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Tax-Induced Portfolio Reshuffling: The Case of the Mortgage Interest Deduction
Abstract
Several provisions of the Tax Reform Act of 1986 had an indirect impact upon the demand for home mortgage debt. These include the elimination of the deductibility of interest on consumer credit, the increase in the standard deduction, and the reduction in the number of expenses that can be itemized. These provisions and the 1983-1989 panel sample of the Survey of Consumer Finances provide an opportunity to study the responsiveness of the demand for home mortgage debt to its tax status relative to the tax treatment of equity-financed investments in housing and consumer credit. The results are strongly supportive of a highly elastic demand for mortgage debt with respect to its tax price. The best point estimate of this elasticity is -1, but substantial variation is found among certain groups. More generally, the results provide strong support for the phenomenon of portfolio reshuffling. Copyright American Real Estate and Urban Economics Association.
... If the tax rules affecting mortgage interest deductions changed, it is likely that taxpayers would respond by making portfolio adjustments and altering the loan-to-value ratios on their homes. There is a substantial literature on the elasticity of household mortgage borrowing with respect to the after-tax cost of debt, with notable contributions including Follain and Dunsky (1997), Ling and McGill (1998), and Dunsky and Follain (2000). These studies suggest that households adjust their mortgage borrowing in response to changes in both mortgage interest rates and marginal tax rates, and they yield estimates of the price elasticity of demand for mortgage borrowing between -1.0 and -1.5. ...
... These studies suggest that households adjust their mortgage borrowing in response to changes in both mortgage interest rates and marginal tax rates, and they yield estimates of the price elasticity of demand for mortgage borrowing between -1.0 and -1.5. These are short-run elasticities, identified either from cross-sectional differences in household marginal tax rates or, in the case of Dunsky and Follain (2000), legislation-induced changes in marginal tax rates between 1983 and 1989. These estimates are subject to the standard criticism that applies to many household-level studies of behavioral response to taxation, namely that there may be unobserved variables associated with differences in marginal tax rates, particularly in the cross-section, that are also correlated with the demand for housing or for mortgage debt. ...
... These estimates are subject to the standard criticism that applies to many household-level studies of behavioral response to taxation, namely that there may be unobserved variables associated with differences in marginal tax rates, particularly in the cross-section, that are also correlated with the demand for housing or for mortgage debt. Follain and Dunsky (1997) and Dunsky and Follain (2000) also estimate long-run elasticities of mortgage demand using a partial adjustment model in tandem with the cross-sectional differences in marginal tax rates. The elasticities in this case are much larger, between three and four in absolute value. ...
We draw on household-level data from the 2004 Survey of Consumer Finances to analyze how changes in the income tax deduction for mortgage interest would affect the distribution of income tax liabilities and the consumption of housing services. Our primary innovation is to focus on the responses of household portfolios and the homeowner loan-to-value ratio to such tax changes. We estimate that repealing the mortgage interest deduction in 2003 would have raised federal and state income tax revenues by $72.4 billion in the absence of any household portfolio adjustments, but by only $58.5 billion if homeowners drew down a limited set of financial assets to partially pay down their mortgage debt. Allowing for such portfolio adjustments not only reduces the estimate of how much tax revenue would be generated by repealing the mortgage interest deduction, but also attenuates the negative effect of such a tax change on owner-occupied housing demand. Our results underscore the importance of recognizing behavioral responses when estimating the revenue effects of changes in the income tax provisions relating to owner-occupied housing.
... Other studies have examined the elasticity of mortgage borrowing as it relates to changes in mortgage interest rates and changes in tax brackets (Follain & Dunsky, 1997;Ling & McGill, 1998;Dunsky & Follain, 2000). Dunsky and Follain (2000) and Follain and Dunsky (1997) find that the elasticity of demand for mortgage debt with respect to marginal tax rates is rather high within a range of -1 to -1.5. ...
... Other studies have examined the elasticity of mortgage borrowing as it relates to changes in mortgage interest rates and changes in tax brackets (Follain & Dunsky, 1997;Ling & McGill, 1998;Dunsky & Follain, 2000). Dunsky and Follain (2000) and Follain and Dunsky (1997) find that the elasticity of demand for mortgage debt with respect to marginal tax rates is rather high within a range of -1 to -1.5. For example, at an elasticity of -1.5, a 3 percent increase in marginal tax rates causes a 4.5 percent decrease in demand for mortgage debt. ...
... Other studies have examined the elasticity of mortgage borrowing as it relates to changes in mortgage interest rates and changes in tax brackets (Follain & Dunsky, 1997;Ling & McGill, 1998;Dunsky & Follain, 2000). Dunsky and Follain (2000) and Follain and Dunsky (1997) find that the elasticity of demand for mortgage debt with respect to marginal tax rates is rather high within a range of -1 to -1.5. ...
... Other studies have examined the elasticity of mortgage borrowing as it relates to changes in mortgage interest rates and changes in tax brackets (Follain & Dunsky, 1997;Ling & McGill, 1998;Dunsky & Follain, 2000). Dunsky and Follain (2000) and Follain and Dunsky (1997) find that the elasticity of demand for mortgage debt with respect to marginal tax rates is rather high within a range of -1 to -1.5. For example, at an elasticity of -1.5, a 3 percent increase in marginal tax rates causes a 4.5 percent decrease in demand for mortgage debt. ...
... The Executive Office of the President (2011) estimates that the MID amounts to $98.5 billion in foregone revenues in 2012, and $609 billion between 2012 and 2016. There is a large and growing literature suggesting that the MID distorts housing market decisions, mainly by increasing the demand for mortgage debt in favor of equity financing (Jones 1995;Ling & McGill 1998;Dunsky & Follain 2000;Hendershott & Pryce 2006;Poterba & Sinai 2011), or increasing the size of home (Hanson 2012b). 1 The MID may also distort decisions by inducing renters to become owners, incentivizing the purchase of a second home, purchasing a larger lot, choosing a longer term mortgage, changing the speed that debt is paid off, and inducing those who would otherwise claim the standard deduction to itemize their tax deductions (or to increase other itemized deductions). The existing body of work on the distortions caused by the MID may not be sufficient to measure the full deadweight loss from the subsidy because it does not jointly capture all of these distortions. ...
