Romney Can Take His Dad’s Idea and Cut Mortgage Tax Break

Side with us, or lose a house.
That’s essentially what Gary Thomas, president-elect of the
National Association of Realtors, was saying this week at the
Republican convention when he warned against the elimination of
the mortgage-interest deduction.

Thomas was provoked by talk from the Republican Party’s
presidential nominee, Mitt Romney, and his advisers of
“limiting” the homeowners’ tax break. So provoked, in fact, that
Thomas didn’t just criticize. He went apocalyptic: “It’s going
to reduce prices again, which would drive that many more people
underwater, which could throw us back into a deeper recession
than we’re already coming out of.”

He is far from the first housing lobbyist to flip out in
defense of the homeowners’ tax break during a presidential
campaign. But this time the deduction is more vulnerable than it
was in, say, 1996, when flat-tax plans — such as that of Steve Forbes — were ruffling lobbyists’ feathers. You can even argue
that now is the perfect moment to close the favored loophole of
the upper middle class forever. And that a President Mitt Romney
would be the one to do it.

To understand why, consider the situation in 1996, the year
of that flat-tax talk. Forbes, for his part, argued that a flat-
tax regime with no deduction “will help housing, not hurt it.”
He and others argued that the house tax break distorted the
investment process. The deduction raised prices and made houses
look as if they were worth more than they were. Prices might be
too high.

Alarmist Realtors

The Realtors naturally didn’t like this argument. Their
president back then, Art Godi, even trotted out a study his
group commissioned that suggested the housing market would crash
if the home deduction was abolished. Godi and the report warned
that the effect of ending the deduction on the housing market
would be “devastating,” with houses losing 15 percent in value.
Those flat-taxers were wrecking an otherwise safe investment.

In those days the Realtors’ case that nothing was “as safe
as houses” was pretty easy to accept. After all, the prices had
been rising reliably as long as most adults could remember.
Those increases were deemed proof of the value of residential
real estate.

Over the years, as the gains continued, more and more
people took it as an article of faith that American housing was
a good deal. Fannie Mae (FNMA) and Freddie Mac believed it, and sold
the idea that home purchases were essential to the American
dream. By 2006, after 10 straight years of increases in the
SP/Case-Shiller index, the idea that houses had been overpriced
in 1996 looked idiotic. Americans did such a good job of selling
property that they convinced not only themselves but also
Europeans, banks, towns and investors, who bought in as well.
American housing couldn’t go too high.

Today, the argument that house prices can go too high, or
that something was wrong about them, doesn’t sound so silly.
June 2012 prices were 31 percent lower than those for June 2006,
according to the Case-Shiller index. A house that looks exactly
the same as it did in 2006, and even has granite in the bathroom
now, may be priced at two-thirds what it was a half-decade ago.
This year prices are trending up, but that can never erase the
lesson. House prices were reflecting something other than their
own value. This market was indeed distorted.

The area where the housing Cassandras of yore erred was in
their description of the sources of the distortion. The
distortion of the housing market, we now know, stemmed not only
from the tax deduction but also from the subsidies of
government-sponsored entities such as Fannie Mae and Freddie Mac (FMCC)
and from inappropriately loose monetary policy promulgated by
the Federal Reserve.

Depreciated Assets

Opponents of deduction abolition today argue that abolition
will make the market crash some more, as per Thomas of the
Realtors. One could argue this the other way. Now Americans see
houses for what they really are: boxes that depreciate. This is
therefore the least expensive time to abolish the deduction. We
have already taken the hit — and 2012 is also the time when we
most need
the $100 billion or so from the elimination.

From time to time economists and politicians have advocated
narrowing the deduction in the name of economic redistribution.
One of them was Mitt Romney’s father, George Romney, who in 1969
proposed the partial repeal of the mortgage-interest break to
“meet the problems of the slums.”

To many today, however, the chief appeal of repeal is the
reduction of price distortion. You are more likely to lose a
house if you paid too much, because its true value was muddied
by politics. You are more likely to keep a house whose price at
the time of purchase was transparent and derived from the
relative quality of the investment.

In tandem with the removal of other tax distortions,
including excessively high income-tax rates, a reform could
finally rationalize our irrational investment landscape. Steve
was right in 1996. People might well invest more in
houses than we imagine if, for once, they know what those houses
are really worth.

(Amity Shlaes is a Bloomberg View columnist and the
director of the Four Percent Growth Project at the Bush
Institute. The opinions expressed are her own.)

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About Amity Shlaes

Amity Shlaes is a senior fellow in economic history at the Council on Foreign Relations and the author of the best-sellers “The Forgotten Man: A New History of the Great Depression” and “The Greedy Hand: Why Taxes Drive Americans Crazy.”

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