Rethinking tax benefits for home owners

The attached piece appeared in the Spring 2014 issue of National Affairs.

The individual income-tax code offers a multitude of benefits for home owners. The largest in dollar terms, and the most apparent to taxpayers, is the mortgage-interest deduction, which allows home owners to deduct the interest paid on up to a $1 million mortgage and up to $100,000 in additional debt backed by home equity. But the tax code also tilts the balance toward home owners by allowing a deduction for state and local property taxes and exempting from taxes the capital gains from the sale of a home. These preferences for home ownership fall under the umbrella of “tax expenditures,” or provisions that create special benefits by lowering tax liabilities. Tax expenditures technically reduce the amount of taxes paid, but they resemble direct spending programs more than they do typical tax laws. The tax benefits for home ownership are thus essentially subsidies.

Although tax expenditures for housing are not real line items in a budget the way other spending programs are, they have real effects on the economy by creating incentives, lowering receipts, raising the debt, and causing tax rates to be higher than they otherwise would be. The cost of the tax benefits for owner-occupied housing adds up to about $175 billion annually, with the mortgage-interest deduction alone costing the Treasury roughly $100 billion. The five-year costs of these tax benefits total well over $1 trillion. To put this amount in perspective, one year of tax benefits for owner-occupied housing costs more than the discretionary budgets of the departments of Education, Homeland Security, Energy, and Agriculture combined.

Proponents of these generous tax benefits often justify them by arguing that they encourage home ownership, which in turn is said to offer society all manner of social and civic benefits. In reality, however, it is far from clear whether mass home ownership is inherently beneficial to our society or even to individual home owners. But whatever the merits of owning a home, the data regarding the reach and distribution of the various tax benefits we offer owners show that these benefits do not in fact encourage such ownership in any meaningful way. Most Americans receive no benefit from the preferential tax treatment of home ownership, and those who do see such benefits tend to be high-income earners who own large, expensive homes, and who are therefore unlikely to be on the fence about whether to buy or rent.

In fact, the tax benefits afforded to home owners are highly regressive, extremely expensive, and of little obvious value to society at large. Even if we do want to encourage home ownership through the tax code — and it is by no means obvious that we should — there are far better ways to do so. By considering the flaws in the tax treatment of housing and examining how our housing-related tax benefits are distributed across incomes and across the country, we may come to see how these policies might be transformed to better serve owners, renters, and taxpayers.

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