Eliminate the Mortgage Interest Deduction or Tax Imputed Rent? Leveling the Real-Estate Playing Field

Jan K. Brueckner
University of California, Irvine

Many commentators call for reducing or eliminating the mortgage interest deduction, arguing that the tax subsidy to owner-occupied housing distorts the economy by encouraging excessive housing investment and costing the government a substantial amount of tax revenue. They argue that nothing is sacred about this deduction, pointing to other countries (including our neighbor Canada) that do not provide it. It is not widely recognized, however, that the tax subsidy to homeownership arises not from the mortgage interest deduction per se but rather from a broader failure to treat owner-occupiers and landlords symmetrically. The failure of the tax code to treat owner-occupiers as landlords renting to themselves, as symmetry would require, is the real source of the subsidy. Eliminating this asymmetry, thus “leveling the playing field” in the tax treatment of real estate, would require taxing imputed rent and preserving, not eliminating, the interest deduction. The argument is that, if the tax code treated the owner-occupier as a landlord renting to himself or herself, this rent payment would be treated as income and taxed. The owner-occupier, like any business, would then be allowed to deduct all operating costs in computing taxable income, with mortgage interest being one of these costs.