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Tax, Credit Constraints, and the Big Costs of Small Inflation

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  • Andrew Coleman

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    (Motu Economic and Public Policy Research)

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    Abstract

    This paper develops an overlapping generations model incorporating credit constraints, owner-occupier and rental sectors, and detailed tax regulations to examine how the interaction of inflation and the tax system affect the housing market. It shows that even modest rates of inflation can have very large effects on the home-ownership rates of young households, particularly at low real interest rates. This occurs even if there is a large supply response in the quantity of housing. The model suggests that the welfare costs of inflation could be ameliorated by exempting the inflation component of interest payments from income tax.

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    File URL: http://motu-www.motu.org.nz/wpapers/08_14.pdf
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    Bibliographic Info

    Paper provided by Motu Economic and Public Policy Research in its series Working Papers with number 08_14.

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    Length: 44 pages
    Date of creation: Dec 2008
    Date of revision:
    Handle: RePEc:mtu:wpaper:08_14

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    Related research

    Keywords: Inflation; credit constraints; capital income taxes; housing markets; home-ownership rates; monetary policy;

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    References

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    1. Martin S. Feldstein, 1999. "Capital Income Taxes and the Benefit of Price Stability," NBER Chapters, in: The Costs and Benefits of Price Stability, pages 9-46 National Bureau of Economic Research, Inc.
    2. Roger H. Gordon & James R. Hines, Jr. & Lawrence H. Summers, 1987. "Notes on the Tax Treatment of Structures," NBER Chapters, in: The Effects of Taxation on Capital Accumulation, pages 223-258 National Bureau of Economic Research, Inc.
    3. Fischer, Stanley & Summers, Lawrence H, 1989. "Should Governments Learn to Live with Inflation?," American Economic Review, American Economic Association, vol. 79(2), pages 382-87, May.
    4. Kearl, J R, 1979. "Inflation, Mortgages, and Housing," Journal of Political Economy, University of Chicago Press, vol. 87(5), pages 1115-38, October.
    5. Martin Feldstein, 1996. "The Costs and Benefits of Going from Low Inflation to Price Stability," NBER Working Papers 5469, National Bureau of Economic Research, Inc.
    6. Modigliani, Franco., 1974. "Some economic implications of the indexing of financial assets with special reference to mortgages," Working papers 736-74., Massachusetts Institute of Technology (MIT), Sloan School of Management.
    7. Bailey, Martin J, 1974. "Progressivity and Investment Yields under U.S. Income Taxation," Journal of Political Economy, University of Chicago Press, vol. 82(6), pages 1157-75, Nov.-Dec..
    8. Nowotny, Ewald, 1980. "Inflation and Taxation: Reviewing the Macroeconomic Issues," Journal of Economic Literature, American Economic Association, vol. 18(3), pages 1025-49, September.
    9. Fumio Hayashi & Takatoshi Ito & Joel Slemrod, 1987. "Housing Finance Imperfections and Private Saving: A Comparative Simulation Analysis of the U.S. and Japan," NBER Working Papers 2272, National Bureau of Economic Research, Inc.
    10. Aaron, Henry J, 1976. "Inflation and the Income Tax," American Economic Review, American Economic Association, vol. 66(2), pages 193-99, May.
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