THE MORTGAGE INTEREST DEDUCTION….PART 2….On Friday I blogged about the mortgage interest deduction and how it was basically a scam that doesn’t really help home buyers. Today I’ve got a bit more detail, courtesy of a real live economics type person, showing that it does help some, but not that much. Warning: I highly recommend that you skip this post.

OK then, here’s a simplified partial equilibrium analysis of what happens:

  • Before the mortage interest deduction was in place, supply and demand intersected to produce an original price for a home. That’s in orange in the chart at the right.

  • After the deduction was put in place, the demand curve moved up and to the right, indicating increased demand due to the subsidy of the tax break. The intersection with the supply curve happens at a higher quantity, so more houses are built. However, because of the subsidy caused by the tax break, the price the buyer pays is different from the price the seller gets. The seller actually gets a somewhat higher price than under the original model, and the buyer pays a somewhat lower price. In other words, they split the difference.

Bottom line: the mortgage interest deduction does cause the quantity of housing to increase and it does save home buyers some money, it just doesn’t save them as much as they think. The actual amount of the savings depends on the slope of the supply and demand curves, how far the demand curve moves, and a bunch of other stuff. As my correspondent points out, this is an undergraduate level analysis, and the graduate level analysis ain’t going to happen. At least, not on this blog.

(And since several people have asked: the effect of the mortgage interest deduction on the rental market is quite complex, and it’s not clear exactly what the end result is.)

Anyway, this is all blather. As Matt Yglesias points out, no one in his right mind will ever suggest getting rid of mortgage interest deduction. Even if you could figure out a way to do it without hurting anyone, it sure wouldn’t benefit anyone, so where’s the support going to come from? In the end we’re stuck with a “middle class” tax break that actually favors the rich disproportionately (they have bigger houses so they get a bigger tax break, and of course those too poor to buy a house in the first place get nothing). Why does this sound hauntingly familiar?

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