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The Biggest Housing Subsidy
Tim Francis-Wright

(Part IV of our series Cracking the Internal Revenue Code: How the tax system rewards the rich)

The biggest housing subsidy in America may surprise you. While the federal government has a number of policies to subsidize affordable housing, it spends more to subsidize homes for the affluent that it does to build, subsidize, or maintain affordable housing for the poor.

The latest IRS statistics show that Americans deducted $272 billion in home mortgage interest and almost $87 billion in real estate taxes in 1999. Of those amounts, 46.87% and 50.13%, respectively, were deductions by taxpayers with adjusted gross income between $60,000 and $200,000. Those taxpayers represented only 11.46% of all taxpayers in that year.

According to the IRS, in 1999, of 127 million individual federal income tax returns, only 40 million used itemized deductions. The rest used the standard deduction that varies with the status of the filer. Itemizable deductions include a slew of categories, including mortgage interest, state and local taxes, charitable contributions, medical expenses, and losses from casualty or theft. With a few exceptions, taxpayers can choose the standard deduction if their itemized deductions and less than the standard deduction for their filing status.

Some deductions reward behavior that certainly benefits society, such as donating money or property to charity. Other deductions buffer the effects of externalities, like disasters or high medical bills. The subsidies for housing are in neither category, although encouraging home ownership is far from the worst thing that a government could do. However, itemized deductions as a whole chiefly benefit the upper middle class, and these housing deductions particularly benefit the affluent. The rich suffer by comparison, because up to 80 percent of their itemized deductions are taken away by statute. (As I wrote three weeks ago, the tax code rewards the richest Americans through tax breaks for capital gains.)

Mortgage interest and real estate taxes disproportionately benefit the affluent for a number of reasons. First, they own more expensive houses and have higher mortgage and real estate tax bills. Second, they have higher deductions in other categories, like state income taxes and charitable contributions, so they are more likely to itemize deductions than their poorer counterparts. Third, their tax rates are relatively higher, so they benefit more from each dollar of additional deductions. None of these facts is particularly earth-shattering.

But the cost to the federal government of these tax breaks is enormous. The Statistical Abstract of the United Statesannually presents data from the Office of Management and Budget on both federal outlays and the costs of tax breaks. In 1999, the federal government spent $32.7 billion on the entire budget of the Department of Housing and Urban Development. These funds include rental assistance for privately-owned housing across America; development and operating subsidies for public housing projects; and funds to rehabilitate and build new housing. Accompanying these budget outlays were $2.82 billion in tax expenditures for the low-income housing tax credit for private affordable housing. (Full disclosure demands that I note that I work at a firm that markets investments in these tax credits.)

The tax expenditures for owner-occupied homes dwarf the funds pertaining to affordable housing. The tables in the Statistical Abstract show $56.9 billion for mortgage interest deductions, $21.2 billion for property tax deductions, and $18.0 billion for exclusion of home sales from capital gains taxes. Affluent taxpayers enjoy the bulk of these expenditures: they claimed about half of the deductions, and claimed those expenditures against higher tax rates than poorer taxpayers.

The preferential treatment of mortgage interest provides a healthy boost to the real estate market. For taxpayers in the 27% tax bracket, the after-tax cost of a 30-year mortgage can be about 20% less than its nominal cost. Strong real estate markets benefit sellers, of course, but also hurt those who would be looking for housing. In some metropolitan areas, like Boston, New York, or San Francisco, the average family has no hope of buying a first home without a massive amount of savings.

Because these tax expenditures are not direct outlays of the federal government, it is easy for casual observers of the federal budget to ignore them when evaluating housing policy. The federal government spent $95 billion in 1999 to subsidize owner-occupied housing, much of it for taxpayers who would remain comfortably affluent without the tax break. It spent barely one-third of that sum on affordable rental housing, much of it drastically over-subscribed.

Americans should be outraged that their government has such a topsy-turvy policy about housing subsidies. Fixing the problem entails one of two extraordinary events. Either the federal government must spend more on affordable housing, or the federal government must cut back on the housing subsidies for the affluent. The inscription on the Statue of Liberty exhorts the world to "send these, the homeless, tempest-tossed to me." We mock that inscription when we turn our backs on the poor in our own country.

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