had the largest effect in increasing homeownership over the past decade.6

The mortgage interest deduction and real estate tax deduction are designed in much the same way. The home mortgage interest deduction allows homeowners to deduct the amount of interest they pay on a mortgage that finances a primary or secondary residence from their taxable income as long as they itemize their tax deductions. The deduction is limited to interest paid on mortgages totaling $1 million or less ($500,000 or less if married filing separately). Similarly, the real estate tax deduction allows homeowners to deduct state and local property taxes without any upper limit as long as they itemize their tax deductions.

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U.S. homeownership tax policies are expensive and inequitable

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The mortgage interest deduction and real estate tax deduction significantly reduce the taxable income of homeowners, disproportionately benefiting high-income households. We take a look at how these deductions vary by income in the graphs below, using 2009 tax data from the public-use version of the Internal Revenue Service’s Statistics of Income microdata. We divide households into 20 groups, or ventiles, of equal size ordered along the horizontal axis from lowest to highest modified gross income.7 By this measure, the median income of tax filers was $33,390; the top five percent earned between $170,650 and $75,700,000. (See Figure 3.)

Figure 3

Figure 3 demonstrates that the average deduction for both home mortgage interest and real estate tax rise strongly with income. These policies overwhelmingly subsidize mortgages for households with upper-middle and high incomes. Examining the mortgage interest deduction, households in the top five percent of earners, on average, received more than 100 times the benefits that went to the bottom 25 percent, and nearly nine times more than the bottom 50 percent. For property tax deductions, the average household in the top five percent received more than 50 times the deduction that went to those in the bottom 25 percent. (See Figure 3.)

Figure 4

In Figure 4, we express the average deduction as a share of the average income in each income group. The figure shows the proportion of income these deductions account for at each income level. The second-highest income group—those in the 91st-to-95th percentile—were the largest beneficiaries, receiving nearly 8 percent of their income in deductions for home mortgage interest payments and nearly 3 percent of their income in deductions for real estate taxes.

Another way of visualizing how federal expenditures on these two programs are distributed is to examine the total share of all tax expenditures on both the home mortgage interest deduction (in dark green) and real estate tax deduction (in light green) that went to tax filers in the bottom 50 percent, the top 5 percent, and the group in between. The bottom half received approximately $760 million, or only 0.7 percent of the total expenditures, compared to $14 billion (13 percent) of the total that went to the next 45 percent, both of which were well below the $96 billion (86 percent) that went to just the top 5 percent of beneficiaries. (See Figure 5.)

Figure 5

These same subsidies also benefit the U.S. financial sector while providing little incentive for lenders to extend mortgage credit to low- and moderate-income households. By providing deductions for interest payments on mortgages and property taxes, the government is lowering the cost of borrowing, creating room for financial firms who provide credit to benefit.8

There are various proposals to reform the mortgage interest and the real estate tax deductions. The Tax Policy Center presented a plan in 2015 that considers three proposals for restructuring the mortgage interest deduction.9 Richard Green, the director and chair of the University of Southern California’s Lusk Center for Real Estate, offered up a plan in 2011 that argues for a targeted, refundable credit in lieu of the current mortgage interest deduction.10 Speaker of the House Paul Ryan (R-WI) has his own plan from last month that proposes eliminating the deduction for real estate taxes.11 And the Congressional Research Service also has analyses and evaluates options to eliminate, limit, or replace both deductions with a credit.12

U.S. policymakers, however, cannot reform these two deductions without considering a comprehensive reform effort that includes reforming the current structure of the two government-sponsored mortgage finance giants, Fannie Mae and Freddie Mac, as well as reforms at the Federal Housing Agency, which also guarantees home mortgages. Policymakers should also address the affordable housing crisis in the rental market as part of any reform effort. Antonio Weiss, counselor to the U.S. Treasury secretary under the Obama administration, called the reform of Fannie Mae and Freddie Mac the housing crisis’ unfinished business: “Where we have fallen short, I think, is that the [two mortgage giants], some 10 years on, are still in conservatorship, and the taxpayers are still exposed.”13

