Saving the US Economy - the Canadian Way

[alfred russel]

To many double negatives in there.  I think you are actually agreeing with me that mortgage deductability is a bad idea.

I'm not--it seems from your post that we could protect our economy from risk by removing all interest deductibility.

[crazy canuck]

To many double negatives in there.  I think you are actually agreeing with me that mortgage deductability is a bad idea.

I'm not--it seems from your post that we could protect our economy from risk by removing all interest deductibility.

Thats an overstatement.  You cant protect your economy from risk but you can reduce the risk of artificially encouraging people to take on more debt then they otherwise would.

[alfred russel]

Thats an overstatement.  You cant protect your economy from risk but you can reduce the risk of artificially encouraging people to take on more debt then they otherwise would.

But what is "artificial?" Businesses wouldn't take on so much debt if they didn't get a deduction for the interest.

Why should investment related real estate, almost always financed through debt, get a deduction while a homeowner doesn't?

[Malthus]

It also changes the dynamic of choice between owning & renting, if money paid in rent is not deductable.

You are ignoring my posts. What screws up that dynamic is the Canadian system, where renters can deduct their interest charges (which are at least partially passed on to rentors in a competitive market) but buyers can not.

Renters getting a deduction isn't the same thing at all as the people who rent getting a deduction.

The rules here seem to be that if you borrow to make money as a business, you get a deduction; if you borrow to buy a non-business asset like a house to live in, you do not.

Seems to me somewhat analogous to a jewelry shop who borrows for inventory for sale, versus a person who borrows to buy a big diamond ring. The first seems at first blush a more economically prudent move than the second (assuming the jeweller has done his or her homework), even though the object in question - a diamond ring - is the same; in that the jeweller hopes to make a profit on it (and presumably spreads his or her risk by buying many different types goods) -- a prudent person should be more reluctant to borrow money for consumption than for business; the two are not the same thing.

[Malthus]

According to wikipedia:

The home ownership rate in Canada is about the same as in the United States,[2] but Canadians have about 70%[3] equity in their homes on average (i.e., 30% mortgage debt), compared to only 45% average home equity in the United States.

[Malthus]

Thats an overstatement.  You cant protect your economy from risk but you can reduce the risk of artificially encouraging people to take on more debt then they otherwise would.

But what is "artificial?" Businesses wouldn't take on so much debt if they didn't get a deduction for the interest.

Why should investment related real estate, almost always financed through debt, get a deduction while a homeowner doesn't?

Here's the standard argument as to why profit-earning businesses should get the deduction while consumption such as housing should not:

http://www.taxfoundation.org/blog/show/1081.html

Despite the political popularity of the tax deduction for home mortgage interest, economists are basically united in their opposition to it.

What's the economic case against it? Simple: by giving a tax subsidy to housing, it distorts investment decisions toward houses and away from assets like factories and equipment that are more productive at the margin. And that makes workers less productive, ultimately lowering wages and making society poorer.

A recent GAO primer on tax reform makes a clear and persuasive case against the mortgage interest deduction:

Tax Treatment of Owner-Occupied Housing Distorts Investment Choices and Lowers Wages
Compared to other types of investment, owner-occupied housing enjoys tax advantages primarily because the value that homeowners receive from housing services, which is a part of the return on their investment in housing, is excluded from taxation. Economists view these services, called imputed rent, as income in kind, which is valued at what the homeowner would receive as income if the house was rented.

Under a pure income tax, imputed rent net of such costs as mortgage interest would be taxed. This tax treatment would help insure that investment in housing is taxed as other investments are taxed. As the table below shows, the tax advantages under the current system lead to lower marginal effective tax rates (METR) for housing relative to other investments.

Marginal Effective Tax Rates on Capital, by Source, 2003  Owner-occupied housing: 2%
Noncorporate investment: 18%
Corporate investment: 32%
 
Source: Jane Gravelle, "The Corporate Tax: Where Has It Been and Where Is It Going?" National Tax Journal, vol. 57, no. 4 (2004): 903-23 


Economists generally agree that the favorable treatment of owner-occupied housing, by lowering METR, distorts investment in the economy, resulting in too much investment in housing and too little business investment. The consequence of this is that businesses invest less in productivity-enhancing technology. This in turn results in employees receiving lower wages because increases in employee wages are generally tied to increases in productivity.

