Fall 2018 Journal: Mortgage Interest Deduction and the Racial Wealth Gap

By Emma Fernandez, Emily McCaffrey, Kimberly Rubens, and Carson Whitelemons

Edited by Joony Moon

The Home Mortgage Interest Deduction (MID) is one of the longest-standing and costliest federal tax deductions in the United States. While the MID has increasingly faced critique for the way it disproportionately benefits wealthy taxpayers, less attention has been paid to the way the MID perpetuates the racial wealth gap and continues a legacy of exclusionary American housing policy. Our analysis traces the history of the MID and its intersection with housing discrimination in the United States, examining the racial consequences of the current American tax deduction structure. Finally, we explore a vision for a more equitable and effective promotion of housing stability and wealth creation.

HOW THE MORTGAGE INTEREST DEDUCTION BENEFITS THE WEALTHY

The MID allows homeowners to deduct from their taxes the interest they pay on any loan used to purchase, build, or make improvements on their residence. Homeowners can also take the MID on loans for second homes. For people in higher tax brackets, the deduction is larger because every dollar not taxed would have been subject to a higher marginal tax rate. In 2015, the MID accounted for $71 billion in lost tax revenue the government would have collected from homeowners without the MID.¹This is the most expensive itemized tax deduction and one of the largest tax expenditures.²

Prior to January 2018, homeowners could deduct up to $1.1 million of interest paid on both homes (up to $1 million on a mortgage payment and $100,000 in home equity loans).³ The 2017 tax reform bill redesigned the MID for mortgages purchased after January 1, 2018: under the current tax code, homeowners can deduct interest paid for a mortgage payment on both homes up to $750,000 and cannot take a deduction for home equity loans.⁴ This is the first major reduction of the MID in decades. Since the new cap on deductions only applies after January 1, 2018, it will primarily curb long-term increases in MID spending rather than impact current spending. A report from Congress’s Joint Committee on Taxation predicts that government spending  on the MID will drop from $59.9 billion to $25 billion, a reduction of about 58 percent. However, it also predicts that the benefit will become even more skewed towards the wealthy because the tax reform bill also doubled the standard deduction for middle-income homes, meaning fewer households will itemize and claim the MID. The report predicts that next year households that earn more $500,000 annually will receive about 24 percent of the benefits, up from 12.4 percent this year. Essentially, this new cap on the MID has made it an even more regressive benefit.⁵

As a consequence of its structure, the MID is an inefficient government program that primarily transfers government spending to the wealthy. In addition to costing the government billions of dollars annually, the MID is disproportionately used by a relatively small number of high-income Americans.  According to the Tax Policy Center, four out of five taxpayers do not claim the MID.⁶ About half of taxpayers with a mortgage receive no benefit from the MID, either because they owe no federal taxes (having paid substantial payroll taxes and/or state and local taxes) or because they claim the standard deduction (claiming the MID requires itemized deductions).⁷  Of those that do itemize, many cannot claim the credit because they either do not own a home or have already paid off their home mortgage loans.⁸ In total, the latest estimates suggest that 84 percent of the benefits from the MID go to households with $100,000 or more of annual income;⁹ in 2016, 75 percent of households in the U.S. made less than that.¹⁰Despite popular rhetoric that the MID supports home ownership, research shows that it has not effectively increased home ownership rates in the U.S.¹¹Because the MID’s benefits are concentrated among wealthy homeowners, it is primarily a supplementary benefit to wealthy home buyers who purchase homes and second residences, rather than an incentive for new home buyers to purchase new houses. Importantly, this concentration of the MID in properties with high home values has clear racial implications given the history of home ownership in the U.S.

