Association for Public Policy Analysis & Management

In an era in which key policy narratives draw attention to the plight of the forgotten man, the story behind the mortgage interest deduction’s century-long transformation from small-scale business tax cut to hidden housing subsidy for the rich offers insight into how the U.S. government facilitated the nation’s gaping socioeconomic divide. Washington has subsidized housing for the wealthy through the mortgage interest deduction (MID), which allows families to list the interest they pay on their mortgages each year as a tax write-off, while simultaneously failing to make large-scale investments in the nation’s affordable housing programs. The program is part of a broader trend that has accelerated over the past 50 years: After the passage of Great Society legislation in the 1960s, the U.S. government has failed to significantly expand critical safety net programs even as social risk has increased dramatically amid growing economic volatility (Soss et. al. 2007).

My analysis is the first to evaluate the twin roles that policy drift and punctuated equilibrium theory (PET) play in shaping mortgage interest deduction policy. Policy drift is the process through which government makes de facto changes by failing to amend current legislation to reflect evolving socioeconomic realities (Beland et. al. 2016). Much of the so-called drift is hidden within the submerged state, government programs that incentivize consumer behavior through tax breaks or private enterprise (Mettler 2010). PET argues that the policy process is composed of long periods with incremental or limited change, broken up by short periods of transformation (Baumgartner and Jones, 2010). My paper offers clues into the political dynamics shaping the fight over a program that costs $30 billion annually and is widely-panned by economists as an engine of socioeconomic inequality.

Since the 1960s, special interests such as realtor and home builder trade groups increased the political costs of changing the tax law even as the deduction’s expense increased exponentially. Electoral pressures and the strength of the home lobby crippled reform efforts. Changes during the 1980s and as part of the 2017 tax reform law incrementally enhanced limitations on the size of eligible mortgages. The slow-moving reforms were in accordance with PET’s focus on slight changes made over long periods of time. In many ways, PET accelerated policy drift by making it more difficult for leaders to significantly revamp or eliminate the MID.

By the 1990s, a tax deduction created under President Woodrow Wilson and initially intended for small businesses had drifted into one of the federal government’s largest handouts for the wealthy. Instead of taking on responsibility for providing a minimum level of affordable housing for all Americans, Washington used the MID to effectively push additional social risk onto the backs of individuals.

My findings reinforce evidence regarding the influence of PET and policy drift within housing policy and the submerged welfare state. Leaders in Washington could only incrementally downsize the program even as costs ballooned and the nation’s affordable housing shortage increased. Insights from this analysis could be applied to other elements of the submerged welfare state.