The Council of Economic Advisers
November 2017
September 29, 2017
CEA • Evaluating the Anticipated Effects of Changes to the Mortgage Interest Deduction
1
Executive Summary
November 2017
The U.S. Treasury estimates that in FY2017 American taxpayers deducted $65.6 billion in mortgage
interest from their Federal tax liabilities (U.S. Department of the Treasury, 2017). Continued use of the
mortgage interest deduction (MID) is likely to be affected by two key provisions of tax reform currently
under debate. First, the doubling of the standard deduction is likely to reduce the number of tax units
that itemize deductions, thereby prompting a lower use of the MID. Second, the current proposal in the
House changes the mortgage cap on which interest can be deducted from $1 million to $500,000.
Changes in the number of itemizers are projected to be large under the increased standard deduction,
falling from about 26 percent to 8 percent of filing tax units. This would indicate a substantial change in
the use of the MID. At the same time, we estimate that the share of potential homeowners in the United
States who would be affected by a change in the mortgage cap from $1 million to $500,000 is only 7
percent. The effects of the changing cap are concentrated in high-priced housing markets and at higher
ends of the income distribution.
More broadly, although the stated goal of preferential tax treatment for mortgage interest is to increase
homeownership, the empirical evidence indicates there is no significant positive effect of the MID on
homeownership rates. This implies that changes in the standard deduction that serve to reduce the use
of the MID are unlikely to lower homeownership rates. Moreover, because the program incentivizes
homeowners to buy larger and more expensive houses, it results in inflated home prices in many
regional markets. As a result of the subsidy’s upward pressure on housing prices, the MID may artificially
depress homeownership by putting homeownership out of reach for many households, implying that a
reduction in the potency of the MID may actually serve to increase homeownership.
Applying recent empirical estimates of the MID’s impact to the current proposed legislation, we
conclude that minimizing the use of the MID may lead to a modest fall in home prices. In the most recent
estimates in the literature, the full, unexpected elimination of the MID corresponds to an estimated
housing price reduction of 2 percent immediately and a total of 4 percent in the long run. This modest
price reduction results in an increase in homeownership over the long term by encouraging home
buying. To be clear, the estimates in the literature are based on a full elimination of the MID; the
proposals before Congress stop well short of full elimination. While we cannot precisely estimate the
scale of the current proposals relative to full elimination, they certainly will be more limited. Thus, we
consider these estimates to be an upper bound on the anticipated effects from Congress’s proposed
tax reforms.
Finally, we should note that the tax reform proposals may impact disposable income in other ways that,
in turn, impact the demand for homeownership. For example, people may have higher disposable
income post reform. We abstract from these details and focus exclusively on analyzing the reform
proposals that directly affect the MID.
CEA • Evaluating the Anticipated Effects of Changes to the Mortgage Interest Deduction
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1. Tax Cuts and Jobs Act
Both Senate and House tax reform bills propose to nearly double the standard deduction (from $6350
to $12,000 for single filing households and from $12,700 to $24,000 for married filing jointly households)
and eliminate most itemized deductions, with notable exceptions of the mortgage interest deduction
and the deduction for charitable donations.
1
Moreover, the House bill proposes to lower the cap on
mortgage debt incurred after November 2, 2017 from $1M to $500,000 on which a homeowner can
deduct the associated interest paid from their federal tax bill. The House bill also restricts the deduction
to the primary residence. The Senate bill retains current law for these last two provisions.
2
In the discussion below, we focus on two main elements of these bills. First, we look at the increase in
the standard deduction that decreases the value of the MID for all households, but in particular those
who choose to no longer itemize under the new regime. Second, we look at the cap proposed by the
House on new mortgages, which will impact fewer households overall but may be particularly relevant
to a number of cities where home prices are much higher than the national average.
2. Distributional Impact of Changes to the MID
On average, according to IRS statistics, about 26 percent of tax units itemize their deductions. The MID
provides no tax benefit to nonitemizers, and nonitemizers are concentrated at the lower end of the
income distribution. Moreover, because the MID – as its name indicates – is a deduction from income
(and not, say, a flat credit against taxes owed), the benefit is larger for households in higher marginal
tax brackets and for those purchasing higher-priced homes. In sum, the MID is typically regarded as a
fairly regressive subsidy.