... They find that mortgage debt is highly sensitive to the potential tax savings it offers. Dunsky and Follain (1997;2000) examine the impact of the Tax Reform Act of 1986 (TRA86) on the demand for mortgage debt using data from the Survey of Consumer Finances. TRA86 made tax savings on mortgage interest generally smaller by lowering marginal rates and increasing the standard deduction. ...
Housing market distortions from the mortgage interest deduction (MID) typically focus on a single choice measure such as home size or self-reported amount of debt on a new mortgage. We estimate the amount of mortgage interest deducted on federal tax returns to capture the full range of housing market distortions from the MID. Our primary results show that for every one percentage point increase in the tax rate that applies to deductibility, the amount of mortgage interest deducted increases by US$303 to US$590. Empirical estimates imply elasticities of mortgage interest deducted with respect to the after-tax cost of housing between −0.78 and −1.62, and deadweight loss estimates ranging from 16 to 36 percent of MID tax expenditure.
... However, Gruber et al (2021) find no effect on homeownership after an enactment of more favorable mortgage treatment in Denmark, although they do find that it increases housing demand and loan to value ratios. Ling and McGill (1998) and Dunsky and Follain (2000) examine the US Tax Reform Act of 1986 and find strong (up to unit elastic) responses to the increased cost of mortgage debt. Jappelli and Pistaferri (2007) look at a tax reform that reduced a mortgage interest deduction in Italy and find no evidence of change on either the intensive or extensive margin, which they attribute to borrowing constraints and lack of knowledge about the policy change. ...
This dissertation contains three essays that use reduced form techniques to examine how taxation shapes residential housing markets. Chapter I studies how homebuyers responded to changes in the US federal tax treatment of housing. Chapter II focuses on the capitalization of property taxes into housing prices. Chapter III investigates the presence of cognitive bias with respect to the size of recurring future payments in residential housing markets. The US tax code contains provisions that significantly reduce homeownership costs, including by allowing itemizing income tax payers to deduct property tax and mortgage interest payments from their taxable income. The Tax Cuts and Jobs Act of 2017 capped these deductions and raised the standard deduction, which increased the real cost of property taxes and mortgages for a subset of taxpayers. This shift in the tax law was the most significant change in the US federal tax treatment of homeownership since the Tax Reform Act of 1986. Chapter I and Chapter II of this dissertation study the impact of this change in the law on residential housing markets. In the first chapter, "The Impact of the Tax Cuts and Jobs Act on Residential Housing Choices", I examine how individual homebuyers responded to these changes. The data used in this chapter was constructed by matching of home loan records to deeds and mortgage documents in New Jersey's Middlesex County. Employing a continuous difference in differences estimation technique, this chapter shows that homebuyers responded by purchasing smaller homes with lower property tax burdens, with the level of response indicating that the price elasticity of housing demand is approximately unit elastic. Homebuyers also reduced the size of their home loans (relative to sale price) by the equivalent of the response to a two percentage point increase in interest rates. The second chapter, "Housing Prices and Deductibility of Property Taxes: Evidence from the Tax Cuts and Jobs Act", focuses on how residential housing prices responded to these changes. Using the universe of residential home sales in New Jersey and employing a repeat sales model, this paper estimates that home prices in high-property tax areas fell by an amount corresponding to 70 percent of the increase in property tax liabilities. Chapter III, "Left Digit Bias in Property Taxes", provides evidence of left digit bias in the housing market when it comes to anticipated future property tax payments. Left digit bias is a well documented cognitive bias wherein individuals overemphasize the left-most digit of a number. Left digit bias means that if one considers all possible pairs of numbers which differ by the same amount, the difference between pairs with different leftmost digits will be perceived as larger than the difference in pairs with identical leftmost digits. Using a regression discontinuity technique, this chapter shows that homes with property taxes just over a $1,000 threshold sell for 0.5% less than homes with property taxes just under a $1,000 threshold. This bias amounts to homeowners overpaying for homes by an average of $1,672. This chapter provides evidence that even in high-cost situations, individuals appear to exhibit bounded rationality.
... IES is a parameter of central importance in macroeconomics and finance and estimates of its magnitude vary. 37 The estimates of IES range widely from an elasticity of around zero (e.g., Jappelli and Pistaferri, 2007;Best et al., 2020) to an elasticity of about one (e.g., Dunsky and Follain, 2000) and 1.5-3.5 (e.g., Follain and Dunsky, 1997;Bansal and Yaron, 2004), to as high as 3.8 estimated in an influential article by Imai and Keane (2004). ...
We analyze how the life settlement market—the secondary market for life insurance—may affect consumer welfare in a dynamic equilibrium model of life insurance with one-sided commitment and overconfident policyholders. In our model, policyholders may lapse their life insurance policies when they lose their bequest motives; however, they are overconfident in the sense that they may underestimate the probability of losing their bequest motives. We show that in the competitive equilibrium without life settlement, overconfident consumers will buy life insurance contracts with “too much” reclassification risk insurance for later periods. The life settlement market can impose a limit on the extent to which primary insurers can exploit overconfident consumers. We show that the life settlement market may increase the equilibrium consumer welfare of overconfident consumers when they are sufficiently “vulnerable” in the sense that they have a sufficiently large intertemporal elasticity of substitution of consumption. Our result is robust to alternative specifications where (i) insurers cannot observe the subjective or objective probability that policyholders will lose their bequest motives; (ii) insurers can include health-contingent cash surrender values (CSVs) in the life insurance contract; and (iii) policyholders underestimate their future mortality risk.
... The Hendershott and Pryce (2006) estimates rely on creating a two-stage model that uses a predicted probability a home-buyer decides to purchase a home above the deductibility limit. Follain and Dunsky (1997) and Dunsky and Follain (2000) examine the sensitivity of mortgage borrowing to tax treatment changes using data from the Survey of Consumer Finances and variation in estimated individual marginal tax rates that occurs because of the Tax Reform Act of 1986. This paper identifies the average effect of the MID on borrower behavior using the budget constraint kink in net-of-tax interest rates created by the $1 million limit on tax deductibility of mortgage interest. ...
