There has been increased concern over the size and sustainability of the United States' recent deficits and the country's long-run budget outlook. This concern has brought the issues of the federal government's revenue needs and fundamental reform of the tax system to the forefront of congressional debates. One place Congress may turn to address these issues is the set of tax benefits for homeowners. The Joint Committee on Taxation (JCT) has estimated that the cost to the federal government in terms of foregone revenue from these benefits will be approximately $136.3 billion annually between 2014 and 2017. Economists have identified the set of tax benefits for homeowners as one area in which reform may improve economic efficiency. This report focuses on the two largest federal tax benefits available to homeowners—the mortgage interest deduction and the deduction for state and local property taxes. The goals of this report are five-fold: (1) briefly summarize the trends in homeownership; (2) provide an overview of what tax benefits are available; (3) analyze the rationales commonly provided for offering such benefits; (4) analyze the effect of the mortgage interest deduction and property tax deduction on the homeownership rate, housing consumption, and the economy; and (5) present policy options. Until recently, the homeownership rate in this country had generally increased over time. In 1900 only 46.5% of Americans owned the home that they lived in. By 1950, the homeownership rate had increased to 55%, and to 67.4% by 2000. Homeownership peaked in 2004 at 69%, and today hovers around 65%. The most current data show that of 132.6 million homes in the United States, 75.0 million serve as principal residences. Another 39.7 million homes are renter-occupied, and the remaining 17.9 million are either for sale, for rent, or for seasonal use. The size of homes that Americans own has also generally trended upward over time, while family size has trended downward. In 1970 the median new home was around 1,385 square feet. By 2009, the median new home was roughly 2,135 square feet—an increase of 54%. Over this same time period the average family size decreased. In 1970 the average family size was 3.58 persons, while in 2009 the average family size was 3.15 persons. Thus, the increase in home size has been even larger after adjusting for family size. The fact is that Americans have tended to build bigger and bigger homes while tending to have smaller and smaller families. This trend can have important ramifications in terms of land use, energy use, transportation, and affordability. These long-term trends in homeownership behavior may be overshadowed by more recent trends in foreclosures. At the beginning of 2001, near the start of the housing boom, the national foreclosure rate on all mortgage loans was 1.24%. The foreclosure rate among riskier subprime borrowers was slightly higher at 3.58%. Foreclosures began to increase between 2007 and 2008, shortly after the turning point in the housing market. After peaking in late 2009 and early 2010, the foreclosure rate has gradually decreased. By the fourth quarter of 2013 the foreclosure rate on all loans stood at 2.86%, while foreclosures occurring among subprime borrowers stood at 10.43%. As of March of 2014, there were at least four significant tax incentives that directly or indirectly benefit homeowner-occupiers. The Joint Committee on Taxation (JCT) estimates these benefits will cost the federal government an average of $136.3 billion in foregone revenue annually between 2013 and 2017. These tax benefits and their associated budget impacts are listed in Table 1 . The three most expensive tax incentives in the JCT's estimate are the mortgage interest deduction ($77.3 billion annually), the itemized state and local property tax deduction ($31.5 billion annually), and the exclusion of capital gains on the sale of a principal residence ($26.5 billion annually). Some argue that another tax expenditure not included in official costs estimates—the exclusion of imputed rental income—should be included. Unofficial cost estimates place the foregone revenue generated by this exclusion at between $20 billion and $30 billion annually. The following overview focuses on the mortgage interest and property tax deductions. The exclusion of capital gains is not reviewed in detail because its effects on the housing decisions of taxpayers is fundamentally different than the effects of the deductions for mortgage interest and property taxes. A brief summary of the capital gains exclusions, as well as the other tax benefits, is provided at the end of this section. The largest and most well-known tax benefit that homeowners can take advantage of is the mortgage interest deduction. Specifically, homeowners are allowed to deduct the interest they pay on a mortgage that finances a primary or secondary residence as long as they itemize their tax deductions. For