Encouraging Homeownership Through the Tax Code

Owning one's home is widely viewed as an integral part of the American dream. Americans are taught from an early age to aspire to homeownership, and several long-standing federal institutions and regulations support owner-occupied residential housing.The income tax deduction for mortgage interest payments is possibly the best-known federal housing policy and is deeply ingrained in the economic and social fabric of the country. Evidence suggests, however, that the mortgage interest deduction (MID) does little if anything to encourage homeownership. Instead, it serves mainly to raise the price of housing and land and to encouragepeople who do buy homes to borrow more and to buy larger homes than they otherwise would. Most tax return filers, especially those with low or moderate incomes, do not itemize their deductions and therefore are not in a position to take advantage of the deduction if they were to buy a home. As a result, the deduction not only drains significant revenues from the Treasury every year, it also provides much larger benefits to high-income households than to low- or moderate-income households, and has at best a small effect on homeownership.In light of those concerns, the President's Advisory Panel on Federal Tax Reform (2005) suggested major changes to the once politically sacrosanct MID. The panel proposed changing the deduction to a 15 percent credit and making it available to all filers, regardless of itemization status. Those proposals would partially address some of the problems noted above.While we believe the panel's proposals regarding the MID would be a step in the right direction, we advocate bolder changes in federal housing policy. We propose a tax credit and a subsidized saving vehicle for first-time home buyers, financed by the elimination of the MID. Relative to current policy or to the panel's recommendations, our proposals would be less expensive, more progressive, and more effective in encouraging homeownership.The report is organized as follows. Parts II and III provide background information on U.S. homeownership rates and federal housing policies, respectively. Part IV discusses the underlying justification for encouraging homeownership through public policy. Part V discusses the economic effects of the MID. Parts VI and VII describe our two proposed alternative policies and describe their potential effects. Part VIII is a short conclusion