Table 1 shows the breakdown of itemizers by income bracket. As the table shows, under current law,
the fraction of itemizing households is generally increasing in income and can reach over 90 percent for
higher income brackets. But, the projected fraction of households that would continue to itemize under
the House version of the tax reform bill falls for each of the income brackets.
3
Overall, only 8 percent of
households are projected to itemize deductions following the House version of the tax reform bill.
1
The Senate bill retains a number of other current deductions like qualified medical expenses.
2
The two bills also differ on the deductibility of refinancing debt. The House bill allows for a deduction of such
debt while the Senate bill does not.
3
As the Senate bill is a bit more generous with retaining current itemized deductions, the decrease will be less
severe. However, the biggest deduction for state and local taxes is eliminated in both bills.
CEA • Evaluating the Anticipated Effects of Changes to the Mortgage Interest Deduction
3
Table 1: The Simulated Percentage of Tax Units that Itemize under
Current Law and under the House Plan
Income Bin
Amount
Percent Itemizers Under
Current Law
Percent Itemizers Under
the House Tax Plan
1
< 0
0.0%
0.0%
2
0 - $10,000
0.1%
0.1%
3
$10,000 - 20,000
3.8%
0.6%
4
$20,000 - $30,000
9.5%
1.4%
5
$30,000 - $40,000
15.6%
2.4%
6
$40,000 - $50,000
22.4%
3.5%
7
$50,000 - $75,000
36.0%
7.5%
8
$75,000 - $100,000
49.8%
11.0%
9
$100,000 - $200,000
72.7%
19.6%
10
$200,000 - $500,000
92.2%
47.2%
11
$500,000 - $1,000,000
91.6%
66.3%
12
> $1,000,000
86.5%
74.8%
Overall
26.3%
7.6%
Source: IRS Statistics of Income Public Use File, 2009 and CPS 2014. CEA Staff Calculations via Open Source
Policy Center Tax-Calculator.
In addition to doubling the standard deduction, the House plan also alters the cap on mortgage values
for the purpose of calculating deductible interest, lowering the cap from $1M to $500,000. The cap is
relevant for new mortgages issued after November 2; previously issued mortgages would not be
affected by the change. But data on recent mortgage transactions can provide an estimate of the scale
of the effect going forward. Using data available through the Consumer Financial Protection Bureau on
new mortgages issued in 2016, we find that 7.1 percent of home mortgages are greater than $500,000
in loan value, implying that roughly 7 percent of future homeowners would be affected by the change
in the MID cap under stable housing prices. Because the first $500,000 of the mortgage value would
remain eligible for the MID, even homeowners with mortgage values above the cap would continue to
benefit from the MID. Based on mortgages issued in 2016, we estimate that the average mortgage above
the proposed $500,000 cap would still receive preferential tax treatment on three-fourths of its total
value. These calculations are based on all new mortgages issued in 2016, including refinances and home
improvement loans, but results are similar for the sample limited only to home purchases.
4
As noted previously, the MID is a regressive subsidy that provides more value to higher income tax units.
Reducing the cap on the MID would also primarily affect higher income homeowners. In 2016, the
median income for homeowners initiating new mortgages of less than $500,000 was $79,000. For
homeowners initiating new mortgages above that threshold, the median income was $219,000. (Again,
for homeowners taking out new mortgages above the $500,000 cap, the first $500,000 remains eligible
4
Sample is restricted to all first-lien mortgages on owner occupied homes of 1-4 families, including manufactured
housing.
CEA • Evaluating the Anticipated Effects of Changes to the Mortgage Interest Deduction
4
for the interest deduction.) Figure 1 shows the distribution of mortgages across loan value as well as
the median income by loan value.
Figure 1. Distribution of Mortgages and Applicant Income by Loan Amount
Note: Includes loans issued for home improvement, purchase, and refinancing.
