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ISSUE 8 | MARCH 2018

F EDE RAL
R E S E RVE
BANK
ST. LOU IS

HOUSING MARKET
PERSPECTIVES
On the Level with Bill Emmons
Bill Emmons is an
assistant vice president and
economist at the Federal
Reserve Bank of St. Louis and
the senior economic adviser for
the Bank’s Center for Household
Financial Stability.

Fewer Tax Breaks for
Homeowners: A Good Thing?
road indexes of real, or inflationadjusted, house prices generally
rise and fall with economic activity.
This suggests that what’s good for
homeowners, vis-à-vis rising house
prices, is also good for the economy.
(See the accompanying figure.)
But could a decline in real house
prices also be good for the economy? If it’s the result of efficiencyenhancing changes in the tax code,
many economists say yes.

Recent Tax Law Changes
The Tax Cuts and Jobs Act (TCJA) of
2017 places new limits on deductions
for state and local taxes and property
taxes, and scales back the mortgage
interest deduction (MID). Many economists expect these changes to reduce
the number of taxpayers who claim
the MID on itemized returns starting
with the 2018 tax year.
Several provisions of TCJA will
affect taxpayers:
• The standard deduction was doubled, to $12,000 for individuals and
$24,000 for joint filers, making it
likely that most low- and middleincome taxpayers who itemized in
the past will choose the standard
deduction instead.

• State and local taxes are no longer
fully deductible, making it less likely
that a household’s itemized deductions will exceed the new standard
deduction.
• The maximum amount of mortgage debt for which interest can be
deducted was reduced to $750,000
from $1 million for joint filers. (Any
loans taken out after Dec. 15, 2017
are subject to the new rule; existing
mortgages have been grandfathered
in with the old limit.)

• The tax deductibility of mortgage
interest on second mortgages (i.e.,
home equity loans) and second
homes was scaled back.
• Marginal tax rates were reduced,
cutting the value to an itemizer of
the MID and all other deductions.

Likely Effects on Housing
As a result of these changes, many
economists expect house prices to
trend somewhat lower.1 Mortgage
borrowing and other aspects of

Annual Growth Rates: Real House Prices and Real GDP per Capita
10

5

Percent

B

0

-5
Real house price index
Real GDP per capita
-10
1975

1980

1985

1990

1995

2000

2005

SOURCES: Federal Housing Finance Agency and Bureau of Economic Analysis.
FEDERAL RESERVE BANK OF ST. LOUIS

1

2010

2015

2020

housing, such as the decision to
rent or buy, also could be viewed
differently.
While some homeowners may lose
wealth in the short run, the benefits
many economists see from a reduction in the MID and lower house
prices could yield a net positive for the
economy. We’ll explain how.

Why Economists Dislike the Mortgage
Interest Deduction
It’s rare to find a policy that’s both
popular among the public and almost
universally disliked by economists. But
the MID is one such policy.

• It’s regressive, benefiting highincome households the most.
• MID hurts low- and middle-income
earners by driving up house prices
and making homeownership less
attainable. (Tax benefits are “capitalized” into house prices, pushing
prices higher than they otherwise
would be.)
• MID encourages the construction
of larger, more expensive houses,
which can contribute to higher
energy costs, urban sprawl and
fewer funds deployed to nonhousing business investment.

While some homeowners may lose wealth in the short
run, the benefits many economists see from a reduction
in the MID and lower house prices could yield a net
positive for the economy.

while also encouraging greater mortgage borrowing.
The MID’s primary benefit is
purported to be its encouragement of homeownership. However,
new research shows that the MID
as it existed before the recent tax
changes did not even do that.4 In
fact, it reduced the homeownership
rate by about five percentage points.
(It raised house prices so much—
through the capitalization of tax
benefits—that homes became out of
reach for some buyers.)
This new research is important
because it’s timely and, as such, may
provide a new benchmark for evaluating the effects of tax policies on
various aspects of housing choice. The
model captures the MID’s effects on:
• Housing demand: whether to buy
or rent and how to finance a home
purchase
• Housing supply: what types of housing to build and whether to become
a landlord
• The resulting equilibrium for house
prices and rents up and down the
housing market

