Question

The largest tax break for most Americans is the mortgage interest tax deduction, which allows homeowners to deduct from their taxable income the amount of money they pay in interest to finance their homes. This tax break is intended to encourage homeownership. Compare this tax deduction to a uniform tax credit for homeownership on equity and efficiency grounds.

Answer 1

Answer:

The more expensive the home, the larger the mortgage; the larger the mortgage, the bigger the deduction.

Explanation:

The more expensive the home, the larger the mortgage; the larger the mortgage, the bigger the deduction. The compounding effect is the tendency for wealthier people to live in larger, more expensive home and face higher marginal tax rate. Therefore, both the size and the marginal value of the mortgage deduction are higher for wealthier taxpayers. This is in direct contradiction to the vertical equity. Deduction favor high tax brackets taxpayers because they reduce the base on which taxes are calculated. Sometimes a deduction can drop the base to a lower tax bracket. Even if it doesn’t reduce the tax paper’s marginal rate, it reduces the number of dollars to which that tax payer’s highest bracket applies, in contract, tax credit benefit all tax payers equally by reducing the tax payer’s tax liability dollar for dollar. As a result, tax credits do not disproportionately benefit high tax bracket payer .In addition, making the credit uniform avoids the problem of providing the largest subsidies to those living in the fanciest homes. On equity grounds, the tax credit appears to be preferred. Offsetting this benefit is the fact that housing prices vary significantly by geographic region. A credit that generous in some parts of the country would be very small relative to housing prices in other areas. The tax credit would seem to be better on efficiency grounds as well .The mortgage deduction is now implemented distorts consumption behavior in favor of more expensive homes .A uniform credit would continue  to encourage home ownership at some basic level (which may be justified based on the positive externalities involved ) but would not subsidize McMansions .