Portfolio Shuffling and Tax Reform

This paper analyzes the response of households to the provision in the Tax Reform Act of 1986 that phased out the deductibility of interest paid on consumer debt The evidence suggests that the policy goals of the provision were frustrated because households shuffled their portfolios, substituting mortgage debt for consumer debt High-income homeowners appear to have shuffled more of their debt and thus increased their share of the benefits of the mortgage interest deduction. One reason for this difference in shuffling may be that highincome homeowners scored better on measures of financial sophistication, and better scores appear to predict greater shuffling. Policy options that would reduce the use of mortgage debt for nonhousing purchases are discussed.