Source: Consumer Financial Protection Bureau Home Mortgage Disclosure Act Data, CEA Calculations.
Sommer and Sullivan (2017) confirm these distributional assessments when they find that the greatest
welfare losses from an unexpected and complete elimination of the MID accrue to landlords and high-
income homeowners who live in large houses with large mortgages and face high marginal tax rates. In
contrast, potential homeowners and current owners in modestly sized homes, with smaller mortgages
and facing lower marginal tax rates, gain the most from the elimination of the MID due to declining
prices. One of the more surprising results in their paper is that 55 percent of current homeowners with
mortgages would benefit from the elimination of the MID, even though they lose a tax deduction and
incur a capital loss due to the fall in home prices. These households gain, however, from lower prices
that allow them to make an eventual upward move to a larger house. We discuss the Sommer and
Sullivan (2017) findings in more detail below.
Finally, home mortgages issued for greater than $500,000 are rare except for a select few urban areas
in the United States. Of the 409 metropolitan statistical areas (MSAs) tracked in the data on mortgages
issued, 93 percent of these areas had less than 10 percent of mortgages above $500,000. And 50 percent
of areas had less than 1 percent of mortgages above $500,000. Thus, the majority of housing markets
will have minimal exposure to any impact of a lowered MID cap.
Median Applicant Income
(Right Axis)
$0K
$100K
$200K
$300K
$400K
0
10
20
30
40
CEA • Evaluating the Anticipated Effects of Changes to the Mortgage Interest Deduction
5
3. Homeownership—Positive Externalities
Taking a step back from the distributional impacts of the MID, for the government to subsidize
homeownership, as a tax credit for mortgage interest purports to do, there should be some social
benefit to homeownership beyond the benefit to the homeowner themselves. Oddly enough,
promoting homeownership was not the original objective of the deduction. Rather, the mortgage
interest deduction was inadvertently created following the passage of the Sixteenth Amendment in
1913, which authorized a Federal income tax. At a time when fewer than 40 percent of non-farm homes
were owner-occupied and, of these, only a third were secured by a mortgage, and, moreover, the line
between small-proprietor business and personal expenses was often difficult to discern, the new
income tax enacted by Congress allowed for the deduction of all debt interest expenses, making them
analogous to other business expenses (U.S. Census Bureau, 1910; Ventry, 2009).
The rationale for maintaining the deduction, though, often lies in arguments that homeowners are
more invested in their residences, making them cleaner and safer and thereby increasing home values
for others. Homeowners are also more involved politically and have more social connection to their
neighborhoods. (See Glaeser and Shapiro (2003) for a review of this literature.) Despite strong positive
correlations between homeownership and these positive externalities, a causal relationship between
homeownership and these behaviors has not been rigorously established.
5
4. The Impact of the MID on Homeownership Rates
Given the stated purpose of continuing Federal investment in the MID, a key empirical question is the
relationship between the subsidization of home mortgages and homeownership rates. The academic
literature has generally been interested in understanding the impacts of the MID compared to an
economy with no preferential tax treatment of mortgage interest. The consensus is that the mortgage
interest deduction fails to achieve the aim of increasing homeownership. The findings are summarized
in Gale, Gruber, and Stephens-Davidowitz (2007), and a number of notable recent working papers since
have solidified this conclusion. Hilber and Turner (2014), find that, in aggregate, the MID has no
statistically significant impact on homeownership rates. Taking a closer look at smaller geographical
markets, they find that the MID boosts homeownership attainment in elastically supplied markets,
where supply responds more readily to price increases, but only for higher-income households. In more
restrictive places (i.e. inelastic supply), the MID serves to raise prices, and effectively reduces
homeownership, though again only for higher income households. They find that the MID has no impact
on homeownership rates of low-income households, regardless of elasticity of supply.
