The Dynamic Effects of Eliminating or Curtailing the Home Mortgage Interest Deduction

Abstract:

The reports of several recent commissions focusing on deficit and debt reduction have suggested curtailing or eliminating the home mortgage interest deduction (MID). This paper examines the economic effects of such proposals to eliminate or curtail the MID. We use a dynamic, overlapping generations, computable general equilibrium (CGE) model of the U.S. economy to simulate both the short run and long run macroeconomic effects of such proposals, including their effects on the housing market, such as changes in housing prices, housing investment and the housing capital stock, and the mix of owner-occupied and rental housing. We also estimate the changes in tax liability by age and income group due to these changes in the MID, taking into account differences across households in whether they itemize and in the marginal tax rate at which the MID is taken, as well as the portfolio reallocations that would be expected to occur as households decide to pay down mortgage debt once the tax advantages of the MID are reduced or eliminated. In addition, we estimate how the reforms would affect the housing user cost of capital, and include estimates of the effects of eliminating or curtailing the MID for a few representative households. Finally, we also perform some rough supplemental “off-model” calculations to estimate the effects of the simulated reform-induced reductions in housing prices on the number of households with negative equity and the numbers of these homes that might be expected to end up in foreclosure proceedings.