W. Reynolds (Letters, Oct. 10) describes several government policies that led to the current crisis in mortgage financing, including excess risk-taking encouraged by Freddie Mac and Fannie Mae as well as the mortgage interest deduction. He forgets to mention one other aspect: the exclusion from capital gains for profits realized on the sale of a house.
Giving tax-advantaged status to certain forms of income inevitably leads to excess investment directed towards the pursuit of that income type, resulting in bubbles that must eventually burst — such as the tech-bubble of the late 90s, fed by investments chasing tax-preferred capital gains.
Efficient allocation of capital requires that returns, whether they be in the form of wage income, profits from a sole proprietorship, capital gains, dividends, or interest, be on an equal footing. Advantaging investment returns that come in the form of capital gains over other returns necessarily distorts the natural flow of capital to its most efficient and proper use.
Take it from this Adam Smith/Milton Friedman devotee, the U.S. would be a lot better off if all forms of income, from all sources, were equally taxed.