example, an itemizing homeowner who pays $10,000 in mortgage interest in a given year can deduct $10,000 from his or her adjusted gross income. If this individual is in the 25% marginal tax bracket, a $10,000 tax deduction reduces his or her income taxes by $2,500 ($10,000 multiplied by 25%). The value of the deduction generally increases with taxpayer income for two reasons. First, the marginal tax rate a homeowner faces increases with income. So an individual in the 35% marginal tax bracket, paying $10,000 in mortgage interest, would realize a reduction in taxes of $3,500 in comparison to a $2,500 reduction for someone in the 25% tax bracket. Second, higher-income individuals tend to purchase more expensive homes, which results in larger mortgage interest payments, and hence, a larger deduction. This relationship explains why most of the total dollar amount of mortgage interest claimed is done so by middle- and upper-income households. There are limits to the amount of mortgage interest that may be deducted. Only the interest paid on the first $1 million of mortgage debt that is incurred in the purchase, construction, or substantial improvement of a residence, and only the interest paid on up to $100,000 of home equity debt may be deducted. Home equity indebtedness is debt that is not incurred in the purchase, construction, or substantial improvement of a residence, but that is secured by the residence. Home equity debt may be used to finance personal expenditures (college education, vacations, etc.) unrelated to the home. Although many contend that the purpose of the mortgage interest deduction is to promote homeownership, this was not the deduction's original purpose. When laying the framework for the modern federal income tax code in 1913, Congress recognized the importance of allowing for the deduction of expenses incurred in the generation of income, which is consistent with traditional economic theories of income taxation. As a result, all interest payments were made deductible with no distinction made for business, personal, living, or family expenses. It is likely that no distinction was made because most interest payments were business related expenses at the time and, compared to today, households generally had very little debt on which interest payments were required—credit cards had not yet come into existence and the mortgage finance industry was in its infancy. Among those that did hold a mortgage, the majority were business farmers. For more than 70 years there was no limit on the amount of home mortgage interest that could be deducted. The Tax Reform Act of 1986 (TRA86; P.L. 99-514 ) eventually restricted the amount of mortgage interest that could be deducted and limited the number of homes for which the deduction could be claimed to two. Mortgage interest deductibility was limited to the purchase price of the home, plus any improvements, and on debt secured by the home but used for qualified medical and educational expenses. Subsequently, the Omnibus Budget Reconciliation Act of 1987 ( P.L. 100-203 ) resulted in the basic deduction limits that exist today. Not all homeowners claim the mortgage interest deduction. Some homeowners have no mortgage, and hence no interest to deduct. The most recent data (2011) show that this group accounts for 34% of homeowners. Among the 66% of homeowners with a mortgage, 73% claim the deduction. This implies that around 48% of all homeowners claim the mortgage interest deduction. The remaining 27% of mortgage holders (or 18% of homeowners) who do not claim the deduction are likely either (1) toward the end of their mortgage payments so that the deduction is not worth much, (2) live in a state with low state and local taxes and thus claim the standard deduction, or (3) live in a low-cost area and therefore have a relatively small mortgage. In terms of tax returns filed, the deduction is claimed on about 25% of all federal income tax returns and 78% of itemized returns. Homeowners also benefit from the ability to deduct state and local property taxes. In general, homeowners are allowed to claim an itemized deduction equal to the full amount of state and local property taxes paid. For example, an itemizing homeowner who pays $1,000 in property taxes can deduct $1,000 from his or her adjusted gross income. If this individual is in the 25% marginal tax bracket, a $1,000 tax deduction reduces his or her income taxes by $250 ($1,000 multiplied by 25%). As with the mortgage interest deduction, the value of the property tax deduction generally increases with taxpayer income for two reasons. First, the marginal tax rates that a homeowner faces increase with income, so an individual in the 35% marginal tax bracket paying $1,000 in property taxes would realize a tax savings of $350. Second, higher-income individuals tend to purchase more expensive homes, which results in higher property taxes, and therefore a larger deduction.