Thursday, April 14, 2005

Getting mortgage tax breaks wrong

I feel dirty saying this, but Slate's economic coverage was much better when they had Paul Krugman writing columns for them. But both the coverage and Krugman have gone to seed.

Take this latest one on the home mortgage tax deducation:
But the once-modest deduction has evolved into a very large and highly inefficient rent subsidy. The deduction plainly causes distortions. People are willing to pay more for houses and buy bigger houses than they otherwise would because they can deduct the interest from their taxes. "When Americans invest the bulk of their life savings in housing, that's a redistribution of capital from the productive business sector," said Sullivan.
Slate is wrong. It is true that the tax deducation was a subsidy making homes cheaper to buy, but this was a one time event and all the benefit from that subsidy was captured by those who already owned homes. From that day, back in 1913 on, it has caused hardly any distortions to markets.

Think of it this way -- there is a house you want to buy and you're willing to pay $100,000 for it. The government passes some law that says whenever you buy a house, Uncle Sam will take $20,000 from other people and give it to you. Great!, you think, you're $20,000 richer!, but guess what -- that $100,000 house now mysteriously costs $120,000. Since you were willing to pay $100,000 when you did not have an extra $20K lying around, you are certainly willing to pay $120K now that you have the extra money, so for you things are a wash. But the house seller is now $20,000 richer, and Other People are now $20,000 poorer. Big whoop.

Similarly, if the $20,000 transfer was eliminated, that $120,000 would go back to being worth $100,000. The buyer is unaffected. The seller is is poorer. Other People are richer.

The benefit of eliminating the home mortgage deduction is the same as eliminating all deducations -- the least impoverishing taxation has a low rate levied on as wide a base as possible. Deductions leave average taxes untouched by raising marginal taxes, making them excellent wealth destroyers.


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