A proposed tax cut for homeowners has bogged down in Congress, but that may not be an entirely bad thing. Tax cuts are usually good ideas, but legislation that would make tax deductible the premiums paid for private mortgage insurance (PMI) has some negative implications.
First and foremost, creating yet another tax break for residential real estate makes it that much more unlikely that fundamental tax reform — featuring a flat-rate tax code — will ever be enacted. Too many taxpayers will be invested in existing tax breaks for reform ever to get off the ground.
Second, the rationale of subsidizing home ownership needs to be examined a little more closely. The deduction for mortgage interest also functions as a savings incentive. To maximize the tax advantage of deducting interest, prospective homeowners need to save something in the form of a down payment to be able to get a mortgage. Make the down payment large enough, and home owners also get the bonus of avoiding private mortgage insurance, which can cost several hundred dollars a month.
By making PMI tax deductible, the tax code would partially remove the incentive to save that's now built into the mortgage-interest deduction. If politicians simply want to subsidize housing costs, they should make that case.
Finally, the flip side of increasing the "affordability" of homes is a decrease in the amount of equity homeowners have in their homes. Primary residences might soon become fantastically leveraged ventures with Uncle Sam functioning as a junior partner in millions of real estate transactions. (And this may already be happening in some hot real estate markets even without PMI deductibility.)
The tax code is always a clumsy tool for social engineering, even if the goal is giving everyone a really nice house.
Jeff Taylor writes the weekly Reason Express at Reason.com.