President Obama’s budget reform commission proposed eliminating the home mortgage interest deduction. This idea has analysts scurrying to estimate the proposal’s economic impact.
Unfortunately, our lawmakers often forget the law of unintended consequences when offering up changes to policies. In this case, our elected officials need to consider how making mortgage interest non-tax deductable will impact small business credit markets.
While policy makers might not see the connection, the mortgage interest deduction is linked to small business credit. That’s because the deduction helps to prop up housing prices. With 25 percent of those running small companies using home equity to fund their businesses, a drop in housing prices would mean that small business loans and lines of credit would be harder to come by.
Getting rid of the mortgage interest tax deduction will have a sizeable effect on small business credit markets. Analysis by the National Association of Realtors indicates that home prices would drop 15 percent in the absence of this deduction. A study I conducted with Mark Schweitzer of the Federal Reserve Bank of Cleveland shows that each one percent decline in housing prices lowers the value of home equity loans (HELOCS) by 1.33 percent. Combined with the estimate of the home price decline from no longer being able to deduct mortgage interest from your taxes, this shift would mean a 20 percent drop in the value of HELOCS.
That’s a lot less small business credit. A report by the New York Fed put the dollar value of outstanding HELOCs at $700 billion in the beginning of 2010. Thus, we should expect to see a $140 billion decline in outstanding HELOCs if the home mortgage interest deduction were eliminated.
A sizeable chunk of this decline would be borne by small business owners. Analysis of the Federal Reserve’s consumer finance survey shows that business owners accounted for one quarter of home equity loans in 2007, the latest year for which data are available. Thus, dropping the deductability of mortgage interest would shave $35 billion from small business owners’ home equity loans.
While we don’t know for sure how much of small business owners’ home equity borrowing is financing business operations, the amount is sizeable. Analysis of Fed consumer finance survey data indicates that households with businesses had median home equity debt that was 50 percent more than that of households without businesses in 2007. If the difference in debt levels between the two types of households represents the portion of home equity borrowing the business owners are using to finance their companies, then one third of the small business owning households’ home equity borrowing is being used to support business operations.
The reduction in housing prices estimated to come from dropping the deductability of mortgage interest would lead to a projected $11.7 billion decline in home equity borrowing by small business owners for business purposes. That’s about 16 percent of the $71.8 billion in loan originations made to small companies (businesses with less than $1 million in annual sales) in 2009, the latest year for which data are available.
And that’s just the effect of eliminating the mortgage interest deduction on small business owners use of home equity loans to finance their companies. Any effect of the eliminated deduction on other types of loans used to tap home equity for business purposes would be on top of this.
Our elected officials need to consider the law of unintended consequences when they debate eliminating the mortgage interest deduction. Doing so will cause a contraction in the small business credit market that could lead small businesses to cut back on capital investment and hiring.
You’re also missing side 2 of this equation. Revenues from small business will also go down as consumers will have less money from tax refunds to spend. As a small business owner, I have used the mortgage interest tax refund generated money to make investments, and improvements to my business and home. Removing this deduction would remove revenue stream from the business I typically spend those investments in.
Wow, I wouldn’t have thought of that. But it seems like the reliance on home equity loans for small business financing is also of concern.
Thanks a lot for that information, Scott!
You wrote that, “With 25 percent of those running small companies using home equity to fund their businesses, a drop in housing prices would mean that small business loans and lines of credit would be harder to come by.”
Harder than it is already?
I don’t even want to think about it.
I agree; we need this deduction; our homes have taken too much of a hit!
The Franchise King®
In no way do I agree with the logic of using home equity to fund your business. My father, a Stanford MBA, spent 30 years running his own real estate office, and during much of that time he looked for investment capital for his business. He always proudly said, “I never took a second mortgage on the house my children lived in.” He always felt it was way too risky to use home equity to fund a business.
Howard, fortunately your Father’s real estate office didn’t require the capital that is necessary to run many businesses today. Especially 30+ years ago when he started it. I’m sure it also wouldn’t have made much sense 30+ years ago when most homes were 30-40k either. Do not criticize those for stepping out of the box and trying to make something of themselves on their own.
If the mortgage interest tax deduction is taken away think of all the construction jobs that will be affected. Small contractors will not be able to get work from the regular guy that wants to build a deck for his family that he’s starting and to raise the value of his home for a few years down the road when he wants to sell it. That tax deduction will affect so many people in so many ways. Banks will lose business from writing such loans and lines of credit. Spending will stop. Spending is what makes the world go ’round. Spending within our own country is the only way to get us out of the mess we’re in. Buy American! China loves Buicks! Why don’t Americans? The Anti-American media and the inability of the republicans to properly educate the public is a big part of the problem. I’m sure all the movie stars and Hollywood do love Obama. They don’t care about their money cause they don’t have to work for it. Why doesn’t Obama start taxing the film industry. See what happens then.