The value of the mortgage interest deduction is overstated

A study that should have implications for tax reform. An optimal tax system collects revenue from the broadest base. Economists have long believed that the homeowner mortgage deduction misallocates capital to the housing sector. This new study, "Do People Respond to the Mortage Interest Deduction?: Quasi-Experimental Evidence from Denmark," from Jonathan Gruber, Amalie Jensen and Henrik Kleven finds that prospective homeowners are not swayed by the tax incentive.

Using linked housing and tax records from Denmark combined with a major reform of the mortgage interest deduction in the late 1980s, we carry out the first comprehensive long-term study of how tax subsidies affect housing decisions.  The reform introduced a large and sharp reduction in the mortgage deduction for top-rate taxpayers, while reducing it much less or not at all for lower-rate taxpayers.  We present three main findings.  First, the mortgage deduction has a precisely estimated zero effect on homeownership. This holds even in the very long run.  Second, the mortgage deduction has a sizeable impact on housing demand at the intensive margin, inducing homeowners to buy larger and more expensive houses.  Third, the largest effect of the mortgage deduction is on household financial decisions, inducing them to increase indebtedness. These findings suggest that the mortgage interest deduction distorts the behavior of homeowners at the intensive margin, but is ineffective at promoting homeownership at the extensive margin and any externalities that may be associated with it.

The paper is available at the National Bureau of Economic Research.