The issue: ‘Mortgage interest relief is perverse’

Text: Gert van der Ende / Photography: Levien Willemse

The new cabinet must find many billions in savings. Public Service committees have submitted numerous recommendations for savings and the parties have developed their programmes. Tampering with the mortgage interest relief is a no-no for the CDA, VVD and PVV political parties. However, it is no longer a taboo for the other parties. And rightly so, according to EUR economist Bas Jacobs.

In response to a comment made by the outgoing Minister of Finance Jan Kees de Jager, stating that he wants to leave the mortgage interest relief out of consideration, you recently said in a TV interview that – and I quote: ‘It is really daft that one of the most insane measures in our system of taxation is considered taboo by the minister’. Could you explain? “The mortgage interest relief costs government a total of € 15 billion per year. This amount is structured as follows: the total tax subsidy on a privately owned home is equal to the mortgage interest relief minus the transfer tax and the imputed income from home ownership. However, also add in the lost income from Box 3 on the income tax return, because the money saved in a privately owned home is virtually untaxed, but it would probably otherwise have been deposited in a savings account and therefore could have been taxed in Box 3.
That amount of € 15 billion, for example, represents half the money we spend on education or three times the budget for development cooperation. It is consequently an enormous sum. You could therefore ask yourself: Is this money well spent? Does it promote private home ownership as conjectured by the CDA and VVD? The answer is ‘no’. This is because the housing market in the Netherlands is subject to so many supply restrictions, that in case of a rising demand due to tax subsidies, the supply barely increases, while housing prices do go up. In short, the only parties that really benefit from the tax subsidy are the home owners, definitely not the starters, because the mortgage interest relief is capitalised as part of the house price. In other words, we spend € 15 billion per year to effectively help home owners get a higher price for their homes. That’s totally absurd.”

However, the mortgage interest relief goes as far back as 1893, precisely to promote private home ownership. Did this regulation never accomplish this goal? “I am not familiar with that part of history. But in my opinion no one ever carried out a serious causal analysis that demonstrates that due to the mortgage interest relief, private home ownership has increased. Over time, other factors of course also played a role in this, such as increased prosperity, declining interest rates, dual-income households, etc.”

The CDA, VVD and, for example, the Netherlands Association for (Prospective) Homeowners as well are afraid that any tampering with the mortgage interest relief will give the already vulnerable real estate market a further shove downward. Are they right? “That is a real reason for concern. Any intervention that affects private home ownership must be made with due care: it will have to be a long-term operation and requires clarity. Abolishing this measure all at once is of course not possible and none of the parties are proposing it for that matter.

The major benefit of the mortgage interest relief is therefore not being realised; what are its disadvantages? “Firstly, because the tax subsidy on a privately owned home is so expensive, it must be recovered through higher income taxes on labour – up to 5 percentage points across the board. A higher tax rate caused by factors that perhaps we should not be subsidising at all. That disrupts the labour market: People reduce their working hours, reduce their participation in the workforce, take early retirement or move abroad.
Secondly, the distribution of the tax subsidy on privately owned homes is lopsided. It favours higher incomes and furthermore, it is skewed in terms of age: older generations have profited in the extreme from the mortgage interest relief due to the fact that it boosted house prices.”

But that’s really nothing new, is it? But then why has the mortgage interest relief, when it comes to savings, been taboo for such a long time? “Almost all economists share the above analysis, even as far back as when I was still a student. So, it is indeed nothing new. The major concern remains the transitional regime. If you were to neutralise the tax subsidy, house prices would go down and that's not a message that wins voters.”

But are you saying that it’s feasible to abolish the tax subsidy on privately owned homes? “Definitely. Initially you could dampen the impact of a decline in house prices by partially giving back the recovered income in the form of reduced taxes. Secondly, the abolishment of the mortgage interest relief should occur in stages and over the long term – I am thinking here of 25 – 30 years or so. Thirdly things should be perfectly clear for people owning their own home. But even then, you are still stuck with the problem that new home owners stand to lose most; people that just came on board and therefore have the highest residual debt. These must be compensated in some way. In short, it’s feasible as long as the government pumps back a portion of the money freed up by abolishing the mortgage interest relief by way of compensation and creates total clarity about the transitional regime.”

