The Impact of the Interest and Capital Mortgage Deduction on Belgium borrowing behavior Annelies Hoebeeck & Carine Smolders ERES Conference 26/06/2015

Context  Belgium home ownership around 70-73%  Becoming an owner gives access to important tax benefits

Context Before 2005: different system for interest cost, capital amortization and mortgage insurance premiums Policy reform in 2005: Mortgage Interest, Capital amortizations and insurance Premiums assembled in one single Deduction: the MICPD ≠ Previous system:  Fixed deduction, independent of loan size  Double deduction for all couples  Only for mortgages of 10 years or more…  To obtain the owner-occupied dwelling…  … which has to be the only dwelling of the household

Context  € 2080 (in 2010 prices) + € 690 first ten years + € 70 for 3 or more children  MICPD extensive housing subsidy over the loan life

Context  Hoebeeck & Smolders (2014) MICPD did not promote Belgian homeownership due to its capitalization into higher house prices  Capitalization is mostly attributed to household behaviour (e.g. Durning & Quigley, 1985)  Survey at a Belgian housing fair (October 2013): households do not add the MICPD to their housing bid  Different transmission channel at work

Context  Different transmission channel at work: more mortgages higher mortgages longer duration MICPD MORTGAGE MARKET HOUSE PRICE HOUSEHOLDS

Context  MICPD induced HH to take out more mortgages  Average loan length ↑ from 18 (2005) to 25 years (2010)

Research Question  MICPD = ineffective & unfair subsidy Higher income households get a larger subsidy No effect on homeownership Household pay more for their house… … and for their loan  Sellers and financial institutions are subsidized instead of homebuyers  To which extent did the MICPD change HH borrowing behavior?

Dataset  First wave of the HFCS(2010)  Questions 2327 HH  Extensive set of loan characteristics  Research unit: mortgage for the household main residence  Loan origination date:  5 multiple imputed datafiles to treat missing values  N=534

Methodology step 2: cope with selection bias

Methodology step 2: cope with selection bias First solution: restrict sample  L_year > 2000  Length ≥ 10 years

Tax bracketTax rate (t) % % % % > % Max yearly deduction Basic amount2080 € First 10 years+ 690 € First 10 years, ≥ 3 children+ 70 €

Methodology step 4: cope with simultaneity and endogeneity  Cross-equation correlation: SUR  Endogeneity of D,M, H, MICPD variable and R: 2SLS  Instruments for D,M,H: all exogenous variables of the model  Instruments for R: interest rate on long term/short government bonds  Instrument for MICPD over loan life: maximum yearly deduction  SUR + 2SLS= 3SLS

Results Permanent income Harel R²= 0.43

Results Selection regression % correct predicted= 0.834% Intercept model: 0.587²+( )^2= 0.515

Results Mc Elroy R²= N=534

Results

Conclusion  MICPD ↑mortgage maturity and demand  MICPD has no direct effect on the house price  Capitalization happens through the mortgage market  Financial institutions= real beneficiaries of the MICPD  MICPD should be eliminated