Wednesday, April 26, 2017

The Home Mortgage Interest Deduction: A Bad Deal for Taxpayers

A new policy brief released by the Mercatus Center and co-authored by Jeremy Horpedahl and Harrison Searles analyzes one of the most popular—and therefore one of the most difficult to reform—subsidies in the tax code: the home mortgage interest deduction. This study touches on many of the points that Emily talked about in her op-ed on the subject last month; namely, this policy’s failure to achieve its intended effects and the fact that a lion’s share of the benefits go to high-income homeowners. Despite widespread enthusiasm for the home mortgage interest deduction, the authors argue that the benefits of this policy are overstated and the consequences are understated.

The home mortgage interest deduction is one of the largest tax expenditures in the U.S. tax code, second only to the non-taxation of employer-provided health insurance and pension contributions. Proponents of the home mortgage interest deduction argue that this policy provides needed tax relief to the middle class and encourages the oft-invoked American dream of homeownership. These folks may be surprised to learn, as Horpedahl and Searles point out, that a mere 21.7% of taxpayers even claim this benefit. What’s more, most of these benefits don’t go to the middle class, but rather to households with incomes of over $200,000. Here’s a breakdown of the tax savings from the brief:


The claim that this policy is necessary to encourage home ownership is dubious as well. The authors explain:

Empirical evidence supports the claim that the mortgage interest deduction has little effect on homeownership rates in the United States. Between 1960 and 1997, homeownership rates stayed within a narrow range of 62 to 66 percent, despite the fact that the implicit tax subsidy fluctuated dramatically. During the recent housing bubble, the homeownership rate rose to 69 percent, but it has since returned to the historical range. This rise appears to have been unrelated to the mortgage interest deduction, though it was almost certainly related to other housing policies that encouraged the bubble. More sophisticated analysis suggests that the homeownership rate would be modestly lower without the deduction, by around 0.4 percent.

Ironically, the home mortgage interest deduction likely creates the perverse effect of discouraging homeownership by artificially raising home values. Economic intuition suggests, and empirical studies have supported, that the deduction does not provide much in the way of savings at all since the value of the deduction is simply capitalized into the value of home prices. The artificially higher house prices prevent would-be home owners on the margins of affordability from purchasing a home within their price range. This effect, combined with the low rates of deduction claims and concentration of benefits to high-income earners, likely contributes to the inefficacy of the home mortgage interest deduction to boost homeownership to the degree that its proponents envisioned.

Additionally, countries like Canada and Australia have managed to produce comparable rates of home ownership as the US without the crutch of a mortgage interest deduction.

While the home mortgage interest deduction doesn’t do much for increasing the number of houses, it has a knack for increasing the size of houses, as a study by Lori Taylor of the Federal Reserve Bank of Dallas pointed out. The deduction has had the unintended consequence of directing capital and labor to high-income residential housing projects that might not have been taken without government intervention—and the benefits overwhelmingly go to the wealthy.

This is all before considering the regressive effects of the policy by design: low- and middle-income renters are made to subsidize the increasingly opulent residences (and sometimes the extra vacation homes!) of their more well-off peers while they struggle to make ends meet in a sometimes-inhospitable economy. This injustice, combined with the inefficacy of the tax deduction to increase homeownership in any meaningful way, causes the justifications for the mortgage interest deduction to grow scarce.

In fact, it is becoming increasingly clear that this policy, which evaded the fate of its similar counterpart—the credit card interest deduction—during the tax fight of 1986, continues as law not because of good economics but because of bad political incentives.

Horpedahl and Searles offer three proposals for scaling back the home mortgage interest deduction: policymakers could 1) eliminate the deduction entirely, 2) eliminate the deduction while simultaneously lowering marginal income tax rates to compensate for the virtual tax increase, or 3) stop the deduction and replace it with a tax credit that taxpayers could redeem upon purchase of their first house. Horpedahl and Searles demonstrate that while this deduction is popular with the public and the real estate industry, it is simply a bad deal for most taxpayers.

January 8, 2013

New Research on West Virginia’s Medicaid Reforms

Today, the Mercatus Cetner released a new policy brief by Tami Gurley-Calvez on Medicaid reforms implemented in West Virginia, based on a working paper she wrote this fall.  In 2007 the state enacted a Medicaid redesign with one objective being to reduce the rate at which Medicaid patients visited emergency rooms for non-emergencies. Additionally, the plan, called Mountain Health Choices, was intended to incentivize healthy behaviors among Medicaid recipients.

