One of the benefits of working in an office full of geeks is that my colleagues, rather than my spouse, bear the brunt of my obsessions over policy minutiae. A little while ago, for example, we had a rollicking debate about whether Sightline’s long-standing opposition to the Home Interest Mortgage Deduction—herein abbreviated as “HIMD”—still makes sense.  (We’re wild and crazy here, I tell you!)

Here’s the rundown.

On equity grounds, the HIMD is crummy social policy.  Most of the benefits go to people who own expensive homes, and whose incomes are high enough that they can benefit by itemizing their deductions.  Worse, the biggest benefits go to the people in the highest tax brackets.  So in essence, the HIMD is ginormous a housing subsidy for the well-off—and one that dwarfs all of the housing subsidies to lower income folks.  This NY Times article lays out the case nicely:  apparently, half the benefit of the deduction goes to the 12 percent of taxpayers who make at least $100 grand per year.

But theconventional wisdom is that the HIMD isn’t just crummy social policy, but crummy environmental policy as well.  Allowing homeowners to deduct mortgage interest on their taxes gives people an incentive spend more of their money on housing than they otherwise would.  And people with extra money to spend on housing tend buy larger homes on bigger lots—which, in theory at least, means that the HIMD primes the pump for low-density sprawl.  (See, e.g., the photo.)

But not too long ago, we got an email from a guy who wanted to buy a condo in a neighborhood close to downtown—a modest place where he didn’t have to drive much.  (In terms of greenhouse gas emissions, downtown living is about the best you can do, short of ditching your car and going off the grid.)

He argued that, condo prices being what they are, he simply couldn’t afford to buy close to the city center without the HIMD.  Take away the interest deduction, and he’s got little choice but to stick with a bigger, more energy-hogging house in the ‘burbs  (Several of the comments on this thread over at Matthew Yglesias’s house make the same point.)

So which is it:  does the deduction accelerate sprawl, by encouraging homeowners to buy more land than they otherwise would?  Or does it temper sprawl, by making homes in expensive, conveniently located neighborhoods more affordable?

I think the answer is both, or possibly neither.

  • Here’s my reasoning, for what it’s worth… 

    The mortgage interest deduction’s chief effect is to encourage people to spend more on their homes, and less on the things that they otherwise might want to buy.  After all, for every $1000 you spend on mortgage interest, you can get $300  or so back on taxes—which is a deal you don’t get from, say, buying shoes, or going out to dinner. 

    Of course, there are a bunch of different ways to spend more money on a home.   For example, you can buy…

    • a bigger yard;
    • a home in a more desirable neighborhood (where the definition of “more desirable” is left as an exercise to the reader);
    • a more spacious home;
    • a nicer home (e.g., fancier, or with better appliances or countertops or whatnot).

    At heart, the first two items represent spending on land, and the latter two represent spending on the home itself.

    But the thing is this:  the supply of land is fixed(or, arguably, declining).  So to the extent that the HIMD encourages people to spend more on land—either for bigger lots, or for better locations—home buyers aren’t actually getting anything extra for their money.  They’re simply bidding up the price of land.  

    (That’s one reason the HIMD is such a sacred cow.  Get rid of it, and land prices fall.  Try selling that to a nation of homeowners.)

    To me, this line of argument suggests that getting rid of the HIMD would have pretty minimal impacts on the affordability of land itself.  Eliminate the interest deduction, and sure, people will have less to spend to on land.  But as the cash available to spend on land declines, the land itself will become cheaper.  On net, the two forces (less money to spend on land, cheaper land prices) will largely balance out, with roughly proportional effects in both surburban and urban locales—which means that the preference for urban vs. suburban living might not change much.

    Now, I’m certain that a sophisticated economic analysis would find that this isn’t quite right—i.e, that eliminating the HIMD would have some effect on land affordability, preferred lot size, or the balance between urban and suburban housing demand.  Still, I’d bet that the effects wouldn’t be all that huge.  And if that’s right, it could mean that the HIMD is no longer the sprawl accelerator that it in the very early years, before the tax breaks had been fully capitalized into land values.  

    On the other hand, to the extent that people currently use HIMD subsidies to buy bigger, fancier homes, the deduction still has a major environmental downside.   Larger homes—with cathedral ceilings, bonus rooms, and palatial master suites—consume lots of energy for heating, cooling, and lighting.  Which means that even if the HIMD no longer does much to encourage low-density sprawl, it still promotes wasteful energy consumption. 

    BUT…high-rise condos are also expensive to build, especially on a square-foot basis.  So the HIMD could help people cover the construction costs of condo, if that’s their preference—which would decrease average energy consumption.  (Gosh, this is getting complicated.)

    So let’s review.  Getting rid of the HIMD would reduce housing subsidies to the wealthy; reduce the nominal price of land; have little effect on the affordability of land; and eliminate subsidies for expensive home construction, which could reduce both house size (a good thing) and the construction of high-cost condos (for energy efficiency at least, not so good).  But on balance—given the market’s preference over the last few decades for big homes over conveniently located ones, I’d bet that maintaining the HIMD would still do more environmental harm than good.

    However, perhaps the case for the HIMD being a sprawl-accelerator isn’t as strong as I thought it was.  That doesn’t completely eliminate my concerns about the deduction, but it certainly makes me think twice about decrying the HIMD as a major accelerator of low-density sprawl.

    (See—I told you we were wild & crazy!!)