The Perfect and the Free

How to think about the 47%... elegantly

The big story over the past 36 hours has been Mitt Romney's comments, at a private fundraising event, to the effect that a large share of the electorate will be unreceptive to his message because they (a) pay no income taxes and thus won't care if tax rates are lowered, (b) are "hooked on entitlements," and (c) see themselves as victims in need of government intervention.  Romney effectively stated that these individuals should be written off in his electoral calculus as unpersuadable.  Both sides are busily spinning the remarks, with the Romney campaign conceding that they were "inelegantly stated," but standing behind the basic message.

How might one craft an elegant argument out of these basic raw materials?  By focusing on something psychologists spend a lot of time studying -- locus of control.  But let's craft a statement that doesn't use jargon.

The recipe for success in life includes two main ingredients: effort and luck.  People have differing views about which of these ingredients is more important.  The more you believe that luck -- forces beyond your control -- determines whether you succeed or fail, the more likely you are to accept the Democratic world view, that government improves society by helping those who do not succeed.  If you believe that effort matters more than anything else, then you think very differently about offers of assistance to those who are not successful.  In a perfect world, we'd be able to separate those who were unlucky from those who didn't exert themselves, but in reality it's hard to craft a policy that does that.

The plain truth is that there's a bit of both ingredients in the recipe for success.  Hard work matters, but being in the right place at the right time makes a difference too.  That should be an uncontroversial statement.  Here's another one.  Regardless of what the true ratio of ingredients might be, society is better off if everyone believes that hard work makes a difference.  When people become cynical, when they conclude that their own effort doesn't matter, society loses.

The problematic slice of the electorate is not those who don't pay income taxes, nor is it the share who receive government benefits at a point in time.  The problematic slice consists of those who believe that the game is rigged against them, that it doesn't matter what they do since forces beyond their control have sealed their fate.

The problematic slice of the electorate has been growing over time.  Over the past fifty years, the proportion of young Americans adopting the fatalistic worldview -- that forces beyond their control determine their fate -- has increased dramatically.  AFL-CIO president Richard Trumka played to this slice of the electorate in his comments to the effect that the 47% are "victims of a system that was rigged...so they'd lose."

Those who believe the system is rigged imagine that government is a "counter-system" that can undo the rigging.  Those who have faith in the system see things very differently.

America will benefit if faith in the system -- namely, the system of capitalism and competitive markets -- is restored.  It's important to understand that the system doesn't always work, and it is persistently threatened by those who have the will and the means to exploit it to their own advantage.  Faith in the system must not be blind to these threats.  But the best course of action is to guard against these threats and construct a system that Americans can trust.

Now, just ask yourself, who are the right people to reconstruct the system?  Those who believe it is doomed to fail?  Or those who believe that with proper vigilance the system can reliably deliver rewards to those that deserve them?

Anyway, that's the way I'd make the argument if it were up to me.

 

Is it time for the mortgage interest deduction to go?

The Vigdor family has lived at the same address since May 2000.  We initially financed the house with an 8.125% 30-year fixed mortgage.  After refinancing twice over the past 12 years, yesterday we locked in a 15-year fixed rate loan at 2.875%.

Like many American households, our net cost of borrowing is reduced by the home mortgage interest deduction.  Putting federal and state taxes together, we get a rebate of nearly 40 cents for every dollar in interest we pay.  The mortgage interest deduction has been around since the dawn of the federal income tax in 1913.

While it's in our family's best interest to see the mortgage interest deduction preserved, and the housing industry certainly welcomes federal efforts to rebate the costs of buying their goods, most economists will tell you that this income tax loophole is bad policy.  It doesn't help anybody who rents a home, and it likewise doesn't help you if you don't itemize deductions on your tax return.  Moreover, the rebate you get on your interest depends on your tax bracket, meaning that the biggest rebates go to the highest-income households.  So basically government is steering help -- over $80 billion worth of help, every year -- to families that need it least.

It's also propping up the housing industry, which is one often-cited argument for why the deduction, flawed though it may be, needs to stay.  My recent refinancing experience, however, got me to thinking that now might be the best time in decades to do something about it.

Why?  Because interest rates are so low, the value of the "prop" is at an all-time low.  Think about it.  My own experience indicates that rates have fallen by 65% over the past dozen years.  American households -- particularly the well-to-do ones that qualify for the most advantageous pricing, and who also happen to be the biggest beneficiaries of the deduction -- are paying much less in interest as a result.  When we first took out our mortgage loan, the deduction essentially let us pay 5% interest instead of 8%, a pretty big deal.  With our new loan, we'll effectively pay 1.7 instead of 2.9.  Proportionately, that's the same difference, but in absolute terms the deduction is worth much less to us now.  If you're going to take something away from people, might as well do it when that thing is close to worthless, right?

If you follow treasury yield curves, it is unlikely that mortgage interest rates will be spiking upward anytime soon.  So regardless of the outcome of elections in November, Congress and the administration will continue to have a great opportunity to make a rational, deficit-cutting modification to the tax code, without raising marginal tax rates.  How about it?