Thursday, January 15, 2009

Helping the Non-Rich, by Accident

-- Posted by Neil H. Buchanan

One of the most politically sacrosanct benefits available to taxpayers is the deduction for home mortgage interest. Along with the deduction for state and local taxes, this benefit expresses a longstanding and bipartisan policy preference to encourage home ownership in this country. Whether the net result of these tax benefits is actually to increase home ownership is a separate question, but there is no doubt that politicians view this benefit as untouchable. In fact, when in 2005 President Bush created a commission to make recommendations for fundamental reform of the federal tax system, he made abundantly clear that any recommendations must include tax incentives to encourage home ownership.  (The panel did as it was told, but their entire report was ultimately ignored by lawmakers, for unrelated reasons.) There seems to be nearly unanimous political support for the idea that the tax code should make us a nation of homeowners.

Who is really helped by these pro-homeowner tax benefits? Last week, at the annual meetings of the Association of American Law Schools, Professor Dorothy A. Brown of Emory Law School offered a fascinating discussion of the effects of these federal tax benefits on low-income and minority homeowners. She showed, among other things, that a surprisingly large number of such homeowners receive no actual benefit from the deductions for mortgage interest and property taxes, because they do not itemize their deductions. As Dorothy demonstrated, this means that the tax code only benefits some homeowners while leaving those with lower incomes and less expensive houses out in the cold. She thus showed that the system currently provides benefits in a regressive fashion, and she argued that "this cannot stand."

I completely agreed with Dorothy's motivations (as I almost always do), and I found her argument to be thought-provoking. Because of my belief (see here, here, and here) that expanded home ownership should not be a goal of public policy, however, I asked Dorothy two questions during the Q&A. First, I suggested in essence that we should address the inequality that she had identified by "leveling down" rather than "leveling up." That is, rather than following her suggestion that we should make sure that the tax benefits for home ownership are available to all homeowners, we should instead take them away from all homeowners. She suggested in response that (beyond the political impossibility) there would be difficult transition costs in such an approach, which is true but (in my opinion) not insurmountable.

My second question, which Dorothy unfortunately was not able to address due to time constraints, was whether the current system is not actually (and completely inadvertently) beneficial to low-income and minority citizens. That is, since home ownership is a very bad way to save money (not only during a dramatic crash like the current crisis but more generally because building home equity is the very definition of undiversified investing), and since low-income people are the least able to cope with the loss of their home equity (since they almost never have any other significant amounts of money saved in any other form), a tax system that leaves out the low-income taxpayers is actually doing them a favor by not encouraging them to own a home.

Therefore, although my first choice would be for the government to completely change course and discourage individual home ownership, the current system -- which seems to disadvantage those with less income and wealth -- might be a better alternative than to adopt a plan to eliminate that supposed disadvantage. This outcome thus works, by sheer luck, as the equivalent of a progressive tax policy to steer the most financially vulnerable away from possibly ruinous risk-taking.

I have to admit that I am somewhat uncomfortable with my own conclusion. There is something unsettling about this "cruel to be kind" approach to social policy. Still, if the choice is to leave things as they are or to change the tax code such that it would encourage more lower-income and minority citizens to buy homes, I think I would choose the former.