Gruber, Jensen and Kleven (2017) make use of a natural experiment from Denmark in the 1980s to look
at the long-run impacts of scaling back the mortgage deduction on homeownership rates, home size,
and home values. The authors find that the mortgage deduction has a moderate impact on the
5
In an attempt to address the causality problem, Engelhardt et al (2010) find that low-income households that
were randomly offered a subsidized saving account for home purchases were more likely to purchase a home but
were no more likely to engage politically or provide more social capital.
CEA • Evaluating the Anticipated Effects of Changes to the Mortgage Interest Deduction
6
intensive margin of housing demand, inducing homeowners to buy larger and more expensive houses
but, at the same time, has no impact on homeownership. These findings suggest that the mortgage
interest deduction affects the size and value of homes purchased – where there is no clear social benefit
– and is ineffective at promoting homeownership where the social benefit arguments are generally
made.
Finally, Sommer and Sullivan (2017) develop a general equilibrium model in which both the price of
owner-occupied housing and the price of rental housing are endogenous. They study the impact of the
mortgage interest deduction on homeownership rates (among other factors) and find that eliminating
the mortgage interest deduction reduces home prices enough to induce an increase in homeownership.
This increase in homeownership comes from relatively lower-income households; in the Sommer and
Sullivan model, eliminating the MID is a progressive reform that transfers value from high-income
households to the remainder of the income distribution by removing a subsidy that is relatively more
valuable to higher income homeowners and passing the benefits to individuals who otherwise would
have been priced out of homeownership and opted to rent.
5. The Impact of the MID on House Prices
A related line of research has studied the effect of the MID on housing prices, again comparing the
existence of the MID to an economy with no preferential tax treatment of mortgage interest. Early
studies found substantial impacts on housing prices. For example, Poterba (1984) estimates a very large
housing price response to the elimination of the MID—on the magnitude of a 26 percent decline.
However, this is in an environment of 10 percent inflation and is perhaps not relevant for today’s
economic setting. Capozza et al. (1996) estimate that eliminating the MID (along with ending the
deduction for property taxes) would decrease home prices by an estimated 13 percent. Harris (2013)
estimates that eliminating the MID would reduce home prices by 12 percent. PricewaterhouseCoopers
(2017), in a report for the National Association of Realtors, estimates that tax reform plans very similar
to those currently being considered reduce home prices by 10 percent.
However, other academic literature that considers the MID within the context of the larger economy
finds significantly lower price effects from elimination of the MID. These studies more flexibly model
housing markets by allowing housing supply to respond to reductions in the demand for housing, or by
incorporating spillover effects in the rental housing market. Most recently, Sommer and Sullivan (2017)
find that eliminating the MID would reduce home prices by 4.2 percent in the long run, although the
effect is only half this size in an environment with the low interest rates observed today. In a similar
model, Floetotto, Kirker and Strobel (2016) estimate that eliminating the MID would decrease home
prices by only 1 percent in the long run. As housing wealth is equal to roughly 30 percent of total
household wealth, even a 4 percent fall in price translates into about a 1.2 percent decline in total
household net wealth (Federal Reserve Board Financial Accounts of the United States, 2017).
Recent research also indicates that the impact of eliminating the MID would vary depending on the
elasticity of supply of housing in different areas. In markets where supply is constrained, eliminating
the MID is more likely to reduce prices because supply does not adjust downward in the long run. As
CEA • Evaluating the Anticipated Effects of Changes to the Mortgage Interest Deduction
7
described above, Hilber and Turner (2014) find that the impact of the MID on homeownership depends
on the elasticity of the supply of housing. In areas with inelastic supply, there is no increase in
homeownership, and eliminating the MID would likely decrease home prices in these areas more than
in areas with elastic housing supply. Rappoport (2016) uses a structural model which allows housing
supply elasticities to vary across areas and finds that eliminating the MID would decrease home prices
by 6.9 percent on average, but with considerable variation across markets depending on the elasticity
of supply. In sum, the most recent state-of-the-art academic literature suggests that the impact of
eliminating the MID on house prices is likely to be modest, and its magnitude in different areas will
depend on the extent to which housing supply can respond to reduced demand. Cities like San
Francisco, California, where the housing stock is relatively inelastic, may experience greater price
responses compared to relatively unregulated cities like Dallas, Texas.
