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Abstract

The mortgage interest deduction is an incredibly popular, politically well-supported and hugely expensive tax incentive. Yet economic studies consistently show that the mortgage interest deduction fails to advance its fundamental purpose. It does not increase the rate of homeownership. On the contrary, to the extent that it is effective in influencing human behavior, it does so by inflating home prices and encouraging borrowing against equity. These effects – inflated home prices and excessive borrowing – contributed to the economic crisis of 2008. In the years leading up to the crisis, Americans spent billions of tax dollars further inflating a dangerously unstable housing bubble. Even if we had the will to change this policy, we did not have the means. The mortgage interest deduction is insensitive to market conditions and resistant to change. These attributes make the mortgage interest deduction bad policy. Rather than perpetuating this costly deduction, Congress should phase it out in its entirety and replace it with targeted tax incentives designed to stimulate the housing market only when the market is weak. Future tax incentives should avoid the structural flaws that caused the mortgage interest deduction to fail by focusing on market responsiveness, timing and flexibility.

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