This paper estimates the behavioral response to mortgage interest tax deductibility by studying the discrete change in the net-of-tax marginal interest rate that occurs at $1 million in mortgage debt. Using data on 2004-2016 mortgage originations, I estimate excess bunching in the loan distribution based on a counterfactual that accounts for bunching at salient loan amounts. Findings suggest excess of about 54,000 loans at the deductibility limit, or 4.4% of the sample. The level of bunching implies an average reduction in borrowing around the $1 million limit of 9.4 percent, and mortgage demand elasticities between -0.132 to -0.115 for home purchase loans. Estimated elasticities imply that from 2004-2016 the MID induced $49.52 billion in deadweight loss in the mortgage market.
... In addition, factors characterising housing market, especially house prices, should be taken into consideration, too -see e.g. Debelle (2004), Jacobsen and Naug (2004), Girouard, Kennedy, and André (2006), Dynan and Kohn (2007), ECB (2009), André (2010) or Bokhari, Torous, andWheaton (2013). ...
This article presents results of the analysis of the relationship between the tax relief for the homeownership and the household mortgage debt. The advantageous treatment of housing is provided especially by a personal income tax if owner-occupiers do not report imputed rents as income but can deduct mortgage interest costs. This preferred tax status is justifi ed by the existence of positive externalities and a desire to enhance housing opportunities available to citizens. However, evidence that the housing policy via the taxation achieves its objectives is still weak. Moreover the tax provisions for the homeownership benefi t rather higher-income households. Furthermore there are indications that the housing taxation encourages levered property purchases and thus contributes to the household debt growth. Since the household indebtedness can have adverse effects on households and macroeconomic performance we focused on the issue whether the income tax relief for homeowners that fi nance their dwellings via a mortgage does affect the household leverage. We constructed the variable capturing especially the mortgage interest payments deductibility. We employed the multiple regression and data for the former 15 EU member countries (except Greece) for the period 2004-2013. We estimated two models for two representative taxpayers who vary in a family status using the panel data analysis with fi xed effects. From our results we inferred that the income tax relief for the homeownership might not have infl uenced the mortgage leverage signifi cantly in the selected European countries in the given period. The mortgage debt was affected rather by the economic level, price of own housing, mortgage interest payments or demographic structure.
... In this article, we estimate the relationship between household wealth and tax breaks from the MID using the 2010 Survey of Consumer Finances (SCF (Follain and Dunsky, 1997;Ling and McGill, 1998;Dunsky and Follain, 2000). ...
... For the effect of mortgage subsidies on LTVs seeFollain and Dunsky (1997),Ling and McGill (1998),Dunsky and Follain (2000), and Hendershot,Pryce and White (2002). ...
Mortgage subsidies affect homeownership costs by reducing effective mortgage rates and increasing house prices. I show analytically the role of mortgage subsidies in determining house price changes, economic incidence, and efficiency costs using a theoretical framework for applied welfare analysis. I derive simple expressions for these effects, as functions of reduced-form sufficient statistics, which I use to measure the effects from eliminating mortgage deductions. My main results characterize the distributional impact of mortgage subsidies among buyers and owners and how house price responses attenuate efficiency losses. My results provide broader methodological insights into the welfare analysis of credit policies.
... In other related work, Martins and Villanueva (2006) estimate how the extensive margin probability of obtaining a mortgage responds to an interest rate subsidy for low-income households in Portugal but do not report direct estimates of the effects on loan size. Similarly, several others including Follain and Dunsky (1997), Ling and McGill (1998), Dunsky and Follain (2000), and Jappelli and Pistaferri (2007) have estimated how mortgage debt responds to changes in the rate at which interest expenses can be deducted from personal income but do not focus explicitly on effective interest rates themselves. 2 See Zinman (2015) for a review of the empirical literature on demand elasticities in consumer credit markets. 3 Many papers have attempted to overcome this challenge using a variety of empirical methods. ...
This dissertation consists of three self-contained chapters that study various interactions between the housing market, mortgage choice, and public policy. The first chapter studies how changes to the collateral value of real estate assets affect homeowner borrowing. While previous research has documented a positive relationship between house prices and home-equity based borrowing, a key empirical challenge has been to disentangle the role of collateral constraints from that of wealth effects in generating this relationship. To isolate the role of collateral constraints, I exploit the fully anticipated expiration of resale price controls created through an inclusionary zoning regulation in Montgomery County, Maryland. I estimate that the marginal propensity to borrow out of increases in housing collateral is between $0.04 and $0.13. The magnitude of this effect is correlated with a homeowner's initial leverage and additional analysis of residential investment and ex-post loan performance further suggests that borrowers used some portion of the extracted funds to finance current consumption and investment expenditures. These results highlight the importance of collateral constraints for homeowner borrowing and suggest a potentially important role for house price growth in driving aggregate consumption.
The second chapter, co-authored with Andrew Paciorek, provides novel estimates of the interest rate elasticity of mortgage demand by measuring the extent to which households "bunch" at a discrete jump in interest rates generated by the conforming loan limit. Our estimates imply that a 1 percentage point increase in the rate on a 30-year fixed-rate mortgage reduces first mortgage demand by between 2 and 3 percent. One-third of this response is driven by borrowers who take out second mortgages, which implies that total mortgage debt only declines by 1.5 to 2 percent.
The third chapter, co-authored with Joseph Gyourko, Fernando Ferreira, and Wenjie Ding, uses extensive micro data to investigate whether contagion was an important factor in the last housing cycle. Our estimates provide evidence of contagion during the housing boom, but not during the bust. We also find that contagion effects are greater when transmitted from a larger to a smaller market, and are more important for the most elastically-supplied markets. Local fundamentals and expectations of future fundamentals have limited ability to account for our estimated effect.
... There is evidence that countries offering more favourable tax treatment for home ownership do indeed have higher ratios of mortgage debt ( Figure 2). Analyses for the UK (Hendershott, Price and White, 2003) and the US (Dunsky and Follain, 2000) confirm that mortgages fell significantly relative to home value after reforms reducing the value of mortgage interest relief. Of course, other factors are also at work, notably regulatory limits on maximum loan-to-value ratios of realistic appraisals. ...
Did taxation have any role in precipitating the financial crisis? Are there lessons to be drawn for tax reform once the crisis has passed? This chapter reviews the main channels by which tax effects might have been felt, and which may require forceful attention. These include, in particular, the large tax biases favouring debt finance, and, in some countries, investment in housing. The complexities of national tax codes, and the international interaction of these, have, moreover, encouraged the use of complicated financial instruments and international tax planning, reducing transparency. Tax distortions did not trigger the 2008 crisis-in the sense that there are no obvious tax changes likely to have triggered it-but they are likely to have contributed by leading to higher leverage and more complexity than would otherwise have been the case. Most of these distortions have long been a source of concern, but dealing with them may be more important than previously supposed.
