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I am not a fan of the federal tax code provision that allows homeowners to deduct mortgage interest for first and second houses on debt up until $1,000,000. I am not convinced it does much, if anything, to help homeownership; it encourages people to take on debt (about which I will say more later); and it helps those near the top of the income distribution more than the middle class (although those near the top benefit more than those at the top).
But chances are, eliminating it would ultimately not bring in as much money to the Treasury as people hope.
According to the Joint Committee on Taxation, the mortgage interest deduction cost the Treasury $69.7 billion in 2013, meaning that if it went away tomorrow, the Treasury would have $69.7 billion for new spending, deficit reduction, and/or tax cuts elsewhere.
But as Jim Follain pointed out fifteen years ago, the elimination of the mortgage interest deduction would likely lead to a behavioral response. With the mortgage interest deduction in place, both sources of housing finance, debt and equity, get a tax preference. Debt gets a preference because of the mortgage interest deduction; equity gets a preference because imputed rent goes untaxed (an ugly phrase in the English language, to be sure, but unavoidable in this discussion).
What does this mean? Consider a situation where you and your neighbor own identical houses free and clear. Now suppose you swapped houses and paid each other rent. Your living conditions are the same. The rents net each other out. But now you both owe taxes on the rent you charge each other. Hence owning your own house has a tax preference relative to renting.
So let's see what happens when we get rid of the mortgage interest deduction. Those at the margin of owning, with little liquid wealth, get little to no benefit from the mortgage interest deduction--they either do not itemize expenses on their tax return, or itemize by a small amount over the standard deduction, and pay at the 10 percent marginal tax rate. Those who get a lot of benefit out of the deduction, on the other hand, have other financial resources--taxable financial resources. Tax incentives would lead such people to pay off their mortgages faster.
To get a very rough estimate of how much owners could pay off their mortgage debt, we note that the median financial holdings of homeowners in 2010 was $45,000. The median first lien mortgage was $110,000 (Data come from the 2010 Survey of Consumer Finances). Hence a household with the median financial net worth and the median mortgage could pay off about 40 percent of its loan immediately, should it wish to do so (this is unlikely, because there are reasons other than taxes to make investment decisions).
Perhaps more important, households would have an incentive to pay off their mortgage more quickly in the event of the elimination of the mortgage interest deduction. Less investment in taxable assets would partially offset the revenue gains arising from the elimination of the MID. [Update: Gervais and Pandey show that the revenue collected from eliminating the MID would be 35 to 65 percent of the current amount of the tax expenditure].
