Working Paper

More Tax, Less Refi? The Mortgage Interest Deduction and Monetary Policy Pass-Through

Abstract: We study how the mortgage interest deduction (MID) constrains mortgage refinancing. Households who deduct mortgage interest from their taxes face a lower post-tax interest rate, reducing the interest savings from refinancing net of taxes. We estimate the effect of the MID on refinancing using the Tax Cuts and Jobs Act (TCJA) of 2017 as a natural experiment. The TCJA doubled the standard deduction, dramatically reducing MID uptake and value. This policy affected borrowers differently based on their pre-existing mortgage interest, federal and state tax rates, and property taxes. We use heterogeneity in borrowers' pre-TCJA exposure to the policy to show that, following the TCJA, the refinancing rate amongst households who lose the MID increased by 25%. In response to a 19 basis point increase in the after-tax mortgage rate, we estimate that refinancing increases 25%. These results suggest that reductions in the MID may improve the pass-through of monetary policy.

Keywords: Consumption; Household Finance; Monetary policy; Mortgages;

JEL Classification: E52; G21; E21; D14;

https://doi.org/10.17016/FEDS.2024.082

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Finance and Economics Discussion Series

Publication Date: 2024-09-24

Number: 2024-082