... Theoretically, mortgage interest tax deductibility, by encouraging debt-financing, may lead to higher household debt and more leveraged loans, and, in turn, to more severe financial sector distress during real estate downturns. Empirically, tax reforms that reduce the value of mortgage interest relief have been shown to lead to lower loan-to-value ratios (see Hendershott et al., 2003, for the United Kingdom and Dunsky and Follain, 2000, for the United States). And, they are estimated to cause an immediate decline in house prices of around 10 percent (see Agell et al., 1995, for Sweden and Capozza et al., 1996, for the United States). ...
... Their dynamic simulation, however, allows households to adjust their portfolios and derives a much smaller revenue gain of just $4.8 billion. Dunsky and Follain (2000) also provide evidence that mortgage holders reshuffle their portfolios in response to changes in effective tax rates. ...
The effect of mortgage interest and local property tax deductions upon single-family housing demand in the U.S. is examined for the 1994-2003 period. A multi-equation model is developed to simulate the impacts from partial and complete elimination of the deductions. The results indicate that the deductions have moderate effects on housing demand. Complete elimination of the deductions could result in as much as a 12 percent decline in the annual number of single-family housing units that are purchased.
... Although this exercise is not identical to the demand we have in 37 We distinguish this elasticity from the price elasticity of the aggregate household demand for mortgage debt. Follain and Dunsky (1998) and Dunsky and Follain (2000) find evidence of an elasticity of the demand for the tax price of mortgage debt to be quite elastic and as high as 2 to 3. The price elasticity of the demand among different suppliers would be expected to be much higher. This is driven by the market price of debt versus equity and other factors. ...
... The FICO scores are scaled by 100, such that the smallest value is 4.00 and the largest value is 8.50. Unlike the baseline or seasoning function, the spline knots for the loan size and OLTV are chosen at expected kinks in the household demand function for mortgage debt (Dunsky and Follain, 2000) and standard underwriting requirements. ...
There are three integral components to value a fixed rate mortgage loan: (1) the mortgagors' American straddle option on the underling loan, (a call option to refinance and a put option to default); (2) the mortgagors' heterogeneous behavior in exercising the options inefficiently; and (3) the market price of risk, (the option adjusted spread (OAS)). Despite the dominance of mortgages in the capital market, scant research considers the valuation of mortgage loans while taking these three components into consideration, a contribution of this paper. Specifically, this paper uses a multinomial logit model to describe the mortgagors' behavior in dealing with the competing refinancing and default risks, and then utilizes a two factor arbitrage-free interest rate model to value the mortgages. The paper shows that the prepayment-default model has significant explanatory power. Using the mortgage loan prices at origination, the model shows that OAS and duration depend on the FICO score, original loan-to-value ratio, the loan size and the recovery ratio. Lastly, a model of the economic value of a loan default guarantee is specified and the model shows that the price elasticities of the guarantee with respect to the loan size and the borrower's FICO score are-0.46 and-11.89 respectively.
... These innovations helped to reduce the risks for mortgage lenders and lowered the costs of mortgages (Van Order, 2001). Second, the Tax Reform Act of 1986 phased out the deductibility of most non-mortgage interest, leading to a shift of consumer debt towards mortgages, including home equity lines (Dunsky & Follain, 2000; Stango, 1999). Greater financial deregulation, among other factors, typically results in greater international capital inflows, e.g. ...
... Raises leverage and housing consumption. Various empirical studies found strong evidence that household leverage is highly sensitive to the tax advantage created by interest rate deductibility (Dunsky and Follain, 2000; Follain and Dunsky, 1997; Follain and Ling, 1991; Ling and McGill, 1998; and Hendershott, Pryce, and White 2003). These studies show that removing interest deductibility provides a strong incentive to homeowners with existing loans to pay off their loans and causes new homeowners to choose loans with less leverage. ...
This paper investigates the role of government intervention in achieving the American dream of homeownership. The study analyzes the role of tax deductions in housing finance, including their impact on homeownership and housing consumption. The role of the Government Sponsored Enterprises in facilitating the creation of a secondary market for mortgage-backed securities is also analyzed as well as the role of the Federal Housing Administration. Cross-country comparisons of how housing is financed in other industrial countries is also provided, emphasizing how other countries have been able to achieve comparable homeownership rates as the United States in a less complicated and fiscally cheaper system. Country experiences of successfully phasing out government intervention are also analyzed.
... Tax reforms that reduce the value of mortgage interest relief can lead to lower loan-to-value ratios, pointing to the role of tax incentives favoring debt-financed homeownership (see Hendershott et al., 2003, for the U.K. and Dunsky and Follain, 2000, for the U.S.). Tax reforms advocating removal or reduction of this tax shelter are estimated to cause around 10 percent immediate decline in house prices (see Agell et al., 1995, for Sweden and Capozza et al., 1996, for the U.S.). ...
The financial crisis showed, once again, that neglecting real estate booms can have disastrous consequences. In this paper, we spell out the circumstances under which a more active policy agenda on this front would be justified. Then, we offer insights on the pros and cons as well as implementation challenges of various policy tools that can be used to contain the damage to the financial system and the economy from real estate boom-bust episodes. These insights derive from econometric analysis, when possible, and case studies of country experiences. Broadly, booms financed through credit and involving leverage are more likely to warrant a policy response. In that context, macroprudential measures can be targeted more precisely to specific sources of risk, but they may prove ineffective because of circumvention. In that case, monetary policy may have to be used to lean against the wind. (c) 2013 Elsevier B.V. All rights reserved.
The US mortgage interest deduction (MID) allows homeowners to deduct the interest paid on their mortgages from their federal tax returns, provided that they itemize deductions. Since the benefit depends on a taxpayer’s marginal tax rate, which increases with income, the MID is an “upside-down subsidy” that becomes more valuable for higher-income homeowners. I analyze the implications of converting the US MID to a mortgage interest credit (MIC) and evaluate the effects on federal revenue and the distribution of income. I argue that a MIC could be better targeted at low- and middle-income taxpayers on the margin of homeownership while also being more progressive and less expensive than the current MID.