The “choice” in the new plan was an option for women and children to opt into an enhanced plan or default into a basic plan. The enhanced plan offered greater benefits but required participants to agree to “doing [their] best to stay healthy’ and to agree to visit their primary care physician for non-emergency treatment. The objective of reducing ER visits was to both reduce healthcare costs for state taxpayers and to improve healthcare outcomes.

Gurley-Calvez finds that with the Mountain Health Choices reforms, patients on this enhanced plan did visit the emergency room at lower rates. However, patients who defaulted into the basic plan began to visit the emergency room at a higher rate, potentially because they were not eligible for treatment for some illnesses with a primary care doctor. She explains:

Based on this research, states should consider whether they can create a greater connection between health providers and members’ involvement in their own health care. However, policymakers must be cognizant of what drives member decision making in their policy designs. In the West Virginia case, a majority of members did not enroll in the enhanced plan in the short term despite additional health coverage and no direct monetary costs to enrollment. Further, states should consider the possible costs, both near term and future, of restricting treatment options by limiting coverage levels.

This case of attempted cost savings by changing incentives represents an ever-present challenge in public policy. Predicting how people will react to new policies in a changing world is difficult, and policymakers should not be overly confident that the incentives that they design will result in the outcomes that they anticipate.

December 18, 2012

New Research on Streamlining Commissions

Tomorrow I’ll be at the Association for Public Policy Analysis and Management Fall Research Conference to present research on streamlining commissions with Carmine Scavo. Carmine and I have written one paper developing a methodology for studying these commissions, and we’re now working on case studies of commissions in nine states.

Well over half of states have appointed one or more streamlining commissions in efforts to find budget savings or to improve state programs. We’re studying streamlining efforts in California, New Mexico, Louisiana, Alabama, Colorado, New York, Maine and Virginia. We hope to get an idea of how effectively these commissions have reduced the size of state government and found efficiencies in existing programs. We also hope to identify the characteristics that make commissions most likely to meet their goals.

In our first paper, we hypothesized that commission success would depend on the following characteristics:

1) clearly defined objectives regarding their final product;

2) a clear timeline for this deliverable with an opportunity to publish interim advice. Preliminary findings indicate that the commission should have at least one year to work;

3) adequate funds to hire an independent staff to study some issues in depth;

4) a majority of the commission members from outside the government. The commission chair certainly should be from outside the government in order to help to get around the challenges that inherently restrict the ability to find streamlining opportunities while working in government. Preliminary findings indicate that representatives from the state legislature and administration should be involved as a minority of the membership to ensure that the commission’s recommendations have buy-in from policymakers.

So far, our research indicates that funding for commissions may not be as important as we’d though. Some commissions have achieved successes with essentially no budgets while others that were well-funded developed recommendations that didn’t go anywhere.

Tomorrow we will be presenting our preliminary findings on the California Commission on the 21st Century Economy, the Colorado Pits and Peeves Roundtable Initiative, and the Virginia Commission on Government Reform and Restructuring. Once we finish this research I will write up our findings in more depth here. If any of you will be attending the APPAM conference, I hope to see you there.

November 7, 2012

New Research on Streamlining Commissions

Tomorrow I’ll be at the Association for Public Policy Analysis and Management Fall Research Conference to present research on streamlining commissions with Carmine Scavo. Carmine and I have written one paper developing a methodology for studying these commissions, and we’re now working on case studies of commissions in nine states.

Well over half of states have appointed one or more streamlining commissions in efforts to find budget savings or to improve state programs. We’re studying streamlining efforts in California, New Mexico, Louisiana, Alabama, Colorado, New York, Maine and Virginia. We hope to get an idea of how effectively these commissions have reduced the size of state government and found efficiencies in existing programs. We also hope to identify the characteristics that make commissions most likely to meet their goals.

In our first paper, we hypothesized that commission success would depend on the following characteristics:

1) clearly defined objectives regarding their final product;

2) a clear timeline for this deliverable with an opportunity to publish interim advice. Preliminary findings indicate that the commission should have at least one year to work;

3) adequate funds to hire an independent staff to study some issues in depth;

4) a majority of the commission members from outside the government. The commission chair certainly should be from outside the government in order to help to get around the challenges that inherently restrict the ability to find streamlining opportunities while working in government. Preliminary findings indicate that representatives from the state legislature and administration should be involved as a minority of the membership to ensure that the commission’s recommendations have buy-in from policymakers.

