**U.S. tax subsidies for home ownership are regressive, particularly in comparison to rental subsidies.** Given the progressivity of the Federal income tax, mortgage deductions have no value for low income households and little value to moderate income owners.<sup>15</sup> In 2005 the total mortgage interest tax deduction claimed amounted to US$340.5 billion (IRS, 2007a). By contrast, the major tax subsidy that supports the creation of new lowcost rental units, the Low Income Housing Tax Credit (LIHTC) cost the government about US$5.1 billion in tax expenditures in 2007 (NLIHC, 2008). While almost 50 percent of homeowner households earn less than the median income, 80 percent of renter households earn less than the median (Census, 2006).

# **A distortion in tax policy contributed to the growth of riskier mortgage lending**

**during the subprime boom.** Until 2006, the interest paid on a second lien mortgage loan was deductible from Federal income tax, but the premium paid for mortgage default insurance was not. This disparity provided an incentive to individuals to finance 100 percent of the purchase price of a house with the combination of an 80 percent first lien mortgage and a simultaneous 20 percent “piggyback” second lien, as discussed earlier in this paper. The popularity of piggyback house purchases resulted in higher levels of indebtedness, and given subsequently falling house prices, a greater chance for negative equity. Starting in 2006, buyers were permitted to deduct from Federal taxes the mortgage insurance premium paid in connection with home acquisition debt (IRSc 2007). Once borrowers were able to deduct the MI premium, market share for MI providers began to rebound from years of decline.

**The Links Between Subprime Lending and Access to Finance**

**Subprime lending has provided only limited access to finance.** More than half of subprime loans have been for refinancing existing mortgages rather than purchasing a house (Chart 4). In the U.S., individuals frequently replace existing fixed rate mortgages with new ones to take advantage of declines in market rates or to extract equity from the house by refinancing at a higher LTV. Many subprime borrowers refinanced to pay off riskier ARM loans before they reached the end of their low teaser interest rate period. As such, refinancing represents no new access to finance. In addition, not all subprime lending has been for low-income households; many subprime loans were made to higher income earners that had blemished credit records.

> 15 Federal tax exemptions are available only to taxpayers who file itemized returns, where they itemize, or list separate deductions to reduce the tax paid. These include mortgage interest paid, moving expenses, medical expenses, charitable contributions, and a host of other expenses. To make itemization worthwhile, the reduction in taxes has to compensate for the extra effort of filing a more complicated itemized return. In 2005, 35.5 percent of taxpayers itemized, and 11.8 percent of these earned less than the median household income. Interest paid on mortgages represented one of the largest categories of exemptions, 32.8 percent of total deductions taken (IRS, 2007).

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