Conventional estimates of the size and distribution of the mortgage interest deduction (MID) in the personal income tax fail to account for potentially important responses in household behavior, and thus overstate the increase in revenues and the progressivity associated with eliminating the MID. Were the MID to be eliminated, households would sell financial assets to pay down their mortgage debt, and the smaller holdings of these taxable assets would offset some of the revenue gains from taxing mortgage interest. We build on previous work that estimates the consequences of removing the MID using a framework that allows for portfolio rebalancing. Our estimates of the revenue loss of the MID are robust to various assumptions about household rebalancing behavior and the ratio of the conventional estimate to the rebalancing estimate is relatively stable over time. Based on these findings, we provide a rule of thumb for policymakers for estimating behavioral responses to changes in the MID.
Using a major reform that scaled back the mortgage interest deduction for middle- and high-income households in Denmark, we study how tax subsidies affect housing decisions. We present four main findings. First, the mortgage deduction has a precisely estimated zero effect on homeownership for high- and middle-income households. Second, the mortgage deduction has a clear effect on housing demand at the intensive margin, inducing homeowners to buy larger and more expensive houses. Third, the deduction has sizeable effects on household financial decisions, inducing them to increase indebtedness. Finally, the reduction of the tax subsidy lowered equilibrium house prices. (JEL G21, G51, H24, K34, R21, R31)
Using a novel source of quasi-experimental variation in interest rates, we develop a new approach to estimating the Elasticity of Intertemporal Substitution (EIS). In the U.K., the mortgage interest rate features discrete jumps—notches—at thresholds for the loan-to-value (LTV) ratio. These notches generate large bunching below the critical LTV thresholds and missing mass above them. We develop a dynamic model that links these empirical moments to the underlying structural EIS. The average EIS is small, around 0.1, and quite homogeneous in the population. This finding is robust to structural assumptions and can allow for uncertainty, a wide range of risk preferences, portfolio reallocation, liquidity constraints, present bias, and optimization frictions. Our findings have implications for the numerous calibration studies that rely on larger values of the EIS.
Between 1980 and 2015, older households in the US more than tripled the use of home mortgage debt. Rather than using owned homes as a source of imputed rent, older households are borrowing against home equity, with loan terms that exceed their expected life spans. Using several data sources, we explore the rising use of mortgages among elderly homeowners. Rising mortgage borrowing provides low-wealth older households with increased liquid assets, but it does not appear to be meaningfully associated with increases in loan defaults. This trend of elderly mortgage borrowing is not explained by increasing levels of income or cohort demographic shifts, but is linked to a rise on ownership of homes by older households in general. However, changes in subsidies associated with mortgage debt partially contribute to differential increases in mortgage use by older households.
The mortgage interest deduction (MID) is the largest source of US federal homeowner support. I estimate that this tax expenditure fluctuated between 0.2 and 0.9 percent of gross domestic product (GDP) over the past five decades. About half of these fluctuations were caused by changes in tax policy, rather than changes in the housing market. Fluctuations in the MID tax expenditure do not tend to move with homeownership rates; instead, they are procyclical, meaning the MID may exacerbate business cycles.
We study the effect of tax expenditures on the stabilizing power of the tax system. We propose a micro-simulation strategy that exploits links that we identify between automatic stabilizers, tax expenditures, and effective marginal tax rates. Using U.S. tax return micro data from 2000 to 2010, we estimate that, on average, the mortgage interest deduction and the charitable contributions deduction decreased the ability of the tax system to absorb fluctuations in aggregate consumption by an average of 7.4 percent and 3.9 percent, respectively.
Purpose
The purpose of this paper is twofold: first, it derives the optimal loan-to-value (LTV)-ratio for a mortgagor that maximizes the return to home equity when considering the capital structure of housing investment. Second, it analyses the demand-side contribution to mortgage market variability across monetary policy regimes.
Design/methodology/approach
The paper endogenizes both the relation between the LTV ratio and the mortgage rate and the relation between LTV and the rate of appreciation. When we consider LTV-variance and the demand-side contribution to mortgage market variability, three stylized regimes is considered.
Findings
The paper finds an intuitive ranking of the optimal LTV-ratios across regimes, and the optimal LTV-ratio peaks during a housing boom. When, however, monetary policy ignores asset inflation the demand-side contribution to market variability is highest during normal market conditions. Hence, there is a potentially hump-shaped relation between the risk exposure of individual mortgagors and the demand-side contribution to mortgage market variability.
Originality/value
The paper finds a potentially hump-shaped relation between the risk exposure of individual mortgagors and the demand-side contribution to mortgage market variability, which, to the best of our knowledge, is novel. The paper shows how macro-prudential and monetary policy are complementary tolls for preserving financial stability.
This paper provides novel estimates of the interest rate elasticity of mortgage demand by measuring the degree of bunching in response to a discrete jump in interest rates at the conforming loan limit-the maximum loan size eligible for purchase by Fannie Mae and Freddie Mac. The estimates indicate that a 1 percentage point increase in the rate on a 30-year fixed-rate mortgage reduces first mortgage demand by between 2 and 3 percent. One-third of this response is driven by borrowers who take out second mortgages, which implies that total mortgage debt only declines by 1.5 to 2 percent.
For the better part of the past three decades, the US economy has been characterized by a growing income disparity. Rising inequality has taken two forms. The share of national income that has gone to employee compensation has tended to decline, and the distribution of this shrinking share of the pie has become more unequal.
People’s exposure to both labor and financial market risks has increased since the 1980s, while labor and financial markets have also become more unstable. The combination of growing risk exposure and rising risks has contributed to increasing wealth inequality, as households with high risk exposure have experienced lower wealth gains over time than households without high risk exposure. In this chapter, I focus on some of the mechanics of rising financial risk exposure with individualized savings, such as retirement savings accounts and housing.
The United States directly provides fewer public benefits such as Social Security than other countries.2 However, it foregoes a much larger share of tax revenue to incentivize private savings in addition to public benefits than is the case in other countries. The US welfare state as a result tends to be as large or larger than that in Western Europe,3 with savings incentives—tax breaks for individual savings and insurance— taking on a much larger role.
