By William R. Emmons
Broad indexes of real, or inflation-adjusted, 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 efficiency-enhancing changes in the tax code, many economists say yes.
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:
As a result of these changes, many economists expect house prices to trend somewhat lower.1 Mortgage borrowing and other aspects of 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.
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.
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
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.
Economists view the MID as inefficient because it distorts house prices and the mix of housing constructed 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:
The authors estimate that a complete elimination of the MID would result in a:
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 long-lasting benefit to the economy as financial resources are redirected toward business investment with higher potential for productivity growth.
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.
This article originally appeared in our Housing Market Perspectives publication.