Mortgage Interest Deduction Causes Incentives To Households’ Decision Making
Holopainen, Senni (2022)
2022
Master's Programme in Public Economics and Public Finance
Johtamisen ja talouden tiedekunta - Faculty of Management and Business
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Hyväksymispäivämäärä
2022-08-17
Julkaisun pysyvä osoite on
https://urn.fi/URN:NBN:fi:tuni-202207206094
https://urn.fi/URN:NBN:fi:tuni-202207206094
Tiivistelmä
Households’ tenure choice is based on practical needs and personal preferences subject to their budget constraint. The Finnish tax system and housing subsidies have a long tradition to promote owner-occupancy by supporting households to purchase homes.
In the Finnish tax system, the most relevant policy measures that support owner-occupancy are the tax exemption from imputed rental income and the right for mortgage interest deductions (MID). Thus, the benefit from residing in own home is not taxed and the cost of acquiring one is subsidized. This thesis concentrates on the latter instrument, because the tax-free imputed rent is both difficult to calculate and elusive concept for any modifications.
The MID aims to ensure reasonable housing costs relative to households’ incomes. Another goal is to resist residential segregation and ensure equality in the housing markets. Hence, the MID should smooth households’ financial facilities, promote residential diversity and control the price development of both rental and owner-occupied housing.
However, there are drawbacks which put the MID somewhat at odds with its targets. A thorough review of the literature on the subject reveals that the MID fails to significantly increase homeownership rate among its intended beneficiaries. Empirical findings support the argument that high-income households are those who benefit most of the interest deduction. They also react most strongly to any policy reforms. For its part, the MID seems to sustain the economic inequality between low-income and high-income earners.
Moreover, the MID motivates households to excessive housing investments with large debts. When households buy overly big houses with hefty mortgages, the housing market gets distorted and other private consumption dampens. The result is a distortion of the allocation of scarce resources. A high debt rate also makes the households’ financial status extremely fragile in the front of any economic turmoil. This results systemic risks, which disturbs the economy’s macro-stability.
The problems of the MID have been noticed and the current trend is leading towards more symmetric tax system. In Finland, the MID has been under a gradual rundown for many years and it will be abolished in year 2023.
In the Finnish tax system, the most relevant policy measures that support owner-occupancy are the tax exemption from imputed rental income and the right for mortgage interest deductions (MID). Thus, the benefit from residing in own home is not taxed and the cost of acquiring one is subsidized. This thesis concentrates on the latter instrument, because the tax-free imputed rent is both difficult to calculate and elusive concept for any modifications.
The MID aims to ensure reasonable housing costs relative to households’ incomes. Another goal is to resist residential segregation and ensure equality in the housing markets. Hence, the MID should smooth households’ financial facilities, promote residential diversity and control the price development of both rental and owner-occupied housing.
However, there are drawbacks which put the MID somewhat at odds with its targets. A thorough review of the literature on the subject reveals that the MID fails to significantly increase homeownership rate among its intended beneficiaries. Empirical findings support the argument that high-income households are those who benefit most of the interest deduction. They also react most strongly to any policy reforms. For its part, the MID seems to sustain the economic inequality between low-income and high-income earners.
Moreover, the MID motivates households to excessive housing investments with large debts. When households buy overly big houses with hefty mortgages, the housing market gets distorted and other private consumption dampens. The result is a distortion of the allocation of scarce resources. A high debt rate also makes the households’ financial status extremely fragile in the front of any economic turmoil. This results systemic risks, which disturbs the economy’s macro-stability.
The problems of the MID have been noticed and the current trend is leading towards more symmetric tax system. In Finland, the MID has been under a gradual rundown for many years and it will be abolished in year 2023.