THE MID AND THE RACIAL WEALTH GAP: INTERSECTING HISTORIES

The MID was created in 1913 as a small part of a federal law implementing an early iteration of the federal income tax. The deduction was not mentioned explicitly but was part of a provision aimed at allowing business owners, such as farmers, to deduct any interest they paid on personal expenses.¹²Since only the richest two percent of the populace met the income threshold required to pay income taxes at the time and most property owners owned their homes outright, the MID only impacted an elite few. There is little evidence to suggest that the provision received much political attention when Congress initially passed the law.¹³

This changed in the 1930s and 1940s, as rising middle class incomes and a changing tax structure meant that the federal income tax applied to a wider swath of American families. Simultaneously, policies like the Federal Housing Act of 1934 infused credit into the housing markets, putting homeownership within reach for millions. As homeownership rates and the cost of homes increased, so did government expenditures on the MID. In 1968, the government spent $1.9 billion annually for the mortgage interest deduction ($13.8 billion in today’s dollars). By 1988, costs had risen to over $33.8 billion ($72.3 billion in today’s dollars).¹⁴

Figure 1: Home Ownership Rates in the U.S. by Racial/Ethnic Group

Source: Consumer Expenditure Survey Data (2015)

However, people of color were deliberately and systematically excluded from access to these home loans and therefore from homeownership, the single largest factor contributing to the continually growing racial wealth divide. The roots of this homeownership disparity can be traced back to early 20th century federal, state, and local housing discrimination through policy (and, of course, if we go back farther, the origin of the wealth gap can be traced back to slavery, when black bodies were property of white landowners and therefore an original source of much of America’s white family wealth).¹⁵

Federal housing laws passed in the 1940s and 1950s mandated segregated neighborhoods and provided financial incentives for the development of whites-only suburbs. The Federal Housing Administration refused to insure bank loans to housing developers who intended to sell, or allow the resale of, homes to black families. The benefits of the G.I. Bill of 1944, largely denied to black veterans, provided millions of white Americans wealth-building opportunities through home, business, and education loans and employment preference. Federal public housing policies required segregated units and were often only available to white Americans, despite an overwhelming need for services for black Americans. Local municipalities zoned black neighborhoods for industrial and waste disposal use — effectively ensuring low home values and slum-like conditions.¹⁶Redlining practices, used by public and private home loan entities, restricted the availability of loans to families of color to specific, and often less-desirable, neighborhoods.

Throughout the 20th century, public and private institutions continued to symbiotically perpetuate the exclusion of black families from the American dream of homeownership. The passage of the Fair Housing Act in 1968 did nothing to recoup the losses these injustices caused to families over multiple generations; it only attempted to prevent future discrimination in housing.

Figure 2: Median and Average Wealth of White and Black Families

Source: Survey of Consumer Finance Combined Extract Data (2013)

THE MID’S RACIAL CONSEQUENCES

This systematic exclusion from homeownership subsequently made wealth creation for black families more difficult. As greater numbers of white Americans were able to access homeownership and the tax benefits afforded to them with this new status, the racial wealth gap has continued to widen. Over the last 30 years, the median wealth of Black and Latino households decreased by 75 percent and 50 percent respectively, while median wealth of White households increased by 14 percent.¹⁷We must therefore take a critical look at the role the MID plays in compounding the benefits afforded to homeowners.

Unequal access to housing has ensured similarly unequal access to the MID itself. This “race neutral” tax deduction whitewashes the systemic history of home ownership exclusion in the United States. It is no surprise then that the benefits of the MID are disproportionately enjoyed by white households. About 4 in 10 white households own homes with mortgages and are thus eligible for the subsidy, while this number is 1 in 4 for black households.¹⁸A recent report jointly released by the Institute on Assets and Social Policy and the National Low Income Housing Coalition found that even though black households comprise about 13 percent of the population, they are able to access just 6 percent of the total benefits from the MID. The report calculates that this amounts to an estimated $44.8 billion in lost housing benefits for black households.