We simulate changes to metropolitan area home prices from reforming the Mortgage Interest Deduction (MID). Price simulations are based on an extended user cost model that incorporates two dimensions of behavioral change in home buyers: sensitivity of borrowing and the propensity to use tax deductions. We simulate prices with both inelastic and elastic supply. Our results show a wide range of price effects across metropolitan areas and prospective policies. Considering behavioral change and no supply elasticity, eliminating the MID results in average home price declines as steep as 13.5% in Washington, D.C., and as small as 3.5% in Miami-Fort Lauderdale, FL. Converting the MID to a 15% refundable credit reduces prices by as much as 1.4% in San Jose, CA, San Francisco, CA, and Washington, D.C. and increases average price in other metropolitan areas by as much as 12.1% (Miami-Fort Lauderdale). Accounting for market elasticities produces price estimates that are on average 36% as large as standard estimates.
Households face complicated financial choices with respect to housing, one of which is the choice of type of mortgage, if any, to use when purchasing a property. This is rendered all the more complex by the great variety of mortgage contracts (mortgage instruments available). Yet mortgage choices also involve the decision on how fast to repay, whether to pay off the debt early, refinance, or even default on the loan. This article looks at those approaches to the analysis of mortgage choice based upon the rational utility maximising framework of economics. Mortgage demand, or the size of debt, is also central or related to these decisions. Brueckner (1994) has made a significant contribution to the analysis of mortgage demand under certainty and uncertainty and these models are often used to guide empirical analysis. There is also much formal modelling of the choice of mortgage instrument, including the risky context of this choice involving variable house prices, interest rates, and incomes. The analysis of prepayment and default decisions (assuming that they are voluntary choices) has been important for the valuation of securitised mortgage debt, but also for understanding household behaviour. The key theme of this article is that all of these decisions, with their sophisticated theoretical and econometric models, are very much interrelated. Imperfect capital markets and imbalances of information underpin this interdependence. Though other approaches to decision making, both psychological and sociological, are important, the classical approach can still offer great insight into the logic of this critical set of financial choices.
After 1995, the United States experienced housing and mortgage booms, fuelled by increased lending from less regulated institutions, such as hedge funds. At the micro level, the housing boom may have left families with more wealth, but the mortgage boom may have increased their financial vulnerability. Using the Federal Reserve's Survey of Consumer Finances, we consider both wealth creation and a select number of financial vulnerability measures of homeowners. The data indicate that the housing boom was not only associated with larger house values, but also moderated wealth gains and substantially greater financial vulnerability of homeowners. Both trends were more pronounced among middle-income and Hispanic families, who saw larger wealth gains, but also greater increases in financial vulnerability than their counterparts. Given the breadth of the spread in homeowners' financial vulnerability alongside sharply higher house prices, our results support the link between more deregulated financial markets and rising financial instability.
DISCLAIMER: This Staff Discussion Note represents the views of the authors and does not necessarily represent IMF views or IMF policy. The views expressed herein should be attributed to the authors and not to the IMF, its Executive Board, or its management. Staff Discussion Notes are published to elicit comments and to further debate.
We examine whether “kiddie tax” legislation in Canada, effective as of 2000, deters income splitting between parents and minor children by taxing at the top marginal rate certain types of non-labor income received by children. OLS estimates based on cross-province and time-series data reveal that the share of dividend income reported by children aged 19 and under declines by 86 % after the introduction of this anti-avoidance rule. The estimates also reveal that the share of capital gains (income not covered by the legislation) reported by minor children increases by 70 % in the post-legislation period, suggesting that parents are switching to an alternative income splitting technique. However, the latter percentage effect is on a small base, and thus, the decrease in dividend income is much larger than the increase in capital gains income. Hence, our analysis suggests that the “kiddie tax” is an effective method to deter income splitting.
The book employs qualitative/quantitative approaches to define problems and to develop suggestions for Turkish mortgage market and housing finance system. In qualitative analysis, we define that existing mortgage system has not provided sufficient background for both market development and solution of housing question of mid/lower income groups. Lack of efficient subsidy scheme and income/wealth constraints of the households are essential reasons of this failure. Research also suggests that an integrated mechanism, involving market based housing supply/finance mechanism and Housing Development Agency’s (TOKI) system, would be useful to develop institutional housing finance and to solve housing puzzle of mid/lower income groups. In quantitative analysis, we scrutinize causal relationship between volume of housing credit and macroeconomic indicators over the period (2005: 01)-(2011: 09). By using monthly data, we employ ADF, VaR analysis, cointegration analysis, VECM, Granger causality tests, impulse-response functions and variance decomposition models. Below conclusions may be drawn from the emprical research. First, housing credit is negatively cointegrated with housing credit real interest rate (RFO) and positively cointegrated with the monetary aggregate (M2), residential buildings floor area according to occupancy permits (KI), and real GDP per person (KB). The findings generally suggest that mortgage market has complicated interactions with macroeconomy. Secondly, it is determined that occupancy permit, as proxy of housing demand and activity level of housing market, is the most critical policy instrument and performance indicator of Turkish housing market. Moreover, based on determinations on M2/KB, findings suggest that policies aim to minimize income/wealth inequalities may also support housing credit growth and hence development of institutional housing finance in Turkey.
The US President's Advisory Panel on Federal Tax Reform has recommended changes to income tax concessions for homeowners. Consistent with the opinions of many economists, the tax reform panel concluded that the existing tax concessions are not particularly effective. The housing and mortgage industry have opposed the reforms, in part due to a fear that the reforms will reduce the homeownership rate. In this paper, 1998 American Housing Survey data are used to estimate a tenure choice equation and to simulate hypothetical changes in tax concessions. Focusing on young households who are likely to be on the margin between renting and owning, it is concluded that the mortgage interest and property tax deductions reduce the homeownership rate for these households due to effects on house prices. The tax credit proposed by the Advisory Panel would be likely to have a similar effect.
Did taxation play any role in precipitating the financial crisis? Are there lessons to be drawn for future tax reform priorities? This paper reviews the main channels by which tax effects might have been felt and which may require forceful attention. These include in particular the large tax biases favouring debt finance and, in some countries, investment in housing. The complexities of national tax codes, and the international interaction between them, have, moreover, encouraged the use of complicated financial instruments and international tax planning, reducing transparency. Tax distortions did not cause the crisis – in the sense that there are no obvious tax changes likely to have triggered it – but they may well have contributed by leading to higher leverage and more complexity than would otherwise have been the case. Most of these distortions have long been a source of concern, but dealing with them may be more important than previously supposed.
