The (Not so) Little House on the Prairie: The Hidden Costs of the Home Mortgage Interest Deduction

Abstract

Is there a connection between the Federal subsidy for home ownership and urban sprawl? Should the Federal government encourage homeownership? Does the home mortgage interest deduction encourage homeownership for all Americans? Is the cost of the home mortgage interest deduction justified?

This article considers whether the home mortgage interest deduction is an effective policy tool for encouraging home ownership, and whether it contributes to urban sprawl. The article concludes that while the home mortgage interest deduction provides an effective incentive for certain taxpayers to purchase certain types of homes, it fails to extend this incentive to all potential home owners. Moreover, combined with Americans' prevailing preference for large, single-family homes, the home mortgage interest deduction encourages urban sprawl, considered by many to be America's most important environmental issue.

The article examines the potential consequences of a repeal of the home mortgage interest deduction, focusing on the economic consequences of repeal and comparing the tax treatment of home ownership and home ownership rates in other countries. Although the economists' opinions on the consequences of the repeal of the home mortgage interest deduction vary, several economists suggest that repeal would reduce housing prices and demand for housing in the outer suburbs. However, repealing the home mortgage interest deduction would neither encourage home ownership for all Americans nor affirmatively discourage sprawl. Accordingly, the article presents a new proposal designed to encourage home ownership for all Americans while reducing incentives for sprawl - the refundable Federal shelter credit, with a location efficiency premium to encourage home buyers to purchase close-in, transit-accessible housing.

Keywords: Tax, income, home, mortgage, interest, deduction, sprawl

JEL Classification: H21, H22, H24, K34, N30, N32, R21, R31