Mark Thoma highlights an article by Hal Varian in the Times on the recent tax reform proposal:
Varian's basic thesis is that the mortgage interest tax break causes "distortions" in the markets
...many economists would argue ... [i]t would make a lot of sense to eliminate the housing mortgage deduction entirely. ...[H]ousing 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.
I find it fascinating how the debate in this country has been turned on it's head. The tax deduction isn't the distorter, it's the tax itself. An individual is compelled to structure his income and investments around the things that are taxed.
In order to support his thesis, Varian piles on the "evidence"
How is housing subsidized? ... First, there is the mortgage interest deduction. Second, the deduction for property taxes. Third, the capital gains exclusion... Fourth, the deduction for points on mortgage loans. Fifth, the deduction ... on home equity loans. And there are many more tax breaks, among them home office deductions.
No question that the mortgage deduction is a biggie. But c'mon Hal, Home Equity Loans are mortgages by another name. And if points weren't deductible then those fees would just be rolled into the loan itself.
Capital gains exemptions don't necessarily impact the price, they impact the liquidity of the market. Can you imagine what would happen if every time you moved you had to sign away your gains? You'd never sell. (If you need an illustration of the impact of this, just look at what happens to apartment supply and demand in a rent-control city.)
The home office deduction isn't a subsidy of home ownership, it is a subsidy of business (particularly small business). You get taxed on those deductions later, from the homeowner perspective.
So that's one thing. But Varian continues...
There are also more subtle ways that housing investment is favored
by the tax system. The most fundamental subsidy is that homeowners are not taxed
on the implicit rent they receive from their housing investment. Think of it this way. Suppose you buy a house outright... If you rent the house out to someone else, you owe tax on the rental payments you receive. If you live in the house, you are effectively renting it to yourself, but no taxes are due on the transaction. ...
Are you kidding me? Living in my home is something you consider taxable? This is a subsidy?
The housing tax subsidy has been built into housing prices ... and 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. The best thing to do is to distract the baby with other sweets, while you gradually extricate the lollipop from that sticky hand.
The insulting conclusion is that the absence of tax is a treat you shouldn't have.
I've been reserving jugdment on the report, because if the proposed simplifications (e.g. eliminating the AMT) and rate changes leave roughly the same cash flow, then simplifications remove inefficiencies and that's a good thing.
The mortgage deduction isn't sacred, in and of itself. Varian is right in that a heavy handed code change that simply eliminated the mortgage deduction would devastate the housing markets. Broad economic consequences would be parallel to simply raising rates across the board by hefty amounts.
That is pretty much what the tax panel has proposed: it offers reduced tax rates on other forms of investment, along with the mortgage interest credit, to make cutting housing subsidies less painful. Carefully tuned policies of this sort may be a politically palatable way to reduce housing subsidies.
So in the end, Varian seems to be recommending that the proposal on the table may have it right: simplify, but keep the effective rates roughly the same. One has to wonder why he takes such a condescending approach to the analysis.
