The Fed Releases Housing Market Perspectives and Looks at Tax Breaks

ST. LOUIS – The new Mortgage Interest Deduction (MID) seems popular with the public but disliked by economists. 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.  William Emmons, assistant vice president, and chief economist of the St. Louis Fed's Center for Household Financial Stability, explains why in this issue of Housing Market Perspectives.

The Tax Cuts and Jobs Act of 2017 places new limits on deductions for state and local taxes and property taxes, and scales back the 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.

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. Economists point to research that Emmons shares where MID actually reduced the homeownership rate by about 5 percentage points. (It raised house prices so much—through the capitalization of tax benefits—that homes became out of reach for some buyers.)

Emmons believes the biggest losers would be home owners with large mortgages. The biggest winners would be renters for whom homeownership is a goal and now becomes possible due to declining house prices.

“Thus, while the new tax law makes a significant dent in a policy that many economists view as inefficient and regressive,” Emmons writes. “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.”