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Don't touch the deductions

I'm a fan of phasing out or paring back both the mortgage-interest deduction and the tax exclusion for employer-based health care, so I've been encouraged by reports that the President's Fiscal Commission is seriously examining both. Economist Robert Shapiro, however, thinks this is the wrong time to be considering changes to either one.

By Ezra Klein  | October 28, 2010; 11:02 AM ET
 
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The mortgage deduction should stay but be converted to a limited credit that isn't based on tax bracket. It's supposed to be about helping homeowners on the margins move from renting to owning, but most of the value of the deduction goes to the wealthy, because they pay more for their homes and pay tax at a higher bracket.

Since homeownership does create positive externalities, it is not inappropriate to subsidize people at that margin, but there's no good reason to offer tax subsidies for the rich to buy really big houses and keep them very leveraged.

The employer tax deduction ... why would we want to remove that? Employer group health insurance is the most efficient private health insurance we have, and removing the deductibility would throw a lot of people into the individual market. Even with PPACA (assuming it doesn't get blocked somehow by future Congresses), that individual market may be dicey. Anyway, we just passed that bill with both subsidies and individual mandates that people get insurance, because lacking insurance creates negative externalities, so why wouldn't we allow a deduction for it?

Shapiro is generally right though about the timing. His post is a rambling one about the basic Keynesian view of the economy now and a host of other issues, but he's not incorrect. Especially regarding the mortgage interest deduction. Removing it now would be a baseball bat to the housing market at exactly the wrong time, and even threatening to remove it in the near future would have significant negative effects on the present.

Posted by: sanjait | October 28, 2010 11:30 AM | Report abuse

What would happen to the housing market/industry if the mortgage deduction was eliminated?

Posted by: bigless55 | October 28, 2010 11:37 AM | Report abuse

Shapiro's argument (we can't change a bad policy because some people benefit from it the way it is) is one I heard repeatedly during my 20-year stint working with Federal social assistance programs, some of which were spectacularly ill conceived and wasteful. But if the economy is dependent on perpetual inflation of housing prices, creating a 'wealth illlusion' which then feeds the inflation of other prices, then we are totally screwed anyway. In my experience, many buyers overestimate the value of the deduction, forgetting that they get a standard deduction anyway, and that the benefit of the mortgage/property tax deduction is limited to the amount by which their total deductions will EXCEED the standard deductions. I think you can even make an argument that the current lowered housing values make this an especially good time to start dealing with this issue, since proportionately, housing prices don't have as far to fall now.

Posted by: guesswhosue | October 28, 2010 12:37 PM | Report abuse

I'm confused. In a time of depressed and even falling wages, why is lowering the cost of housing (which is the main factor behind inadequate wages) a bad thing? Isn't it all relative, anyway?

Posted by: uberblonde1 | October 28, 2010 12:39 PM | Report abuse

"Since homeownership does create positive externalities, it is not inappropriate to subsidize people at that margin, but there's no good reason to offer tax subsidies for the rich to buy really big houses and keep them very leveraged."

Homeownership also creates negative externalities (suburban sprawl which means lower density living and more carbon emissions, household wealth is concentrated into one basket, reduced labor mobility, economy is wrecked when the housing market goes down).

In addition, the mere fact of a positive externality does not require that the activity which creates it be subsidized.

There might be external benefits that "society" isn't willing to pay more for - the fact that individuals don't band together voluntarily to provide additional funding for the activity with alleged positive externalities suggests as much.

For that matter, externalities are impossible to calculate because interpersonal utility is not comparable.

"Removing it now would be a baseball bat to the housing market at exactly the wrong time"

When is the "right" time? Why not just take the pain and let the market (finally) find a bottom?

"Anyway, we just passed that bill with both subsidies and individual mandates that people get insurance, because lacking insurance creates negative externalities, so why wouldn't we allow a deduction for it?"

There are negative externalities as well as positive ones (inflates costs and usage of health care services, increases taxes and the distortionary effect thereof, reduces work incentives, joblock). As before, we can't calculate the impact on utiilty so we have no way of knowing whether or not correcting for an externality is welfare enhancing.

People should be allowed to keep what they earn even if they don't act in a manner directed by government.

Posted by: justin84 | October 28, 2010 1:55 PM | Report abuse

The tax exclusion for employer-based health care serves the same function as the individual mandate in the health reform bill; it forces people to buy health insurance (or pay higher taxes). The time to eliminate the tax exclusion for employer-based health care is after the provisions of the ACA have been fully phased in, we can see that they are working, and the Supreme Court has decided not to strike down the individual mandate.

Posted by: KennethAlmquist | October 28, 2010 6:33 PM | Report abuse

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