Why Canadians should be grateful that Joe Clark lost the 1980 election

Ed Glaeser lists five problems with the US policy of letting homeowners deduct mortgage interest payments. Megan McArdle (among others) agrees, but isn't very optimistic about the chances of getting rid of it:

Current homeowners bought their homes on the expectation not only that they would enjoy tax deductibility, but that they would be able to resell their house at a higher price because of the imputed value of the tax deduction to the next owner.  If you remove the deduction, most people will see a permanent decline in the value of their largest asset.

To a libertarian, this is a valuable cautionary tale:  we should assume that any program we introduce will be with us in approximately that form forever, because ending it will harm the beneficiaries.  Liberals are understandably unhappy with applying this lesson very broadly.  Which is one of the reasons I suspect that the mortgage interest tax deduction will outlive us all.

Canadian readers of a certain age and with an improbably high mastery of Policy Wonk Trivia will no doubt recall that one of the features of the 1979 Progressive Conservative (remember them?) government's budget was a proposal to make mortgage interest tax deductible. The budget also included other measures such as a stiff increase in the tax on gasoline, which was a good idea, but disastrous politics. Something like Stéphane Dion's Green Shift. The budget was defeated, Joe Clark lost the resulting election, and mortgage deductibility hasn't been seriously proposed since.

But if Joe Clark had won the 1980 election and implemented his budget, we'd be looking at a Canadian housing market that is in much worse shape than the one we have now.

Comments

[Dee]

The Green Shift would have been perfect right now, it would have created added value to our economy. The implementation of it may have gone through some kinks but at least it was a plan. What do the unemployed have now? Pontification? Great help that is.

We do have something like a mortgage tax deduction. People can write off their interest on a loan if that money is used to earn dividend income.

And the argument that we would have been in the same boat as the U.S. doesn't work. Americans have a different attitude about owning their homes than Canadians. Foreclosure in Canada is more arduous than in the U.S. Americans can pretty much walk away, Canadians can't.

However, it wouldn't be good political optics if any Canadian government were to allow mortgage interest deduction after what's happened in the U.S.

[Nick Rowe]

Yep. We dodged a bullet there.

But I'm more optimistic about the US eliminating mortgage interest deductibility. The UK used to allow it, but slowly phased it out, from 1974 to 1999 (I think).

As Dee says, you can deduct mortgage interest against investment income in Canada if you take out a home mortgage in order to buy income-earning assets. But all that really means is that you can use your home as colateral when investing on margin (using leverage).

Home ownership already has two tax breaks: 1. You don't pay income tax on the implied rents for an owner occupied house, 2. You don't pay capital gains tax either.

If we were to eliminate those two tax breaks, then mortgage interest deductibilty would make sense. It would put treat home-ownership the same as all other investments.

[ClaudeB]

LOL! You mean we have to thank Fabien Roy and his rowdy bunch of Créditistes? Strange indeed.

[Nick Rowe]

Wandering totally off-topic (I blame ClaudeB for leading me astray): 1. I asked my students a couple of months ago, and none had ever heard of Social Credit!, 2. I wonder if we will see any return of Social Credit economics in the current recession?

[Stephen Gordon]

I always thought Social Credit got a bad rap. As far as I could tell, it called for creating fiat money and giving it out to people - in other words, a helicopter drop. In the context of an economy facing depression and deflation, it made a lot more sense than the gold standard.

And Dee is quite right to point out that in the US, mortgages are non-recourse, so Canadians will be even less inclined to abandon a house when its price falls. I suppose that US homeowners who choose foreclosure instead of paying the mortgage on a house that is underwater will get a black mark on their credit records, but it'll be hard for banks to hold a grudge against millions of people.

[ClaudeB]

Nick, you need some old geezers like me in your undergrad classes :)

I was a teenager at the time, and learned about the vote of non-confidence while I was on a school trip to Belgium. From what I recall from the period, the particular strain of Socreds operating in Quebec was a different bunch from the people operating with the same name out west.

The most devoted supporters here mixed a anachronistic blend of catholicism and populism, including the economic doctrine of Louis Even (For an example, see this documentary in the Radio-Canada archives: http://archives.radio-canada.ca/emissions/59-13345/page/4/). They were especially popular in the Beauce and Abitibi regions, the home turf of the colourful Réal Caouette (link here: http://archives.radio-canada.ca/economie_affaires/transports/clips/5822/).

[Raging Ranter]

Stephen, Paul Hellyer and his Canada Action Party strike me as being much like Social Credit. (I know the Canada Action Party is still around, but I don't think Hellyer has anything to do with them anymore - he's off chasing UFOs someplace. In fact he was just quoted in the G & M yesterday regarding UFOs.)

Hellyer always talked about getting the government out of the private debt market completely, and instead borrowing directly from the BoC - which, if I'm not mistaken, is pretty much straight monetization of government debt. To me, that's basically helicopter money, with the exception that it is first being dumped on government, which would then distribute it to everyone else.

In that sense, Social Credit lives on. Not that that's a good thing or anything. I'm not a gold standard nutter, but I think helicopter money in general deserves a bad rap, deflation or no deflation.

[grok]

My own pet wish has been a cap on the principal residence exemption. Say, CPI + 1%. This would perhaps assist in keeping the family home from becoming the sole retirement account, keep them from overspending on a home, and cause them to actually save and diversify. It would also level the playing field between those who rent (for whatever reason) and those who own, though the TFSA has done that to a certain degree (or will do that as the contribution room accumulates).

Obviously this is more relevant in boom times -- recently we've seen people do the slow flip -- spend a year at a time in a residence, fix it a little, and flip, and enjoy tens of thousands in tax free gains based on the PRE. As we're seeing housing bubbles unwind, it is less of a burning issue.