So far, our research indicates that funding for commissions may not be as important as we’d though. Some commissions have achieved successes with essentially no budgets while others that were well-funded developed recommendations that didn’t go anywhere.

Tomorrow we will be presenting our preliminary findings on the California Commission on the 21st Century Economy, the Colorado Pits and Peeves Roundtable Initiative, and the Virginia Commission on Government Reform and Restructuring. Once we finish this research I will write up our findings in more depth here. If any of you will be attending the APPAM conference, I hope to see you there.

November 7, 2012

The Problem with States’ Rights

This week, Eileen Norcross hosted a fiscal federalism symposium, bringing together scholars of various disciplines to discuss some of the challenges that our system of federalism faces today. Part of the discussion centered around Michael Greve’s new book The Upside-Down Constitution.

One of his key points is a reminder of the reason federalists believed that states’ rights are important. We shouldn’t care about states’ rights for the sake of states’ rights — states are merely groups of residents. Rather, we should care about people’s rights, and how these can be better protected in a federalist system than under a centralized government. This distinction sometimes gets lost when people advocate states’ rights rather than states’ enumerated powers. The problem with advocating states’ rights is that this nuance paves the way for states to collude rather than to compete.

A clear example of this collusion happened in 1984 when Congress passed the National Minimum Drinking Age Act. Because setting a drinking age does not fall under the federal government’s enumerated powers, when Congress wanted to change the rules in this area, it had to bargain using tax dollars. States that kept a drinking age in place below 21 would have lost 10-percent of their federal highway funding dollars.

While this may sound like the federal government is coercing the states, it’s key to remember that the goal of federalism is individuals’ rights. With the National Minimum Drinking Age Act, the states and federal government colluded to bring an end to competition in policy. This Act made state policy in this area the same, taking away Americans’ opportunity to choose to live in states with lower drinking ages.

When multiple levels of government pay for a given service, such as roads, many opportunities arise for this type of collusion, leading to the growth of government and the erosion of competition between governments. A competitive federalism means both that governments have incentives to provide the policy environments that their residents want and that people will have greater variety of policy climates to choose from. If the drinking age is an important issue to a family, competitive federalism could provide them with the option of living in a city or state with a higher or lower minimum age.

In the coming year, we hope to pursue research exploring what institutions limit competition within American federalism and what institutions prevent collusion between the federal, state, and local jurisdictions.

 

September 17, 2012

Maryland Study Finds States Spend Too Much on Wall Street

A report from the Maryland Tax Education Foundation and the Maryland Public Policy Institute finds that state pension funds spend a significant amount of money paying investors to manage their funds. States spent $7.8 billion on Wall Street in 2011. Funds’ recent poor performance casts these expenditures in a particularly bad light for taxpayers, and the Maryland researchers Jeff Hooke and Michael Tasselmyer suggest these funds are not well-spent.

Much less expensive investment strategies are available to investment funds, however, these investment strategies rely on index funds that typically seek to match the market’s performance rather than outpace it. However, as Governing the States and Localities explains:

Pension experts interviewed for this story, though, question the validity of the report, which compares investment firm fees with each plan’s net assets. Even with the higher fees, they say additional returns from investment managers outweigh the added cost in the long run, and tossing more money into equity index funds wouldn’t diversify portfolios.

“The suggestion that all public pensions should be shifted into index accounts is just not well informed,” said Keith Brainard, research director for the National Association of State Retirement Administrators.

The need to outperform the market comes from the way that states value their liabilities. Rather than valuing defined benefit pensions at the appropriate risk-free discount rate, states choose to assume higher rates of return, commonly 5 percent above the risk-free rate. When a low-risk investment strategy fails to meet these returns, state fund managers are incentivized to pursue riskier strategies with the hope of making the return needed to make the defined benefit obligations. This is demonstrated in state funds’ participation in recent IPOs.

