Implications of Fiscal Policy for Housing Tenure Decisions

Many of the world's wealthy countries provide fiscal incentives tohomeowners. However, the impact of such tax breaks on housing tenuredecisions is unclear. Many existing policies, aimed at promoting housepurchases and widely used among taxpayers, have proved to be bothexpensive and not targeted, thus creating controversy about their overalleffect. This paper aims to shed light on the effectiveness of such fiscalincentives by providing empirical evidence on their impact on housingtenure decisions. Specifically, this work focuses on the effect of mortgageinterest deduction (MID) on home-ownership in the United States. Toanswer this question, the panel survey data from PSID for the period 2001to 2011 is used. To identify the effect of MID on home-ownership, thispaper analyses two channels through which MID affects user cost ofhousing: first, changes in personal state income tax rates; second, changesin the standard deduction allowed at the state level. Variation in these fiscalpolicy parameters allows for the identification of the causal effect of MID onhome ownership for several reasons. Firstly, in presence of MID, highermarginal tax rates lead to higher tax savings from housing, other thingsbeen equal. On the other hand, lower standard deduction increases afraction of households that qualify for this program. Moreover, both statelevelstandard deductions and state personal income tax rates are setindependently by each state and were revised several times during theanalyzed period. This fact creates a quasi-experimental set up which allowsfor exploiting the difference-in-differences estimation strategy. Theidentification of the effect of MID on home-ownership proposed in this paperrelies on large changes in fiscal policy. The largest of these changes led toan increase in income tax rate by as much as 23,9% and to a decrease inthe standard deduction by 7,2% between 2002 and 2004. The estimatessuggest that increases in income tax rates in a state that allows mortgageinterest deduction is associated to a 2 percentage point increase in homeownershiprelative to states that didn't change their fiscal policy.Furthermore, in states where more households were able to qualify for MIDbecause of the lower standard deduction, home-ownership increased by 4,8percentage points relative to control states. Thus, this study suggests that MID has a positive effect on home-ownership decisions. The results arerobust to a range of alternative specifications and have wide ranging policyimplications.