The sensitivity of homeowner leverage to the deductibility of home mortgage interest

Abstract

Mortgage interest tax deductibility is needed to treat debt and equity financing of houses symmetrically. Countries that limit deductibility create a debt tax penalty that presumably leads households to shift from debt toward equity financing. The greater the shift, the less is the tax revenue raised by the limitation and smaller is its negative impact on housing demand. Measuring the financing response to a legislative change is complicated by the fact that lenders restrict mortgage debt to the value of the house (or slightly less) being financed. Taking this restriction into account reduces the estimated financing response by 20 percent (a 32 percent decline in debt vs a 40 percent decline). The estimation is based on 86,000 newly originated UK loans from the late 1990s.In many economies debt financing of housing is penalized relative to equity financing, i.e., interest payments are not fully tax deductible. In the Commonwealth countries-Australia, Canada, New Zealand, and the UK (since 1999)-interest is not deductible at all; in most European countries (the UK in the quarter century prior to 1999) interest is only partially deductible, being limited by a ceiling on the deductible amount, application of a lower tax rate to the deduction, or both. As a result, the Modigliani-Miller [14] debt neutrality theorem does not hold; the user cost of capital for owner-occupied housing (through the weighted average cost of capital) is not

The Distributional and Revenue Consequences of Reforming the Mortgage Interest Deduction

“…This can offset federal income tax revenue increase brought about by the modifi cations to the MID. 19 Poterba and Sinai (2011), Gale, Gruber, and Stephens-Davidowitz (2007), Hendershott and Pryce (2005), Gervais and Pandey (2005), and Follain and Dunsky (1997) examine this type of behavior in the context of modifying the MID. Gervais and Pandey (2005) estimate that eliminating the MID will lead taxpayers to lower their loan-to-value ratio by 25 percent.…”

“…ance. This type of behavior could reduce tax revenues by as much as 20 to 40 percent relative to keeping fi nancial portfolios constant in response to the removal of the MID (Poterba and Sinai, 2011;Hendershott and Pryce, 2005;and Gale, Gruber, and Stephens-Davidowitz, 2007). This offsetting revenue effect should be lower if the MID is capped, or replaced by a tax credit, because debt fi nancing will remain tax-preferred.…”

Metropolitan Area Home Prices and the Mortgage Interest Deduction: Estimates and Simulations from Policy Change

“…Academic work on the price effects of reforming the MID is thin, estimates vary considerably, and most are based on pre-2008 housing market data. 1 Most of the academic work on the MID focuses on its distortionary impact in the lending market Follain, 1997, 2000;Hendershott and Pryce, 2006;Poterba and Sinai, 2011), tenure choice (Green and Vandell, 1999), size of dwelling (Hanson, 2012), 1 Capozza et al (1996) estimate the impact of eliminating both the property tax deduction and the MID to be between 13 and 17 percent depending on behavioral change in loan to value ratios. More recently, Harris (2013) estimates the effect of several MID reform options and finds that eliminating the MID would result in an average price decline between 11 and 20 percent, with varying impacts across metropolitan areas.…”

“…6 Each market's simulated price is therefore responsive to an array of local market conditions. 5 Previous literature describes the effect of the MID on LTV ratios: see for examples Dunsky and Follain (2000), Hendershott and Pryce (2006), and Poterba and Sinai (2011). 6 We consider to measure price appreciation net of physical depreciation in the local market when using historic appreciation rates as a proxy, thus dropping the parameter.…”

Metropolitan Area Home Prices and the Mortgage Interest Deduction: Estimates and Simulations from Policy Change

“…The MID is effectively the largest housing-related subsidy in the United States with a price tag of over $100 billion/year during the housing market peak (currently $70 billion). Despite its seemingly small size relative to the mortgage market, the MID has a substantial distortionary impact on financing (Dunsky and Follain, 2000, Dunsky and Follain, 1997, Hendershott and Pryce, 2006, Poterba and Sinai, 2011, the size of dwelling choice (Hanson, 2012a), and the transition from renter to owner (Green and Vandell, 1999). Theoretical models and simulation also link the MID to suburbanization and sorting within cities (Voith and Gyourko, 2002) and to locational choice across metropolitan areas (Albouy and .…”