In terms of public support, the MID
was favored by a two-to-one margin
in a 2017 opinion poll.2 Even those
who didn’t benefit personally from
the MID—renters and homeowners
not claiming the deduction—supported the policy by comfortable
margins. Perhaps they sided with the
policy because they planned to use it
someday, or because they believed it
would raise the homeownership rate
and promote the general welfare of
their communities.
Economists, however, point to a
litany of shortcomings with the MID:3

• By enabling people to finance
homes with debt, the MID increases
the likelihood of loan defaults when
house prices drop, especially during downturns such as the Great
Recession.

• It’s expensive, reducing federal
tax revenues by about $60 billion
in 2017.

Economists view the MID as inefficient because it distorts house prices
and the mix of housing constructed

Of course, some economists point
to the jobs and income produced
by homebuilding, home sales and
ancillary activities. But there is little
debate that the MID is an imperfect tool for promoting housing and
homeownership.

Why the MID Is Inefficient

2

The authors estimate that a complete elimination of the MID would
result in a:
• Five percentage-point increase in
the homeownership rate
• Roughly four percent decline in
average house prices, with larger
price declines for more expensive
houses and smaller price declines
for cheaper houses
• More than 30 percent decline in the
average mortgage balance
• Negligible change in rents, although
landlords’ profitability would decline5
The biggest losers would be owners of existing housing with large

mortgages. The biggest winners would
be renters for whom homeownership
is a goal and now becomes possible
due to the decline in house prices.
Lower house prices and greater
demand over time for less expensive
new homes would provide a longlasting benefit to the economy as financial resources are redirected toward
business investment with higher potential for productivity growth.

A Worthy Goal?
The Tax Policy Center (TPC) estimates that the share of tax-filing
households benefiting from the MID
will fall to about 9 percent under the
new law from 21 percent under the
old law.6 The total benefit of the MID
to taxpayers, which is a revenue loss
to the Treasury, is expected to fall in
2018 to about $36 billion; under the

old law, this benefit would have been
about $83 billion.
TPC estimates also suggest that
the MID will become more regressive under the new law. According to
TPC, the 8 percent of taxpayers with
annual incomes of $200,000 or more
will receive about 63 percent of the
total benefit—albeit from a smaller pot
of money—versus about 54 percent
under the old law.
Thus, while the new tax law makes
a significant dent in a policy that
many economists view as inefficient
and regressive, a worthy goal for
future tax reform may be a closer
examination of the MID as a whole,
particularly if the expected economic
benefits from partial repeal of the MID
materialize.

3

ENDNOTES
1

2
3

4

5

6

See Mark Zandi, “Housing Market Could
Shift under New Tax Law,” The Washington
Post, Jan. 4, 2018.
See Kathy Frankovic, “Tax Deductions Are
Hard to Part With,” YouGov, Oct. 30, 2017.
See Leonard E. Burman, “The Mortgage
Interest Deduction Would Be Worth Much
Less Under the Unified Framework,” Tax
Vox Blog, Tax Policy Center, Oct. 24, 2017;
and William G. Gale, “Gutting the Mortgage
Interest Deduction,” Tax Vox Blog, Tax Policy
Center, Nov. 6, 2017.
See Kamila Sommer and Paul Sullivan,
“Implications of US Tax Policy for House
Prices, Rents, and Homeownership,” American Economic Review, Vol. 108, No. 2, 2018,
pp. 241-74.
Landlords are themselves owners of housing
that often is financed with substantial mortgage debt. Thus, they are likely to be large
beneficiaries of the MID and would suffer
disproportionately from its elimination.
See Tax Policy Center, “Impact on the
Tax Benefit of Home Mortgage Interest
Deduction (MID) of H.R.1, The Tax Cuts
and Jobs Act, by Expanded Cash Income
Percentile, 2018.”