The resulting distortions from the tax-preferred treatment of owner-occupied housing lead to efficiency costs that have been estimated to be large. Gravelle's summary of estimates reports that the efficiency costs of the tax-preferred treatment of owner-occupied housing could be as much as 0.1 to 1 percent of GDP.

That's from a text box on page 39. Let's hope Members of Congress—who may be taking on federal tax reform next year—are actually reading these excellent GAO reports. Read the full report here (PDF).

[crazy canuck]

Why should investment related real estate, almost always financed through debt, get a deduction while a homeowner doesn't?

I dont understand the argument that business debt is the same as personal debt.  They are fundamentally different, have different risks, different terms and have different impacts.   In Canada they are treated differently and, as already mentioned, our banks didnt fail.

edit: just read what Malthus posted.

[Admiral Yi]

Seems to me somewhat analogous to a jewelry shop who borrows for inventory for sale, versus a person who borrows to buy a big diamond ring. The first seems at first blush a more economically prudent move than the second (assuming the jeweller has done his or her homework), even though the object in question - a diamond ring - is the same; in that the jeweller hopes to make a profit on it (and presumably spreads his or her risk by buying many different types goods) -- a prudent person should be more reluctant to borrow money for consumption than for business; the two are not the same thing.

Not a good analogy.  The consumer is not faced with a choice of buying vs. not buying jewelry, he's faced with the choice of buying vs. renting.

[crazy canuck]

Not a good analogy.  The consumer is not faced with a choice of buying vs. not buying jewelry, he's faced with the choice of buying vs. renting.

I disagree, the choice is to take on debt or not. 

[Malthus]

Seems to me somewhat analogous to a jewelry shop who borrows for inventory for sale, versus a person who borrows to buy a big diamond ring. The first seems at first blush a more economically prudent move than the second (assuming the jeweller has done his or her homework), even though the object in question - a diamond ring - is the same; in that the jeweller hopes to make a profit on it (and presumably spreads his or her risk by buying many different types goods) -- a prudent person should be more reluctant to borrow money for consumption than for business; the two are not the same thing.

Not a good analogy.  The consumer is not faced with a choice of buying vs. not buying jewelry, he's faced with the choice of buying vs. renting.

The issue is whether the business getting a deduction or the person getting a deduction for borrowing on the exact same asset is really similar or not.

[Admiral Yi]

In Canada they are treated differently and, as already mentioned, our banks didnt fail.

Which is explained better by Canada's regulation of the type of mortgages that can be offered, not the interest deduction.

[alfred russel]

Renters getting a deduction isn't the same thing at all as the people who rent getting a deduction.

The rules here seem to be that if you borrow to make money as a business, you get a deduction; if you borrow to buy a non-business asset like a house to live in, you do not.

Seems to me somewhat analogous to a jewelry shop who borrows for inventory for sale, versus a person who borrows to buy a big diamond ring. The first seems at first blush a more economically prudent move than the second (assuming the jeweller has done his or her homework), even though the object in question - a diamond ring - is the same; in that the jeweller hopes to make a profit on it (and presumably spreads his or her risk by buying many different types goods) -- a prudent person should be more reluctant to borrow money for consumption than for business; the two are not the same thing.

The general rule is that interest related to business expenses is deductible, and interest related to personal expenses is not. The effect of this rule is a homeowner can not deduct interest expenses, while an investor renting out the property can.

A home interest deduction can negate the imbalance in the rent versus buy decision created by the tax law, it really doesn't create a new one.

I disagree that you can generalize that one type of debt is more prudent than another. My understanding is that in fact default rates are higher on investment properties than for homeownership, for example.

[crazy canuck]

In Canada they are treated differently and, as already mentioned, our banks didnt fail.

Which is explained better by Canada's regulation of the type of mortgages that can be offered, not the interest deduction.

Its all part of the same thing.  Canada's regulation policy is all based on restricting the amount of debt a home owner can take on.  US policy encourages more debt.

[crazy canuck]

My understanding is that in fact default rates are higher on investment properties than for homeownership, for example.

Which is why, in Canada anyway, the amount of equity a person investing in a property with the intent of renting must maintain a higher equity ratio then someone who is owning.

Again, getting back to the basic pricinciple that debt, in the housing market, should not be encouraged.

[Malthus]

The odd thing is that while home ownership rates are about the same in the two countries, rates of debt to equity are much higher in the US.

Put this together with the alleged fact mentioned upthread that homes in the US tend to be larger and more expensive, it appears that what US policies encourage is not rate of home ownership per se, but rather ownership of more expensive homes.