Other reform proposals include more equity-based mortgages. Atif Mian, professor of Economics and Public Affairs at Princeton University and Director of the Julis-Rabinowitz Center for Public Policy and Finance at the Woodrow Wilson School at Princeton University, and Amir Sufi, the Bruce Lindsay Professor of Economics and Public Policy at the University of Chicago’s Booth School of Business have co-authored an essay to encourage the use of shared responsibility mortgages to mitigate the amount of risk on families who own their homes.14 This type of mortgage would help homeowners—particularly less wealthy ones—manage the risk of debt-financed mortgage products while encouraging equity savings. These kinds of innovative reforms could help make U.S. home mortgages more equitable and reduce housing inequality compared to current mortgage interest deductions.

  1. “The Joint Committee on Taxation,” JCS-1-13. Accessed January 25, 2017. https://www.jct.gov/publications.html?func=startdown&id=4503.
  2. National Archives and Records Administration, “Promoting the American Dream of Homeownership,” (Washington, DC): https://obamawhitehouse.archives.gov/blog/2013/08/06/promoting-american-dream-homeownership.
  3. Melvin Oliver and Thomas Shapiro, “Wealth of a Nation: A Reassessment of Asset Inequality in America Shows at Least One Third of Households Are Asset-Poor,” The American Journal of Economics and Sociology 49, no. 2 (1990): 129-151.
  4. Douglas Perkins, Barbara Brown, and Ralph Taylor, “The Ecology of Empowerment: Predicting Participation in Community Organizations,” Journal of Social Issues 52, no. 1 (1996): 85-110.
  5. Jorgen Lauridsen, Niels Nannerup, and Morten Skak, “Does Owner-Occupied Housing Affect Neighbourhood Crime?” Discussion Papers on Business and Economics, University of Southern Denmark 19/2013, (University of Southern Denmark, 2013).
  6. Matthew Chambers, Carlos Garriga, and Don Schlagenhauf, “Did Housing Policies Cause the Postwar Boom in Homeownership?” Federal Reserve Bank of St. Louis Working Paper Series, April 2012.
  7. Modified gross income is calculated as adjusted gross income plus the value of the home mortgage interest plus the value of the real estate tax deduction. This is a measure of income before deductions for homeowners reduce the amount of taxable income for each tax filer.
  8. “A senseless subsidy,” The Economist, May 16, 2015, available at http://www.economist.com/news/briefing/21651220-most-western-economies-sweeten-cost-borrowing-bad-idea-senseless-subsidy.
  9. Chenxi Lu, Joseph Rosenberg, and Eric Toder, “OPTIONS TO REFORM THE DEDUCTION FOR HOME MORTGAGE INTEREST,” (Urban Institute & Brookings Institution Tax Policy Center, 2015).
  10. Richard Green, “The Mortgage Interest Deduction,” Economist’s View, October 6, 2011, available at http://economistsview.typepad.com/economistsview/2011/10/the-mortgage-interest-deduction.html.
  11. “Paul Ryan’s tax plan could cost New Yorkers $68B deduction,” The Real Deal New York, December 14, 2016, available at https://therealdeal.com/2016/12/14/paul-ryans-tax-plan-could-cost-new-yorkers-68b-deduction/.
  12. Mark Keightley, “The Mortgage Interest and Property Tax Deductions: Analysis and Options,” ( Congressional Research Service, 2014).
  13. Robert Abare, “What is the Obama administration’s legacy on housing?” Urban Wire,. January 12, 2017, available at http://www.urban.org/urban-wire/what-obama-administrations-legacy-housing.
  14. Atif Mian and Amir Sufi, “Shared responsibility mortgages,” (Washington: Washington Center for Equitable Growth, 2016).