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Counterintuitive response to tax incentives? Mortgage interest deductions and the demand for debt

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  • Dag Einar Sommervoll

    ()
    (Statistics Norway)

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    Abstract

    A number of European countries changed their tax system in the early 1990s along the lines of the US tax reform act of 1986. After the reforms marginal tax rates were generally lower, and mortgage interest deductions less generous. At the same time a long period of house appreciation started in most countries. This paper considers this puzzle empirically using a rich data base of Norwegian tax records from 1986 to 2000. We use nonparametric, difference in difference and tobit approaches in attempt to control for a wide array of factors that may offset, or mask, response to changed incentives. Of special concern is possible credit constrains as implied by credit score models routinely applied by credit institutions. We find a surprisingly static relationship between the probability of debt across age groups, and a strikingly linear and unchanged relationship between debt and gross income for young households. After the reform house prices doubled and tripled. The wealth effect may spur consumption. We find no sign of consumption smoothing by using self-owned housing as debt collateral, not even for older households. On the contrary, older households did react to the reform by reducing real debt.

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    Bibliographic Info

    Paper provided by Research Department of Statistics Norway in its series Discussion Papers with number 492.

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    Date of creation: Jan 2007
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    Handle: RePEc:ssb:dispap:492

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    Keywords: Tax incentives; credit rationing; mortgage market; household debt;

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    1. Glenn D. Rudebusch & Lars E. O. Svensson, 1998. "Policy rules for inflation targeting," Working Papers in Applied Economic Theory 98-03, Federal Reserve Bank of San Francisco.
    2. Chiuri, Maria Concetta & Jappelli, Tullio, 2003. "Financial market imperfections and home ownership: A comparative study," European Economic Review, Elsevier, vol. 47(5), pages 857-875, October.
    3. Jappelli, Tullio & Pistaferri, Luigi, 2007. "Do people respond to tax incentives? An analysis of the Italian reform of the deductibility of home mortgage interests," European Economic Review, Elsevier, vol. 51(2), pages 247-271, February.
    4. Francois Ortalo-Magne & Sven Rady, 1998. "Boom In, Bust Out: Young Households and the Housing Price Cycle," Finance 9810004, EconWPA, revised 25 Oct 1998.
    5. Satchell, Steve & Timmermann, Allan, 1995. "On the optimality of adaptive expectations: Muth revisited," International Journal of Forecasting, Elsevier, vol. 11(3), pages 407-416, September.
    6. Karl E. Case & Robert J. Shiller, 1988. "The Efficiency of the Market for Single-Family Homes," NBER Working Papers 2506, National Bureau of Economic Research, Inc.
    7. Shiller, Robert J, 1990. "Speculative Prices and Popular Models," Journal of Economic Perspectives, American Economic Association, vol. 4(2), pages 55-65, Spring.
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