In sum, the MID, as it is currently implemented, disproportionately provides greater wealth building opportunities to already wealthy white households, rather than spurring homeownership writ large. This in turn exacerbates racial inequality and widens the racial wealth gap. So why has the policy persisted, despite its inequitable benefits? When legislation establishes a wealth-building policy like the MID — a benefit that is largely only available to people in the top 20 percent of the income distribution — it becomes quite difficult to retract or limit the benefit. Homeowners demonstrate this possessive investment in the economic benefits of whiteness, or the “incentive to remain true to identity that provides them with resources, power, and opportunity” by supporting policies that maintain the inequitable status quo.¹⁹If we decided to change how we spend the more than $80 billion a year currently devoted to the MID, we could help millions of people maintain secure housing. For instance, according to White House estimates under the Obama administration, by diverting $1 billion of the MID benefit a year to permanent housing for homeless individuals and families, we could end homelessness in 10 years.²⁰

The 2017 tax reform bill, which came into effect in January 2018, lowers the cap and reduces the qualifying types of loans eligible for the MID. Despite a seeming alignment of interests, the authors of this report are skeptical that this reduction will have any significant impact on mitigating the ever-increasing racial wealth gap. By not addressing the racial wealth gap in homeownership, the MID fails to systematically counteract the ways power holders have historically excluded people of color from wealth-building opportunities.

REFORMING THE MID

Reform is needed to prevent the MID from continuing to perpetuate the racial wealth gap and other forms of economic inequality. While the 2017 tax reform bill was the first significant reform to the MID since its inception and will help to limit federal costs, it did not fundamentally change the structure of the deduction. Such a change will be necessary to meaningfully shift the MID’s policy consequences.

Below, we explore two categories of solutions: incremental changes that would shift the MID’s benefits towards the middle class, and structural changes that would more directly address the underlying legacy of discrimination that is reified by the MID.

PARTIAL TAX REFORM FOCUSED ON THE MID

Changes to the structure of the MID could mitigate its concentration in the wealthiest homeowners. Long considered an untouchable “third rail” of taxes and vigorously defended by the real estate lobby, the recent changes to the MID demonstrate that reform is possible and may even garner bipartisan support.

Change the MID from a tax deduction to a tax credit.Its format as a tax deduction makes the MID especially beneficial to the wealthy. Simply shifting to a credit rather than a deduction would grant access to the benefit to a wider group of homeowners. Currently the MID is only available to homeowners who itemize their tax deductions, generally the wealthiest homeowners. Shifting to a credit would allow homeowners of all incomes to claim the benefit. If the deduction were shifted to a credit, 16 million more homeowners would receive the benefit, including $7 billion more in benefits awarded to homeowners with incomes under $100,000.²¹

Lower the benefit cap.Under the current MID structure, homeowners can deduct up to $750,000 (down from $1.1 million after the most recent tax legislation). Lowering the cap even further to $500,000 would help reduce MID spending on wealthy taxpayers with expensive homes. The change in the capped value should be combined with the transformation to a tax credit in order to ensure the benefit reaches those with lower incomes.

These policy options have been widely discussed, and have been recommended by the Congressional Budget Office, bipartisan deficit reduction committees, and organizations such as the Center for Budget and Policy Priorities and the Brookings Institution. However, though these reforms are an important step towards improving the MID (and would save the government money in the process), the focus inherent to the policy still targets homeowners, and therefore primarily wealthy white Americans.

MORE AMBITIOUS RECOMMENDATIONS ADDRESSING RACIAL INEQUITY AND HOMEOWNERSHIP

Policy options that explicitly consider racial inequities are needed to counteract the effects of the MID, but, because of politicians’ incentive to maintain power through the status quo, would be more challenging to implement.

Create a renter’s tax credit.By focusing on homeowners, the MID excludes the large population of renters, who are disproportionately families of color. Currently more than three-fourths of federal housing subsidies go to homeowners, even though renters make up more than a third of the population and are at a higher risk of facing housing insecurity.²²The tax code could be used to create a renter’s credit, for example, by capping spending on rent at 30 percent of income for households making less than 80 percent of area median income.²³ The government could finance this credit with the money saved by lowering the cap on MID deductions.

