New York Times, The Misunderstood Mortgage Interest Deduction, by Casey B. Mulligan (University of Chicago, Department of Economics):

The home-mortgage interest deduction does not by itself significantly distort housing markets. Too much owner-occupied housing has been built because housing is excluded from sales and other taxes owed by businesses.

The housing boom and bust of the last decade, and government revenue shortfalls, have brought back the topic of whether the government excessively encourages home building. Those discussions invariably mention the elimination of the home-mortgage interest deduction. …

At first glance, the home-mortgage interest deduction would seem to cause homeowners to borrow excessively for home ownership, and thereby deplete government treasuries. But that ignores the fact that one person’s mortgage interest payment produces interest income for another person or a business. The lender may well owe taxes on the interest income.

More home-mortgage borrowing means more home-mortgage lending, and the latter means more interest income that can be taxed. In theory, home-mortgage borrowing could even add revenue to the Treasury if the lender is in a higher tax bracket than the borrower (or if the borrower is not itemizing her tax deductions).

Tax Prof William J. Turnier (North Carolina) disagrees:

It is hard to believe that Professor Mulligan holds a position at the University of Chicago and is apparently unaware of the Haig-Simons definition of income which is in part the work of Henry Simons, a University of Chicago professor of economics. Simons’ definition put most simply posits that income is consumption (money spent to further personal living) plus savings (with a negative adjustment made for disgorgement of savings). This definition is very widely accepted by tax policy analysts. The result of applying it to our individual lives is that although one can justify allowing a deduction for business expenses, one cannot do so for personal outlays such as groceries, haircuts, rent, interest, etc, unless such expenditures are in furtherance of profit seeking activities. Just because a party on the other side of a transaction take a payment into income does not justify allowing a deduction for the outlay. For example, although Professor Mulligan’s barber reports the sum and tip the professor pays him for a haircut, the professor is not thereby going to be allowed to claim a deduction for the cost of the haircut. The right question to ask when examining the home interest deduction is whether it is an expenditure in furtherance of personal consumption or profit seeking. Quite clearly it is an expenditure in furtherance of personal consumption and as such fails the test of being allowed as a deduction under the Haig-Simons definition of income. Henry Simons’ book is a slender offering of only about 100 and is recommended as the first step in reading fir all interested in tax policy analysis.

Update: Dan Shaviro (NYU), There Is No Joy in Mudville – Casey Mulligan Has Struck Out:

Thanks again to a link in the Tax Prof Blog, I see that Casey Mulligan of the University of Chicago Econ Department is saying that the home mortgage interest deduction is no big deal, hence no particular reason to repeal it. He focuses mainly on the point that “one person’s mortgage interest payment produces interest income for another person or a business. The lender may well owe taxes on the interest income.”

My god, but Mulligan has missed the boat on this one. William Turnier pretty much makes the point, back in the Tax Prof blog link, by referencing the Haig-Simons definition of income and calling the home mortgage interest payment consumption-related.

But I would make it a bit clearer still. The problem isn’t really the home mortgage interest deduction as such, although it may encourage the sort of excessive home leverage that helped contribute to the 2008 financial crisis. The real problem is the fact that homeowners get to exclude imputed rental income because it isn’t derived from an observable market transaction. The home mortgage interest deduction merely builds off that. Its allowance would be uncontroversial if imputed rental income were included.

One can’t seriously discuss the home mortgage interest deduction without understanding its relationship to the underlying imputed rent exclusion. This is really basic stuff. Mulligan ought to know, not just before he blogs about the issue in the New York Times, but as a supposedly informed professional in the field of public economics. …

The University of Chicago Law School has a pretty good tax faculty, whose members I am sure would have been happy to bring Mulligan up to speed. But if you don’t know that you don’t know, I guess it’s hard to find out.