Changes in credit market architecture are an important but unobservable structural influence on economic activity. For Australian data, we model non-price credit supply conditions within equilibrium correction models of consumption, house prices, mortgage credit and housing equity withdrawal. Our "latent interactive variable equation system" (LIVES) employs a single latent variable to capture evolutionary shifts (in credit conditions) that affect not only the intercept of each equation, but also interact with key economic variables. We show that credit conditions impact on consumption by: (i) lowering the mortgage downpayment constraint facing young households; (ii) introducing a housing collateral channel from house prices to real activity; and (iii) facilitating intertemporal consumption smoothing.
With an annual growth rate of 0.62 per cent since 1980, Taiwan's homeownership rate reached 88 per cent in 2007. This study explores possible causes of Taiwan's high homeownership rates. The institutional and economic context for tenure choice in Taiwan is reviewed, paying particular attention to the taxation and financing of owner-occupied housing, house prices relative to rents, housing subsidies and housing demand. A model of tenure choice is estimated and then used to simulate policy and other changes. It is concluded that Taiwan's high rate of homeownership is due primarily to the low user cost of owner-occupied housing, which is due in part to house price inflation. Government mortgage subsidy policies designed to support ownership appear to have little effect.
Many economists and policy analysts argue that broadening the tax base is one of the most efficient ways to raise income tax revenues. Current tax deductions, credits, and exclusions, which are collectively known as "tax expenditures," reduce tax revenues and create complicated incentives that affect the ways taxpayers earn and spend their incomes. Because these tax provisions distort behavior relative to a neutral tax code, it is possible that eliminating some or all of them could simultaneously raise revenue and reduce tax-induced distortions of economic activity. Sweeping changes in tax expenditures have been recommended in several recent high profile reform proposals. The papers in this special issue of the National Tax Journal examine the revenue effects of the distribution of benefits from, and the efficiency costs of current tax expenditures. These papers will be a valuable input for the analysis of potential reforms, and will help to identify unresolved issues that deserve further research attention.
The 1993 Finnish tax reform reduced the incentives to use mortgage financing in home acquisition for high-income households. Before the reform, mortgage interest was deductible according to a progressive schedule which meant that the benefit from the deduction was the greater the higher was the taxpayer 's marginal income tax rate. After the reform, the deduction is made according to a flat schedule and the benefit no longer depends on taxpayer 's marginal income tax rate. This setting can be seen as a natural experiment, where one can distinguish multiple treatment groups and a control group. This paper uses household level repeated cross-section data from before and after the reform to study whether Finnish households responded to these changes in incentives to borrow. The results, based on difference-in-differences estimates, show that high income households with high marginal tax rates responded to the reform by clearly reducing their mortgage borrowing compared to the control group which was unaffected by the reform.
The personal bankruptcy rate increased more than fourfold in the last quarter century. Other measures of economic distress, particularly foreclosure and credit default rates, also increased sharply. A possible explanation for this is greater household indebtedness. Household debt relative to income, however, did not even double over the same period, suggesting that the aggregate increase in household economic distress was disproportionate to the rise in household debt. We consider if the simultaneous increase in income inequality has contributed to the rise in household economic distress, Specifically, we hypothesize that greater inequality led to a larger expansion of credit, especially in the form of credit card debt, among low and moderate income households than among higher income ones. This expansion of disproportionately more expensive credit may have contributed to the growth in household economic distress. Based on data from 1980 to 2004, we find robust evidence for a link between inequality and credit card debt and between credit card debt and economic distress.
Mortgage demand is a poorly understood and under-researched aspect of the financial behaviour of households. This paper tests empirically the basic results of Brueckner's model of mortgage demand on UK mortgage market data. The choice of mortgage instrument is used to identify impatient debt maximizers and patient borrowers who borrow at intermediate levels. Thus the research confirms the conditions under which households will use the largest possible mortgage and the circumstances under which savings are invested in the property. A unique contribution of the work is the estimation of mortgage demand equations corrected for endogenous housing demand, for a single housing finance system, where borrowers face different opportunity costs of equity in their owner occupied property, allowing a purer test of the theoretical model.
This paper examines the size of the current tax expenditure to homeownership, as well as its vertical and horizontal distribution. The authors construct a model of homeowner tax preferences that includes net implicit income and that explicitly models the complex interaction among standard deductions, nonhousing expenses, and household mortgage debt. Then the authors estimate annual tax savings from homeowner tax preferences by individual household, by income class, and in the aggregate. Including the nontaxation of net implicit income in the measurement of homeowner tax expenditures substantially increases the estimated aggregate tax expenditure to owner-occupied housing. In addition, once the nontaxation of net implicit income is incorporated, total homeowner tax preferences are not generally a function of the amount of mortgage interest expense households can claim as itemized deductions. Finally, the authors find that lower income households receive more and higher income households less than their propor- tionate share of the total homeowner tax expenditure.
There are very few sources of high-quality data on the dynamics of wealth accumulation. This paper uses newly-available data from the 1983-89 panel of the Survey of Consumer Finances to examine household saving and portfolio change over the 1980s. The 1983 SCF collected detailed information on households' assets, liabilities, income and other characteristics for a sample of 4,103 families. In 1989, 1,479 of these families were re-interviewed using a similar questionnaire. After describing the sample and methodology of the panel survey, we analyze changes in household wealth over the 1983-89 period. We also investigate changes in the structure of households' assets and liabilities.
Abstract This article examines,the demand,for the amount of mortgage,debt owed,by U.S. homeowners.,The analysis,focuses,on the,behavior,of individual,households,and,examines,how,their demand,for mortgage,debt responds,to the,tax rate at which,interest,on mortgage,debt can be deducted,and,how itvaries with income, age, education, and other characteristics. The 1983 and 1989 Surveys of Consumer,Finance,are used,to estimate,the demand. The analysis,indicates,that the demand,for mortgage,debt,is highly responsive,to changes,in the
This article explores the potential effects of eliminating the home mortgage interest deduction. Estimates of the tax expenditures generated by the home mortgage deduction usually exceed $40 billion, which give the impression that much additional tax revenue can be obtained by eliminating it. We argue otherwise. Many households, especially wealthy households, would change the way they finance their homes if the mortgage interest deduction were eliminated; they would rely less on mortgage debt and more on their own assets.