Tie homeownership credit to residence in a minority community.Housing segregation, the legacy of redlining and exclusionist housing policies, underpins the gap in black and white home value. Since the MID is linked to the value of an individual’s home, it continues to widen this gap. Emory University Law professor Dorothy Brown has proposed giving the MID only to homeowners living in neighborhoods that are at least 10 percent black.²⁴This policy would use the tax code to counteract the gap in home pricing, rather than promote it. We recommend that this approach be tied to length of time of residence in a community or other similar measures to ensure it would not compound issues of displacement and gentrification.

Promote black wealth building.In the past 30 years, the average wealth of white families has grown by 84 percent, which was three times the growth rate for that of black families.²⁵Instead of exacerbating the racial wealth gap through the MID, the priority should be to close it with policies that promote black wealth building. One key method is to create programs that help black first-time homeowners purchase a home. Other policy strategies for building wealth could include expanding and strengthening the Earned Income Tax Credit (EITC), which has a high proportion of black recipients, or offering an easy-to-access retirement savings product to black families. The tax code can be used to counteract the concentration of wealth through strengthening estate and inheritance taxation, net worth taxation, and state-level estate taxation.²⁶Alternatively, programs that proactively create opportunities for wealth building could include opening a savings account with an initial government contribution and matched savings for every black child. These and others would be creative methods of providing reparations for the history of slavery and exploitation embedded in our financial system.

RETHINKING THE SYSTEM

The MID compounds and perpetuates racial and economic inequity. The solutions considered here would advance black homeownership and wealth building while supporting the incomes of renting families of color in various ways. However, they only support black families in a system largely controlled by white elites (through lending and renting), who continue to retain the majority of power across our financial system. In order to address this system-wide imbalance of power, there are bigger questions to be answered. Is there a path towards alternative systems of home financing that generate wealth for communities over corporations?

New models of non-extractive finance attempt to reject the tenets of capitalist lending practices. By following the values of a regenerative economy, organizations like Regenerative Finance, Movement Generation, and the Climate Justice Alliance promote and support economic and financial systems that (among other things) build power through community wealth, shift economic interests to the enterprise instead of the investor, drive social equity, restore indigenous sovereignty, and promote decolonization.²⁷Re-examining the values that underpin our lending practices would provide an opportunity for communities to begin to shift the ways in which oppressed groups are able to control their own collective financial well-being.

Thinking even more broadly, how can we attempt to mitigate, and eventually make up for, hundreds of years of enslavement, de jure and de facto oppression, and the continual systematic racism of our country’s institutions? Though reforming or eliminating the MID could slow the trend of the black-white wealth gap, these changes do not fully address the legacy of centuries of missed wealth-building opportunities for people of color in the United States. Creativity and critical analysis are required in designing future policies and programs to more fully address the racial wealth gap.

 

ENDNOTES

1. Derek Thompson. “The Shame of the Mortgage Interest Deduction.” The Atlantic, May 14, 2017, https://www.theatlantic.com/business/archive/2017/05/shame-mortgage-interest-deduction/526635/.

2. Will Fischer and Chye-Ching Huang. “Mortgage Interest Deduction Is Ripe for Reform.” The Center for Budget and Policy Priorities, June 23, 2013, https://www.cbpp.org/sites/default/files/atoms/files/4-4-13hous.pdf.

3. Matthew Desmond. “How Homeownership Became the Engine of American Inequality.” The New York Times, May 9 2017, https://www.nytimes.com/2017/05/09/magazine/how-homeownership-became-the-engine-of-american-inequality.html

4. “How The Mortgage Interest Deduction Is Changing Under The New Tax Bill,” The Washington Post, https://www.wsj.com/livecoverage/tax-bill-2017/card/1513387809https://www.wsj.com/livecoverage/tax-bill-2017/card/1513387809

5. Weissmann, Jordan. “Republicans Gutted the Mortgage Interest Deduction. Democrats Should Finish It Off.” Slate, April 24, 2018, https://slate.com/business/2018/04/its-time-for-the-mortgage-interest-deduction-to-go.html.