[Neil]

My own pet wish has been a cap on the principal residence exemption. Say, CPI + 1%. This would perhaps assist in keeping the family home from becoming the sole retirement account, keep them from overspending on a home, and cause them to actually save and diversify.

The problem with that is that for those of us who don't see a home as a retirement account. Let's say I bought my condo for $120,000 in 2004. It's worth, even with declining land values about double that today (downtown Edmonton). Now, it's a starter home so I'm wanting to move into an actual house. When I bought the condo, I could have gotten a nearby house for about $300,000. Now it's about $450,000. Should I still be taxed on my gains in excess of CPI, which makes this move up much less affordable?

Also, this would make your taxes much more complicated since it means you need to account for all the capital spending that went into your primary residence. It's just easier for both the government and the homeowner if gains on your primary residence are exempt.

[Mike Moffatt]

"Canadian readers of a certain age and with an improbably high mastery of Policy Wonk Trivia will no doubt recall that one of the features of the 1979 Progressive Conservative (remember them?) government's budget was a proposal to make mortgage interest tax deductible."

I was 2 years old at the time and I recall it - or at least recall learning about a decade and a half ago in Poli. Sci. class.

Ernie Eves ran on the same idea in Ontario during the '03 election and lost pretty badly for reasons that probably had nothing to do with the promise. Still, though, I don't think we'll be seeing the idea return any time soon.

[Stephen Gordon]

Good lord. Apparently I am that old...

[grok]

"Should I still be taxed on my gains in excess of CPI, which makes this move up much less affordable?"

Sure, why not? I'm not sure I see your point. Is it that you could have bought something with a larger cost base that appreciated less? Well, sure. Who's to say that the house wouldn't have increased 100% and the condo 50%?

Or is it that this will make trading up less attainable because of the tax costs? Well, wouldn't other potential trade-up purchasers be in the same boat, and wouldn't that impact demand and therefore price of the tradeup house?

My beef is with the tax free windfall of 120k in 4 years. What is the rationale for tax exempting that gain in the first place? Why shouldn't you include some portion of that as income? I can see the policy that doesn't want to hit a little old lady on her way to assisted living with a honking tax bill when the family house of 50 years is sold, so sure, exempt some reasonable amount. But 100% in 4 years? C'mon.

And the taxes could be simplified by calling it CPI + 1% plus a deemed capital improvement amount, be it a percentage of the deemed value or a fixed amount.

[geoff]

Just a couple of points re the Mortgage Interest and Property Tax Credit, as it's official name implies it was to be a non-refundable tax credit and not a deduction and also it wasn't part of the Clark govt's Crosbie December 1979 Budget. Prior to the Budget, in October 1979, a separate piece of legislation was tabled in the House to implement the new tax credit. The legislation die with the fall of the Clark gov't. As I recall Finance officials advised against mortgage interest deductibility in meetings with the Minister and suggested he have a chit-chat with the US Treasury Secretary regarding the potential fiscal dangers - the Secretary I think indicated if he had an option he'd dump it. Whatever, deductibility became a 25% tax credit on the first $5,000 of mortgage interest to be phased in over 5 years.

Re: an investment tax strategy to arrange mortgage interest deductibility see report of the Lipson case:

http://tinyurl.com/83tjg5

I'd expect CRA might, if there ever was an upsurge in certain strategies to make interest deductible, that GAAR would be more aggressively used and potentially even amended to make it even more scary for tax planners or simply amend the ITA to stop any potential revenue haemorrhage.

[westslope]

Funny how Joe Clark proposed that the Canadian Embassy move from Tel Aviv to Jerusalem--it never happened, thank goodness--and then years later went on to become one of Canada best ever ministers of foreign affairs.

Senior folks in External loved him. As prime minister he almost frightened foreign service workers to death. hehe

[Nick Rowe]

geoff's comment reminds me of why blogging is so great: you get comments from people who really know something about some of the finer points of the stuff you post.

[Stephen Gordon]

No kidding. It's like peer review, only much, much faster.

[Nick Rowe]

And what's the chance that a journal editor would know "geoff", and know that he knew that stuff?

[Paul Wells]

I believe the Progressive Conservatives ran on the same policy under Clark in 2000, the last campaign the party ever fought. So we may be more recently lucky than Stephen first suspected.

[Neil]

Sure, why not? I'm not sure I see your point. Is it that you could have bought something with a larger cost base that appreciated less?
While the condo has appreciated more (percentage-wise), that was actually irrelevant to my point. The point was that both my condo and the surrounding houses have increased in value more than inflation. The 120k isn't a windfall because if I'm selling one home, I have to buy another one, and that's going to eat up my 120k. One of the benefits to owning a home where capital gains are tax-exempt is that it gets you into a housing market that more or less moves up and down together - so that as income increases over the course of a career, a person can move to a nicer home.

Basically, what I'm trying to get at, and explaining poorly, is that if I'd had the income I have now 4 years ago, I could have bought a house. Now, since my primary residence gains are exempt, I can still buy a house, but if I had to pay tax on the gains, that would increase the mortgage debt that I'd have to take on to upgrade, basically meaning that my income growth would have to be even higher to make it work.

(On a side note, if gains on primary residence were taxable then mortgage interest would be deductible, the same as buying anything else on margin.)

Furthermore, I'd have to say that giving a CPI+1 exemption to allow for capital improvements is still a disincentive to home improvement if you don't intend to live there a very long time. The consequences of that will mostly manifest themselves in older neighbourhoods going to shit, while the tax code would implicitly encourage people to build new because they would be able to pocket the 1% while having to put minimal maintenance money into the house. No, if you're going to make the gain taxable, you have to treat it like second properties and that means everyone has to track their capital expenses.