Roughly $10 billion in additional tax revenue is generated by eliminating the mortgage interest deduction when such portfolio reshuffling is taken into account. Those hardest hit would be younger, upper-middle-income households. Wealthy households, low-income households, and many elderly households would be less affected.
* Abstract - This paper analyzes the response of households to the provision in the Tax Reform Act of 1986 that phased out the deductibility of interest paid on consumer debt. The evidence suggests that the policy goals of the provision were frustrated because households shuffled their portfolios, substituting mortgage debt for con- sumer debt. High-income homeowners appear to have shuffled more of their debt and thus increased their share of the benefits of the mortgage interest deduction. One reason for this differ- ence in shuffling may be that high- income homeowners scored better on measures of financial sophistication, and better scores appear to predict greater shuffling. Policy options that would reduce the use of mortgage debt for nonhousing purchases are discussed.
I explore the determinants of the demand for home mortgage borrowing to satisfy non-housing portfolio objectives. This component of the demand for mortgage debt is empirically identified from a model in which instruments for housing demand and net wealth are utilized. The estimation of mortgage demand is performed on Canadian household survey data. The Canadian tax rules on deductibility of mortgage interest enhance my ability to identify mortgage demand and measure the effect of household marginal tax rates. Controlling for tax rates, wealth and household sociodemographic attributes, I am able to estimate the effect of asset choices on mortgage demand.
Cross-sectional data from the 1983 Survey of Consumer Finances (SCF) enable us to identify two groups of households: those whose housing tenure status is unaffected by borrowing constraints, and those whose housing tenure status may be affected by borrowing constraints. Using these data, a bivariate probit model is estimated to evaluate the joint probability of whether families prefer to live in owner-occupied housing and whether borrowing constraints affect access to owner-occupied housing.Findings indicate that borrowing constraints have a significant negative effect on homeownership rates. Indeed, if borrowing constraints had not been binding in our sample period (the early 1980s), ceteris paribus, owner-occupancy rates in the United States would have risen from 64.5% to nearly 73%. Moreover, borrowing constraints appear to have a disproportionate effect on the ability of younger families and non-white families to own a home, consistent with popular perceptions.
This paper explores the relationship between household mortgage debt burdens and housing consumption, periodic income, nonhousing wealth, the income tax position of the household, expected mobility, and other micro-level characteristics that proxy for household risk preferences and life cycle effects. We use 1985 and 1989 American Housing Survey data to estimate mortgage debt level equations simultaneous with house value equations, controlling for the contemporaneous nature of these two choices. We find that larger debt levels are positively associated with greater value residences and with the level of household income. Numerous household level demographic characteristics are also systematically related to mortgage demand. Of particular interest are our findings that the use of mortgage debt is affected significantly by the rate of tax savings on mortgage interest deductions and by the expected mobility of the household.
Home mortgage debt is decomposed into a component that represents debt demand, derived from housing demand and a residual excess demand. This excess demand derives principally from the demand for nonhousing assets. An empirical model of the determinants of the demand for excess debt is specified and estimated using databases from the 1983 and 1986 Surveys of Consumer Finance. The estimations focus on evidence of linkages between debt demand and household preferences for illiquid risky assets, and on the substitutability of personal debt for mortgage debt. Positive linkages are found between household choices of investments in vacation homes, investment real estate, and closely held business and the demand for excess debt. However, personal debt and mortgage debt appear to have largely separate financing roles. Copyright 1994 by Kluwer Academic Publishers
This article investigates the portfolio choices of homeowners, taking into account the investment constraint introduced by Henderson and Ioannides (1983). This constraint requires housing investment by homeowners to be at least as large as housing consumption. It is shown that when the constraint is binding, the homeowner's optimal portfolio is inefficient in a mean- variance sense. Thus, portfolio inefficiency is not an indication that consumers are irrational or careless in their financial decisions. Instead, inefficiency can be seen as the result of a rational balancing of the consumption benefits and portfolio distortion associated with housing investment. Copyright 1997 by Kluwer Academic Publishers
Assessing the price evolution of houses on the basis of average sales prices, as is current practice in Belgium, might be misleading due to changing characteristics of the houses sold in the periods observed. A hedonic index which takes into account changes in characteristics is more appropriate. We use the budget surveys of the Belgian Statistical Institute to illustrate how this also applies for Belgium. The estimated hedonic price index for house sales on the secondary market is practically always below the index based on average sales values for the period considered. This demonstrates the need to collect more extensive data on the characteristics of the dwellings sold in Belgium.
There are few sources of high-quality data on the dynamics of wealth accumulation. This paper uses newly available data from the 1983-89 panel of the Survey of Consumer Finances to examine household saving and portfolio change over the 1980s. The authors main findings are as follows. First, median household wealth rose modestly over the period. Second, while overall wealth inequality increased, households in the top 1 percent of the wealth distribution in 1983 saw their share of total wealth decline, probably reflecting turnover among the very wealthy. Third, although age, income, and initial wealth had significant effects in regressions on household saving, a large part of the variation in saving was unexplained. Finally, there were clear life-cycle patterns in the portfolios of assets and liabilities held by households, with younger households acquiring homes, businesses and all types of debts, and older households divesting themselves of these assets and debts. Copyright 1997 by The International Association for Research in Income and Wealth.
The Tax Reform Act of 1986 constituted the most sweeping postwar change in the U.S. federal income tax. This paper considers what the Act accomplished and its implications for future tax policy. After a review of the Act itself, and why it happened, we consider the evidence of the Act's impact on economic activity and how this evidence squares with initial predictions. Where appropriate, we draw out how consideration of the impact of TRA86 has contributed to the development of the methodology of economic analysis. We conclude with an overall evaluation of the Act.
In the United States, religious attendance rises sharply with education across individuals, but religious attendance declines sharply with education across denominations. This puzzle is explained if education both increases the returns to social connection and reduces the extent of religious belief, and if beliefs are closely linked to denominations. The positive effect of education on social connection is the result of both treatment and selection: schooling creates social skills and may increase people’s utility from engaging in other social activities such as church attendance. The negative effect of education on religious belief occurs because secular education emphasizes secular beliefs that are at odds with many traditional religious views.