6. Lu, Chenxi and Eric Toder. “Effects of Reforms of the Home Mortgage Interest Deduction by Income Group and by State.” The Tax Policy Center, December 6, 2016, http://www.taxpolicycenter.org/sites/default/files/publication/136906/2001015-effects-of-reforms-of-the-home-mortgage-interest-deduction-by-income-group-and-by-state_0.pdf.

7. Will Fischer and Chye-Ching Huang. “Mortgage Interest Deduction Is Ripe for Reform.” The Center for Budget and Policy Priorities, June 23, 2013, https://www.cbpp.org/sites/default/files/atoms/files/4-4-13hous.pdf.

8. “Effects of Reforms on the Home Interest Deduction,” 1.

9. Joint Committee on Taxation.

10. Heather Long. “Is 100,000 ‘Middle Class’ In America?” The Washington Post, Oct. 25th,2017, https://www.washingtonpost.com/news/wonk/wp/2017/10/25/is-100000-middle-class-in-america/?utm_term=.54446e27f47b.

11. Will Fischer and Chye-Ching Huang. “Mortgage Interest Deduction Is Ripe for Reform.” The Center for Budget and Policy Priorities, June 23, 2013, https://www.cbpp.org/sites/default/files/atoms/files/4-4-13hous.pdf.

12. Dennis Ventry. “The Accidental Deduction: A History and Critique of The Tax Subsidy for Mortgage Interest.” Law And Contemporary Problems, Vol. 73. 2009, https://scholarship.law.duke.edu/cgi/viewcontent.cgi?article=1561&context=lcp, 235.

13. Ibid, 236.

14. George Lipsitz, The Possessive Investment in Whiteness: How White People Profit from Identity Politics (Philadelphia, PA: Temple University Press, 2006).

15. Dedrick Asante-Muhammad, Chuck Collins, Josh Hoxie, and Emanuel Nieves, The Road to Zero Wealth (Washington, DC: Institute for Policy Studies, 2017), https://prosperitynow.org/files/PDFs/road_to_zero_wealth.pdf.

16. Richard Rothstein, The Color of Law (New York: W. W. Norton & Company, 2017).

17. Asante-Muhammad, Collins, Hoxie, and Neives, 2017.

18. Laura Sullivan, Tatjana Meschede, Thomas Shapiro, and Maria Fernanda Escobar, Misdirected Investments: How the Mortgage Interest Deduction Drives Inequality and the Racial Wealth Gap (Waltham, MA: Institute on Assets and Social Policy, Brandeis University, 2017), https://iasp.brandeis.edu/pdfs/2017/NLIHC-IASP_MID-Report.pdf.

19. Lipsitz, 2006.

20. Matthew Desmond, “How Homeownership Became the Engine of American Inequality,” The New York Times, May 9, 2017.

21. Will Fischer and Chye-Ching Huang, Mortgage Interest Deduction is Ripe for Reform (Washington, DC: Center on Budget and Policy Priorities, June 25, 2013), https://www.cbpp.org/research/mortgage-interest-deduction-is-ripe-for-reform.

22. Fischer and Huang, 2013.

23. Carol Calante, Carolina Reid, and Nathaniel Decker, The FAIR Tax Credit: A Proposal for a Federal Assistance in Rental Credit to Support Low-Income Renters (Berkeley, CA: Terner Center for Housing Innovation, 2016), http://ternercenter.berkeley.edu/uploads/FAIR_Credit.pdf.

24. Emily Badger, “A radical idea to compensate black homeowners harmed by racial bias,” The Washington Post, June 21, 2016.

25. Dedrick Asante-Muhammad, Chuck Collins, Josh Hoxie, and Emanuel Nieves, The Ever-Growing Gap (Washington, DC: Institute for Policy Studies, 2016) http://www.ips-dc.org/wp-content/uploads/2016/08/The-Ever-Growing-Gap-CFED_IPS-Final-2.pdf

26. Asante-Muhammad, Collins, Hoxie, and Nieves, 2016.

27. “Regenerative Finance” http://regenerativefinance.com.