Wednesday, August 17, 2005

Mortgage interest deductibility

Garth Turner has made a case for Canada introducing a mortgage interest deduction into the Canadian Income Tax Act. I have voiced my skepticism on this matter based on my experiences doing individual tax returns here in the U.S., where one can deduct mortgage interest and property taxes, and based on the history of unintended consequences of targeted tax programs on the economy.

Here are my obsverations:

  • The vast majority of income tax filers in the U.S. do not have sufficient mortgage interest to itemize their deductions rather than use the standard deduction. The majority of 1040 filers can not take advantage of this.
  • The deductibility of mortgage interest lowers the cost of capital, and inflates housing prices by increasing the amount of financing buyers can obtain given a certain costs.
  • Tax measures like this have unintended consequences. When president Reagan brought in tax reform in 1982, one of the stimulus packages was to lower the depreciable lives of property from 40 to 19 years. This created a boom in commercial and residential rental construction - and is one of the prime causes of the 1990's real estate bubble.
  • Finally, once you bring in targeted tax cuts, you open up the Pandora's box and every little thing the electorate wants becomes a deduction or what not. This is why the 1040's in the U.S have become increasingly complex.
My solution for Canada - slash personal rates across the board (heck - if it starves the government, so much the better!) and have large personal exemptions. If I was doing it here, I would get rid of almost all the itemized deductions and up the standard deduction for a married couple from $9,750 to $30,000 (that would take off a large portion of taxpayers of the tax rolls, and the rich folks would be paying at a higher effective rate because they lose all sorts of deductions and not get dinged with AMT). Something like that would do more to help ease the cost of home ownership and spur the economy than a targeted deduction.

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