Monday, August 09, 2010

Down with the home mortgage interest deduction

The 2008 financial crisis made it clear that the home mortgage interest deduction is even worse, and perhaps I should say much worse, than experts had previously thought. The long-obvious (to tax policy types) points against it were that it inefficiently encourages both home consumption relative to other consumption, and home ownership relative to home rental (unless the tax breaks for the latter are commensurately big, as they may have been, say, in the mid-1980s).

But what hadn't been fully appreciated until 2008 was just how devastating the deduction's encouragement of highly leveraged home ownership can be. The deduction probably played an important background role in encouraging the blizzard of crazy U.S. mortgage loans that helped to sink the U.S. and world economy. (Although, to be fair, it's true that problems also arose in countries without a similarly designed tax break for housing, and that many subprime borrowers probably couldn't reasonably expect to get much value from the deduction.)

Now we see its poison playing out in another dimension. An article in today's Wall Street Journal notes that employers are often having a hard time hiring even though unemployment is so staggeringly high. While the problem has multiple causes, one of them is that "getting people to move for work has been especially difficult this time. Often, that is a function of the mortgage and credit problems many potential employees face. In a recent study, Fernando Ferreira and Joseph Gyourko of the University of Pennsylvania, together with Joseph Tracy of the Federal Reserve Bank of New York, found that people who owe more on their mortgages than their homes are worth are about a third less mobile."

Reducing people's mobility, in the event of a downturn that makes it extra-important, through a tax incentive for highly leveraged home ownership, harms us all, not just the prospective worker and employer who would have mutually enjoyed surplus from their job deal if moving were less costly. It has social, political, and revenue costs that are becoming all too familiar.

For one of the less obvious angles, think of Greece's difficulties in getting out from under its budget problems because, given the euro, it can't devalue its currency. Economists note that adjustment would be easier if labor were more mobile between different countries in the EU. But with language and cultural barriers, Greece is relatively stuck, and the adjustment much slower and more painful.

The U.S. obviously has much more of a common culture and language than the EU, which should help us, but when we encourage people to tie themselves down a bit of this may be lost.


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Rey Abisan said...

2010 was kinda a bizarre year for the mortgage market. In the first half of the year, you had a decent number of home sales keeping mortgages for purchases stable, thanks to the home buyer credit. In the second half of the year, that changed as demand crumbled when the credit was withdrawn. At the same time, you had very low mortgage interest rates throughout much of the year cause a mini-refinancing boom. 2011 will look very different, as the housing demand continues to struggle and mortgage interest rates have begun rising.

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