The Maryland report states:

For many state pension funds, investment results over the last 10 years have failed to hit target returns of 7 to 8 percent annually. This has prompted Maryland’s System and other state systems to make large commitments to “alternative investments,” like leveraged buyout funds and hedge funds, with the hope of obtaining higher returns than conventional public stocks and bonds. In fiscal 2011, 25 percent of the Maryland System’s investment portfolio was in alternative investments, including private equity and real estate.

alternative investments are less liquid, less transparent, and more volatile than conventional public stocks and bonds. It is also questionable whether these investments provide higher returns than a similar risk-adjusted portfolio of public equities. Buyout fund promoters claim higher returns, for example, but many of their leveraged buyouts from the pre-crash period have yet to sell, and the state pension systems rely on the buyout funds’ in-house valuation of such investments to determine pension investment returns. The states exercise limited supervision over the buyout funds, and the examination of buyout fund portfo- lio values by fund auditors is typically inadequate.

With a risk-free discount rate for valuing guaranteed defined benefits, state fund managers would not be faced with the choice of either accepting higher risks or facing a reality of falling short on obligations. In determining what discount rate to choose, state policymakers should remember that the benefit level determines the cost of pension plans. Lowering the assumed rate of return does not change the cost of pensions, but merely means taxpayers will be paying for benefits as they are accrued, whereas a higher discount rate pushes these payments into the future.

 

August 17, 2012

New Jersey’s Pension Crisis: New Research

Eileen Norcross and Andrew Biggs have a new paper out this morning entitled “The Crisis in Public Sector Pension Plans: A Blueprint for Reform in New Jersey.” While it’s focused on New Jersey, it does an excellent job of outlining the larger problem with state pension plans nationwide and what policy makers can do about it.

Here’s the abstract:

New Jersey’s defined benefit pension systems are underfunded by more than $170 billion, an amount equivalent to 44 percent of gross state product (GSP) and 328 percent of the state’s explicit government debt. Depending on market conditions, the state will begin to run out of money to pay benefits between 2013 and 2019. The state’s five defined benefit pension plans cover over 770,000 workers, and more than a quarter million retirees depend on state pensions paying out almost $6 billion per year in benefits. Nationwide, state pensions are underfunded by between $2.8 trillion and $5.2 trillion, some 20 to 37 percent of America’s annual output as much as $3 trillion, approximately 20 percent of America’s annual output..

This path is not sustainable. In order to avert a fiscal crisis and ensure that future state employees have dependable retirement savings, New Jersey should follow the lead of the federal government and the private sector and move from defined benefit pensions to defined contribution pensions. While significant liabilities will remain, the first step to addressing the pension crisis is capping existing liabilities and providing new employees with more sustainable retirement options.

Specifically, the paper recommends that policy makers:

  • Extend the defined contribution plan already available to state university faculty and staff and the state’s Defined Contribution Retirement Program to all state employees.
  • Reduce or freeze cost of living adjustments (COLAs) to reduce the state’s unfunded liability.
  • Transition non-vested workers to defined contribution plans.

Whole thing here.

June 23, 2010

Crushed by Taxes in New Jersey

Gannett has done its homework — and the homework of New Jersey’s government(s). This week its New Jersey papers are running a week long series on the state’s property tax crisis.

Visit the Asbury Park Press‘ website and click on a municipality in any one of New Jersey’s 21 counties. Wave your cursor over the bar chart to get a tangible sense of how property taxes are crushing the state’s residents.

For example in Fort Lee, Bergen County, residents face an average tax burden of $8,510, up from $5,545 since 2000. Factor in the property tax rebates from Trenton — the average check sent out in 2008 amounted to $944 — and that’s a 41 percent increase in property taxes in eight years with the rebate. You can get property tax details for each of the state’s 566 municipalities.

Yesterday’s analysis (Day 2) featured a series on one of the major drivers of property taxes: salaries for public sector workers.

Binding arbitration rules mean that unions negotiate their benefits and salaries through a seven-member commission in Trenton with the costs passed on to localities. (For background on the evolution of public sector negotiations in New Jersey from 1968 to today, read, “PERC After 40 Years.”)

Now,  thanks to what must have been a massive amount of data work for Gannett’s reporters, you can easily discover how much police officers, municipal workers, teachers, firemen, and judges are being paid in your town.

Each of New Jersey’s 460,000 public employees enrolled in a benefits program is in this data base by name, jurisdiction, and retirement fund. You can also look inside a police contract.

The Asbury Park Press highlights some of the biggest beneficiaries:

  • A principal at Freehold Regional earns $146,316.
  • A police officer in Belmar grossed $109,975.
  • In Eatontown, a patrol officer earns $90,000.

The reporting continues through Sunday, and it’s worth exploring. It’s also worth asking why some towns were more forthcoming with their data than others.

September 29, 2009