Idealism and the Mortgage Interest Deduction

After learning to see the world through the lenses of economics, one of the things that most startled me was how different the world looked even though I had exactly the same values that I had had when I accepted the views of Harper's Magazine, Utne Reader, Mother Jones, etc.

A specific case: Why aren't do-gooders outraged by the home mortgage interest deduction? It is an enormous factor in our economy ($779 billion in 1999 vs. around $400 billion total spent on K-12 education) that:

1. Primarily benefits high income people; the higher your mortgage (up to $1 million on up to two homes) the more you benefit. It is a case study in effectively regressive taxation. See http://www.taxfoundation.org/prmortgage.html for how a flat tax that eliminated the mortgage interest deduction would primarily harm those with homes over $300,000.

2. Provides a huge incentive to build or buy bigger homes. Commentators sometimes rant about "real estate porn" when they see ads for enormous homes - and yet, through the mortgage interest deduction the government subsidizes large homes. One would have thought the environmental movement would also be outraged by this - Insofar as one is concerned that we are using too much energy or killing too many trees, one might try to fight this massive payment system that encourages people to build bigger houses.

I can only come up with two reasons why this obvious case of rent-seeking by the wealthy, the real estate industry, and the banking industry has been almost completely ignored by do-gooders:

1. The profound emotional resonance of home ownership is so powerful that either do-gooders believe it (most likely, I'm afraid) or they are strategically afraid to call it into question. What a beautiful emotionally-laden cover for bankers and developers.

2. People become so entrenched in traditional ruts of argumentation that it never occurs to them to quit debating whether or not we should have a flat tax so that they fail to notice this monstrous regressive feature of the existing "progressive" tax code.

One of the reasons that I no longer pay any attention to Harper's Magazine, Utne Reader, Mother Jones, etc. is that they don't usually provide much original thought even regarding the consistent application of their own principles.

To add outrage to outrage, Voith makes the case that the mortgage interest deduction is implicated in the dynamic that creates our disastrous inner-cities, http://www.phil.frb.org/files/br/brma99rv.pdf. This is an amazing argument, brilliant economic analysis that typifies the unintended consequences of a beloved policy (the rhetorical tug of home ownership is right up there with baseball and apple pie). Why don't Utne or Mother Jones report on this stuff!

In the absence of understanding economics, people are prone to believe that somehow Americans simply have the wrong preferences. Do-gooders often wish that people would spend more on education and less on monster houses. But the government is bribing people to buy monster houses while also forcing them to pay for meaningless K-12 education whether they use it or not. In the absence of government influences, houses would be smaller and more would be spent on education.

Moral outrage should not be directed at people's preferences (outrage concerning individual consumer decisions, while satisfying in an atavistic way, is simply not an effective means of changing behavior in a large, pluralistic society) but rather should be directed at those policy distortions that cause those outrages (laws can be changed by means of outraged public opinion).

For more on the mortgage interest deduction, see http://post.economics.harvard.edu/hier/2002papers/HIER1979.pdf, which concludes that there are small positive externalities associated with it (they include local political activism as a positive externality, whereas I suspect that it is usually really rent-seeking) but that it does primarily benefit the rich, banking, and real estate industries while not much increasing levels of home ownership.

The best guess of flat tax advocates in the U.S. is that even if we got one, the mortgage interest deduction would be untouchable.