How should this take shape from a technical income tax perspective? “From a tax perspective, the superior regime would be to tax a privately owned home as part of Box 3 on the income tax return. To do this you set the mortgage interest relief at 30 percent and the imputed income from home ownership at 4 per cent of the value under the Netherlands Valuation of Immovable Property Act. That addition is also taxed at 30 per cent.
There is also an important economic argument for taxing houses more heavily and labour less so: houses cannot just get up and go. Imposing higher taxes on labour or financial capital results in behavioural changes. People start to work or save less and capital and labour go abroad. As soon as you move the privately owned home to Box 3, you achieve three benefits. Firstly: it yields a potential income of € 15 billion, although this goes down as the generosity of the compensation regime goes up. Secondly: people no longer have an incentive to take on the maximum possible mortgage debt. The Dutch economy has become vulnerable due to the large mortgage debts; this undermines the economy’s shock-resistance, because government provides fiscally driven encouragement to incur debt. As soon as the house is moved to Box 3, it no longer matters how you finance your home. Thirdly: by including the addition in Box 3, you remove the stimulus for people to invest their savings primarily in their own home, because the way things are now you would be crazy, if you simply deposited your money in a savings account or put it into an investment.”

And given the survey conducted by TNS Nipo in which 63 per cent of respondents said that they thought the mortgage interest relief should be tackled, does this now all of a sudden seem to be open to debate and feasible? “The transitional regime is crucial to gaining support among private home owners. If the three requirements that I just mentioned – partial compensation, phasing and total clarity – are not met, people will be justifiably concerned. Indeed, they entered into a long-term commitment.”

CDA, VVD and PVV do not want to get burned by the mortgage interest relief. The other parties in the meantime all have developed an action plan. Which party has the best regime? “GroenLinks goes farthest in what tax specialists consider to be the most desirable regime: abolishment of the mortgage interest relief over a period leading up to 2045, but in addition the abolishment of the transfer tax. It would be even better, if that idea could be amended to make compensation dependent on the residual debt. Other variants, such as the limitation of the relief rate to 38 per cent only make a minor difference and do not solve the problems related to excessive debt financing and the lost income in Box 3. The same applies to ideas that would limit the relief to houses below a certain price, as proposed by the SP.

You just said that the Dutch economy is vulnerable due to the enormous mortgage debts. According to the De Nederlandsche Bank, these debts rose from € 144 billion in 1996 to € 590 billion in 2008. Is this an additional reason for abolishing the mortgage interest relief? “Since the internet bubble burst in 2004, banks no longer just hand out high mortgages. As a result, the risks to the economy are nevertheless quite a bit less than in, for example, the United States. Furthermore, it’s true, the Dutch carry a great deal of debt, but this is offset by a huge pension reserve. This is not – yet – a reason for concern, but it is nevertheless a good idea to remove the stimulus for entering into debt.”

Your conclusion? “There is a need for implementing reform that is the equivalent of eight to ten times the reform of the General Old Age Pensions Act [to raise the pensionable age]. Furthermore, I consider the tax subsidy for private home ownership to be so perverse, ineffective and disproportional, that it should absolutely be included in the social debate on savings. There is money to be had here; the mortgage interest relief really is low hanging fruit!”

Friday, April 16th 2010 (week 15).

The issue is a section in Erasmus Magazine, the opinion and information magazine of Erasmus University Rotterdam, in which an EUR-academic responds to a current-social issue.

Bas Jacobs (1973), apart from being one of the most quoted and interviewed economists in the Netherlands, is primarily professor of Economics and Public Finance at the Erasmus School of Economics (ESE). He is also associated with research institutions, such as the Tinbergen Institute and Netspar. He publishes on a range of topics, including public finances, tax policy and the greying of the population, human capital and innovation. Until some time ago, he also wrote about the economy for the news magazine the De Groene Amsterdammer.