6. International Comparisons
Figure 2. Rates of Homeownership in the United States and Canada
(Percent)
Source: U.S. Census Bureau via Federal Reserve Economic Data; Statistics Canada and National Housing Survey
The experience of other developed countries indicates homeownership subsidies are neither necessary
nor sufficient to ensure high rates of ownership. For example, unlike the United States, Canada does
not provide preferential treatment for mortgage debt. Nonetheless, the homeownership rate in Canada
is very similar to that in the United States. (See Figure 2.) Although the United States had higher
homeownership rates in the 1970s and 1980s, the rates converged by the mid-1990s and have moved
Canada
United States
58
60
62
64
66
68
70
1976 1981 1986 1991 1996 2001 2006 2011
CEA • Evaluating the Anticipated Effects of Changes to the Mortgage Interest Deduction
8
in almost lockstep in the period since. In the last year of available data, 2011, Canada’s rate was slightly
above that in the United States. To be clear, this comparison does not imply that homeownership in
Canada would not be higher with a preferential tax treatment of mortgage interest.
That the MID is neither necessary nor sufficient to ensure homeownership is confirmed by a simple
analysis of OECD countries more broadly. Tax relief for homeownership is relatively rare in the OECD.
Figure 3 shows the relevant comparisons for countries that report both the value of mortgage interest
deductions (frequently zero) and homeownership rates. Although the United States has the second
highest level of tax relief for homeownership among reporting member countries (at 0.5 percent of
GDP), the homeownership rate is lower than 10 out of the 13 OECD countries reporting both
homeownership and MID value data. A more complete tabulation of homeownership rates in the OECD,
including 37 nations, ranks the United States 28
th
. To be sure, there are other government policies in
OECD countries, including the United States, to promote homeownership beyond preferential tax
treatment of mortgage interest expenses, such as mortgage guarantees and down payment or direct
interest subsidies. But the data still indicate that the MID is not a critical component of a developed
country’s homeownership policy agenda.
Figure 3. Mortgage Interest Deduction Subsidies and Homeownership Rates
in OECD countries
(Percent)
Note: Cyprus, France, Germany, Korea, Latvia, Lithuania, Mexico and Slovenia do not apply tax relief for access to
homeownership. No information was provided for Belgium, Turkey, Bulgaria, Greece, Korea, Israel, Italy,
Romania, the Slovak Republic, and the United Kingdom.
Source: OECD Questionnaire on Affordable and Social Housing (2016).
Mortgage Interest Deduction
(as percent of GDP)
Homeownership
Rate (Left Axis)
0.0
0.5
1.0
1.5
2.0
2.5
0
20
40
60
80
100
CEA • Evaluating the Anticipated Effects of Changes to the Mortgage Interest Deduction
9
7. Conclusion
It is important to note that the tax reform bills do not propose the elimination of the MID. By doubling
the standard deduction and eliminating most other itemized deductions, many households will find it
beneficial to choose the standard deduction rather than to itemize. Evidence from recent mortgage
activity in the United States indicates that up to 7 percent of new borrowers would be affected by a
reduction in the mortgage value cap from $1M to $500,000. Because the proposals before Congress
fall short of a full elimination of the MID, measured impacts of eliminating the MID from academic
literature should be considered an upper bound on potential changes to housing prices and
homeownership. We project that equilibrium housing prices will experience a muted reduction of less
than 4 percent, while homeownership rates may rise modestly as a result of the current tax reform
proposals before Congress.
CEA • Evaluating the Anticipated Effects of Changes to the Mortgage Interest Deduction
10
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ABOUT THE COUNCIL OF ECONOMIC ADVISERS
The Council of Economic Advisers, an agency within the Executive Office of
the President, is charged with offering the President objective economic
advice on the formulation of both domestic and international economic
policy. The Council bases its recommendations and analysis on economic
research and empirical evidence, using the best data available to support
the President in setting our nation's economic policy.
www.whitehouse.gov/cea
November 2017
