April 3, 2015


The Tax Deductions Economists Hate (BEN CASSELMAN, 4/03/15, 538)

Of course, to say "economists" think anything is a bit nuts. There are thousands of economists in the U.S., with widely varying ideologies and opinions. When it comes to taxes, much of that disagreement focuses on tax rates -- both how much the government should be raising in total and how evenly distributed those taxes should be up and down the income ladder. There's less disagreement (though certainly not none) on how those taxes should be structured. And there are some tax breaks that a wide swath of economists hate.

At the top of many economists' hit list is the mortgage-interest deduction. If you have a mortgage on your home, you don't have to pay taxes on the interest on that loan. According to the Congressional Budget Office, that tax break cost the federal government $70 billion in 2013.

Economists have all sorts of problems with the mortgage-interest deduction. For one thing, because wealthier people own bigger homes with bigger mortgages, the benefit disproportionately benefits the rich. In 2013, 73 percent of that $70 billion went to the wealthiest 20 percent of earners; 15 percent went to the richest 1 percent. The poorest 20 percent, who rarely own homes, got essentially nothing.

The problems don't stop there, economists say. The mortgage-interest deduction also gives people an incentive to borrow as much money as possible -- to buy bigger homes and make smaller down payments. That probably isn't good for either homeowners or the economy (remember the housing bubble?), and it might even drive up home prices artificially, making homes less affordable for new buyers.

Perhaps because of the effect on prices, the mortgage-interest deduction doesn't even seem to encourage homeownership. Thomas L. Hungerford, an economist with the liberal Economic Policy Institute, notes that Canada and the United Kingdom have homeownership rates similar to that of the U.S., even though they don't let borrowers write off the interest on their mortgages. "Having the mortgage-interest deduction does almost nothing for increasing homeownership rates," Hungerford said. Economists at the libertarian think tank Reason reached the same conclusion in a 2011 report. [...]

Next up on economists' chopping block: the deduction for state and local taxes. Right now, if you pay taxes in your home state, you can write them off on your federal tax return.7 That might seem reasonable -- you're already paying taxes once! -- but from the federal government's perspective, state taxes really aren't much different from any other expenditures. Your taxes pay for roads, schools and police protection, the same way your rent pays for housing.8

The deduction for state and local taxes helps the rich even more than the mortgage-interest deduction. Eighty percent of the benefit goes to the top 20 percent of earners, and 30 percent to the top 1 percent. That's hardly surprising: The wealthy pay more state and local income tax, both because they have more income and because most state income taxes are progressive -- they tax the rich at a higher rate.

Inequality isn't the only issue, though. "It's in effect a subsidy for having higher taxes at a state level," said Alan Cole, an economist at the Tax Foundation, a Washington think tank. If New York raises its state taxes, its citizens don't actually have to pay for that full tax increase themselves because they can deduct the state taxes on their federal returns. Instead, taxpayers around the country are in effect picking up part of the tab. That especially bothers conservative economists, since it makes it easier for some states to have higher taxes. But even liberal economists generally agree that it isn't the most efficient system.

Posted by at April 3, 2015 3:32 PM

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