The problem with taxes is that people refuse to think systemically.Take tax rebates for instance. Imagine everyone got a million dollars from the federal government.It sounds good until you realize that prices would have to rise.Admittedly there is a lot of slippage and friction in prices so there would be points of advantage but everyone understands at some fundamental level that if everyone has a million dollars, then millionaire doesn’t mean what it used to.The same thing is true if everyone gets five hundred dollars.Again there is some slippage and friction on prices so you aren't quite as equal as you might think but in a great hydraulic sense, no one has made anything. In order for tax rebates to work, someone has to be losing money.
This doesn’t mean that Keynes was wrong. Keynes argued that government should borrow to flatten the business cycle and get people through the recession. One of the fundamental market paradoxes is that someone can win.Almost everyone has played monopoly.No one plays it to resolution with the shoe circling the board yelling out that it won with every shake of the dice and all the other players shivering out in the cold or in debtor’s prison, but this can happen in real life.There is no point in giving the shoe any more money. The shoe is not going to build more hotels or buy more property.If you want to keep the other players in the game you have to take money and property from the shoe and give it to the other players.Keynes didn’t explicitly say that the money borrowed would have to come from somewhere and be repaid with interest devalued by inflation, but that is what he meant. Keynes opponent, goofy Hayek, the shoe concerned with moral hazard, keeps whining:
-I won, I won!
-Don’t you want to share with the other children?
-No I won!
-They won’t want to play with you.
-I won I tell you!
If a deduction is truly fair then no one got the deduction. The same thing is true for a rebate.
Let us apply this same systemic thinking to the mortgage interest deduction. People think that the mortgage interest deduction holds up house prices, but the true subsidy is to mortgage holders.Banks get to charge more interest on mortgages because of the subsidy.It seems reasonable that a subsidy for interest expense would increase home purchases but not when banks get the first cut. The mortgage interest deduction was originally intended and functions as a bank subsidy. Since all home buyers are getting the deduction the banks would be foolish not to increase their prices to meet the subsidy.
The $250,000 home exclusion on the sale of a house after owning it for three years does increase market activity.People are more willing to sell at a lower price since they don’t have to pay as much capital gain tax and they are more willing to purchase since they can expect to get tax free return. It also has operational benefit for the IRS in that they aren’t concerned with fraud on sales that generate tax free return.
Doing away with the mortgage interest deduction would lead to a small drop in mortgage interest rates and not much else. We would pay more in taxes and less in interest. Since banks merely generate mortgages and no longer hold them they may even favor dropping the deduction as that would encourage refinancing.