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Monday, 17 January 2011

Prime Minister Rutte, kill your darling…

Why The Netherlands would be better off without the mortgage interest deduction tax break

I’m such a hungry man that I beg you over and over and over and over
I’m loving you above everything I have
I’m a prisoner of love- just stay square

If you live in The Netherlands for a longer time and you watched the 8 o’clock news for a number of times, you would know about the H-word (H stands for “hypotheek” or mortgage). The H-word is about the tax deductability of interest on mortgages. If you believe the VVD, the party of current conservative Prime Minister Mark Rutte, it is the main issue in Dutch politics. He seems to love the Mortgage Tax Break above everything else.

The mortgage tax break was initially invented as a social-democrat solution to give every citizen the possibility to own a house. However, as many well-meant laws it had unintentional consequences: the mortgage tax break eventually evolved into an incentive for having a mortgage at the highest possible amount without paying anything back for 30 years or more. Adversaries call it jokingly the estate bonus.

How does it work? A couple that buys a house for EUR 200,000 against 5% interest has to pay EUR 10,000 interest per year. The Dutch IRS (internal revenue service) states that this interest amount can be deducted from income, due for income tax. This means that 30-50% (depending on your taxable income and tax rate) of this EUR 10,000 is paid back by the IRS.

This seems like a good system for Dutch people. The result is, however, that the amount of money that can be borrowed increases by about 30-50%, if the amount that can be paid annually by this couple (EUR 10,000) doesn’t change. The maximum borrowed amount is not EUR 200,000,  but EUR 260,000 – 300,000. The extra EUR 3200-5000 of interest payments is returned by the IRS.

The nasty fact is that housing prices seem to increase to the maximum amount that interested people can pay for it, if a certain scarcity is in the market. Would the price of a typical family dwelling without tax deductibility be about EUR 200,000, the tax break increases this amount to about EUR 250,000. This situation remains until houses have become too expensive due to external factors, like a decrease in the amount of money and credit in the market. And this is exactly the situation that we’re in right now. Interested readers can find a more extensive explanation in Dutch Housing Market Next Bubble to deflate?

The results are grim:
·    Dutch houses are at least 30% more expensive than comparable houses near the Dutch border in Belgium and Germany.
o    Farther away from the border houses in Belgium and Germany are even cheaper
o    Besides that Belgian and German houses have commonly at least twice as much ground as Dutch houses.

·    Many Dutch people are underwater, as the current sales value of their houses is (much) lower than their remaining mortgage.

·    The Dutch housing market is totally locked up as sellers don’t want to lower their prices and buyers won’t buy for the current prices.
o    Prices are decreasing, but not very quickly, as banks don’t want to push people with too much debt into default. They are afraid for substantial write-offs on their mortgage portfolio.

·    People with a decent salary of EUR 30,000 per year can’t afford to buy a small house anymore.       
o    Banks like ABN AMRO have lowered the maximum amount to be borrowed for these "minimum" incomes from EUR 180,000 to 140,000. This amount of money is too little for buying a house
o    As the social renting sector as of January, 2011 excludes these people also, they are “too rich to rent and too poor to buy a house”

The VVD, in the person of Prime Minister Rutte, promised their voters to keep the Mortgage Tax Break at all costs. This was a logical choice as many VVD-voters do have large residences with full mortgage financing on it (100-120% of the house value). Getting rid of the Mortgage Tax Break would have enormous impact on their financial situation.

Unfortunately, however, there are no easy solutions in this situation. To rejuvenate the Dutch housing market and to make it possible for people with relatively small salaries to buy a house, Mark Rutte has to kill his darling. This would lead to a healthy reshuffling of the housing market, as houses would become cheaper. This sounds bad for the people that have a fully financed house, but it would stimulate them to pay back their mortgages, instead of keeping it there forever: a blessing in disguise.

And there is something more: The Mortgage Tax Break costs approx. EUR 16 billion per year. Money that would be so much better spent on general tax breaks, lowering the now ridiculous costs of labour in The Netherlands. That would be a two-edged knife: lower housing prices and lower costs of labour, making it less expensive for companies to produce goods in The Netherlands.

Dear Prime Minister: I dare you to show true backbone and get rid of the Mortgage Tax Break.


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