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Inflation, Income Taxes, and Owner-Occupied Housing

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  • James M. Poterba

Abstract

Owner-occupied housing receives favorable treatment under current tax law for several reasons. A homeowner's imputed rent is not taxed, and mortgage interest payments are tax deductible. Many past studies have analyzed the effects of these provisions. Inflation's importance in determining the implicit subsidy to owner-occupied housing has received less attention. Since home- owners can deduct their nominal mortgage payments, they do not bear the full cost of higher interest rates. They also receive essentially untaxed capital gains on their homes during periods of high inflation. The after-tax capital gains outweigh the higher after-tax interest payments, so inflation reduces the effective cost of homeownership. This paper develops a simple model to estimate the effect of higher expected inflation rates on the real price of houses and the equilibrium housing stock. Simulation results suggest that the inflation-tax interactions can have a substantial impact on the housing market. The increases in expected inflation during the 1970s could have accounted for as much as a thirty percent increase in real house prices. Over time, builders should respond to higher home prices and increase the amount of new construction. The persistence of current inflation rates could lead ultimately to a twenty percent increase in the housing stock.

Suggested Citation

  • James M. Poterba, 1980. "Inflation, Income Taxes, and Owner-Occupied Housing," NBER Working Papers 0553, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:0553
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    Cited by:

    1. Goulder, Lawrence H. & Summers, Lawrence H., 1989. "Tax policy, asset prices, and growth : A general equilibrium analysis," Journal of Public Economics, Elsevier, vol. 38(3), pages 265-296, April.
    2. Summers, Lawrence H, 1981. "Inflation, the Stock Market, and Owner-Occupied Housing," American Economic Review, American Economic Association, vol. 71(2), pages 429-434, May.
    3. Martin Feldstein, 1982. "Inflation, Capital Taxation, and Monetary Policy," NBER Chapters, in: Inflation: Causes and Effects, pages 153-168, National Bureau of Economic Research, Inc.
    4. Olivier J. Blanchard & Mark W. Watson, 1982. "Bubbles, Rational Expectations and Financial Markets," NBER Working Papers 0945, National Bureau of Economic Research, Inc.
    5. Martin Feldstein, 1983. "Inflation, Portfolio Choice, and Prices of Land and Corporate Stock," NBER Chapters, in: Inflation, Tax Rules, and Capital Formation, pages 229-242, National Bureau of Economic Research, Inc.
    6. Kotlikoff, Laurence J, 1984. "Taxation and Savings: A Neoclassical Perspective," Journal of Economic Literature, American Economic Association, vol. 22(4), pages 1576-1629, December.
    7. Christian A. L. Hilber & Tracy M. Turner, 2014. "The Mortgage Interest Deduction and its Impact on Homeownership Decisions," The Review of Economics and Statistics, MIT Press, vol. 96(4), pages 618-637, October.
    8. Lawrence H. Summers, 1980. "Inflation, Taxation, and Corporate Investment: A q-Theory Approach," NBER Working Papers 0604, National Bureau of Economic Research, Inc.
    9. Martin Feldstein, 1982. "The Fiscal Framework of Monetary Policy," NBER Working Papers 0966, National Bureau of Economic Research, Inc.
    10. Patric H. Hendershott & David C. Ling, 1984. "Prospective Changes in Tax Law and the Value of Depreciable Real Estate," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 12(3), pages 297-317, September.

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