Interest Deductibility, Market Frictions, and Price Discrimination.

Abstract

This study shows that borrowers who benefit from the mortgage interest deduction pay an interest rate that is on average 11.6 basis points higher than that of otherwise similar borrowers. This result implies that mortgage originators capture between 7 to 15 percent of this government subsidy. Consistent with a model of first-degree price discrimination, this additional markup increases with borrowers’ marginal tax rate and with market frictions such as concentration, search cost, and leverage in bargaining. Thus, the study suggests that interest deductibility functions as price support in credit markets characterized by high market frictions.

Keywords: Interest deductibility, credit markets, mortgage, subsidy incidence

JEL Classification: G21, G51, H24, H31, R28