Home owners anticipate end of tax relief

As housing prices slump and state finances are in dire shape, scrapping the tax deduction for people with home mortgages is on the table for the Dutch election.

The suggestion of abandoning the mortgage-interest deduction long equalled political suicide in the Netherlands. Parties across the political spectrum considered it an acquired right that couldn't be tampered with. Moreover, no party dared to risk losing all homeowners to another. But now, those on the left in particular are arguing that the government shouldn't spend billions supporting its wealthiest citizens. Parties on the right warn now is not the time. But the discussion alone is already affecting the market.

In a nutshell, the Dutch tax system allows every resident who owns the home he or she lives in to fully deduct the interest paid on their mortgage from their assessed income. A person who earns gross wages of 60,000 euros and spends 15,000 on mortgage-interest, only has to pay income tax on 45,000. The higher the mortgage, the bigger the benefit. In 2001, the period during which the taxpayer could profit from the tax-deduction was capped at 30 years and a second home mortgage was excluded. But that was as far as politicians were willing to go at the time.

Under the current economic conditions, the Dutch government has to make structural cuts of at least 29 billion euros to balance it books. With an estimated 11.4 billion in tax revenues lost to people who deduct their mortgage-interest, scrapping this policy seems a likely cutback candidate for any coalition government that will emerge after Wednesday's parliamentary election. Special government committees that looked into ways of reducing annual state spending by 20 percent came up with several scenarios to phase out the deduction, which they labelled "unsustainable". As the election campaign narrowed onto domestic economic issues, this particular tax rebate has become its centrepiece.

Left v. right Mortgage-interest deduction is a topic in every election programme and debate in the Netherlands. The right-wing liberal VVD, Christian democratic CDA and populist PVV don't want to meddle with it. The CDA has even announced it will not be part of a coalition that does. Parties on the left all want to cap or gradually reduce the rebate. Left-wing liberal D66 has made this a prerequisite to enter into a coalition.

International criticism

Kees Goudswaard, a professor of economics at Leiden University who headed a committee advising the government on the issue, recently told NRC Handelsblad the current system encourages people to take out big loans. "Anyone who pays offtheir mortgage is hurting their own interest", Goudswaard said. "The Netherlands has the highest per capita mortgage debt in Western Europe. The credit crisis has taught us that is a very unhealthy situation."

Despite the incentive to buy a house -- and a more expensive home than one could afford without the deduction – slightly more than half of the Dutch live in a house they own themselves, relatively few compared to other European countries. The rebate has driven up prices, however, the average home cost as much as 228,000 euros by the end of last year, while the modal gross income in the Netherlands is 32,500 euros. Research comparing housing prices with average incomes showed homes all over the Netherlands are about as affordable as they are in New York City. This can’t be fully attributed to the interest deduction though, the crowded Netherlands also has very strict regulations for building new homes, which keeps the market tight. Today, the Netherlands has a total mortgage debt that about equals its GDP: 590 billion euros.

Several other countries have some form of mortgage-interest deduction or tax benefit for homeowners, but none are as generous as the Dutch. This has led to international criticism from the IMF and the Organisation for Economic Co-operation and Development (OECD), which advises high-income economies on their policies. Both have long told the Netherlands its system encourages households to maintain excessive debt. "High tax subsidies for owner-occupied housing, especially mortgage financed, have reduced economic efficiency, may have accentuated price volatility and are unlikely to have achieved their social objectives," the 2004 OECD report on the issue read.

Political perspectives

Left-leaning parties -- Labour, left-wing liberal D66, green party GroenLinks, socialist SP and the orthodox Christian ChristenUnie -- are all in favour of gradually reducing the mortgage-interest tax credit . As part of the ongoing election campaign, their leaders argue it is not only costing the state a lot of money, but that that money ends up in the pockets of those who need it least. Parties on the right, on the other hand, guarantee voters their mortgage is safe with them. The VVD for example, believes the mortgage-interest deduction is an adequate instrument to promote home ownership and wants to offer security to current owners with long-term financial commitments, it says in its election programme. These parties believe more is to be gained by taking on the rental market, which is being subsidised at an annual cost of 14.5 billion euros.

Supporters of the deduction often cite the Swedish example as a worst case scenario. In 1991, the Swedes put an end to their unlimited deduction and house prices dropped by nearly 30 percent. But the currency crisis and banking crisis that hit Sweden in the 1990s were also factors in this development. In the UK, however, the deduction was phased out between 1974 and 1999 without hurting the market; a process that has been widely credited as a success.

Abrupt scrapping of the interest deduction in the Netherlands could lead to a drop of housing prices by 25 percent, according to the economic policy bureau, CPB. Gradually reforming it, as parties on the left propose, could mean prices will be 10 to 15 percent lower in the long term, the CPB calculated.

The right-wing parties have found an unlikely ally in Nout Wellink, the president of the Dutch central bank and a long-time critic of the deduction system. "You can decide on [scrapping] it now," he said in a recent NRC Handelsblad interview. "But you shouldn’t commence now when the housing market is weak."

Meanwhile, the uncertainty about the future of the tax credit is already being felt on the housing market. Home owners and potential buyers anticipate a lower subsidy and seem to be holding their breath at least until a coalition is formed. The housing market, which tripled in value since 1996, has slumped since 2008, mainly as a result of the credit crisis, and shows little sign of recovery. This is now making it easier for people who have never owned a home to enter the market: an oft cited argument by the advocates of reform.