Tax Deductibility, Market Frictions, and Price Discrimination: Evidence from the Mortgage Market.

Abstract

Although not the primary intended beneficiary of the Mortgage Interest Deduction (MID) program, lenders capture a significant fraction of this government subsidy. This paper shows that borrowers who benefit from the MID pay on average 14.9 basis points higher interest rate than similar borrowers who do not benefit from it. This interest-gap represents a present value of $6,600 (or 2.35% of the original loan amount) for the median borrower. Consistent with a model of first-degree price discrimination, the interest-gap increases (1) with borrowers' marginal tax rate, and (2) with the degree of market frictions such as lenders' concentration, search cost, and leverage in bargaining.

Keywords: Mortgage interest deduction, Distortionary tax, Market power, Redit markets

JEL Classification: G51, H24, H31, R21, R31