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Inflation, Income Taxes, and Owner-Occupied Housing

  • James M. Poterba

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.

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File URL: http://www.nber.org/papers/w0553.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 0553.

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Date of creation: Sep 1980
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Publication status: published as Poterba, James M. "Tax Subsidies to Owner-Occupied Housing: An Asset-Market Approach." Quarterly Journal of Economics, Vol. 99, No. 4, (November 1984), pp. 729-752.
Handle: RePEc:nbr:nberwo:0553
Note: PE
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  1. David Lipton & James M. Poterba & Jeffrey Sachs & Lawrence H. Summers, 1983. "Multiple Shooting in Rational Expectations Models," NBER Technical Working Papers 0003, National Bureau of Economic Research, Inc.
  2. Polinsky, A Mitchell & Ellwood, David T, 1979. "An Empirical Reconciliation of Micro and Grouped Estimates of the Demand for Housing," The Review of Economics and Statistics, MIT Press, vol. 61(2), pages 199-205, May.
  3. Martin Feldstein & Lawrence H. Summers, 1979. "Inflation, Tax Rules, and the Long Term Interest Rates," NBER Working Papers 0232, National Bureau of Economic Research, Inc.
  4. Meltzer, Allan H, 1974. "Credit Availability and Economic Decisions: Some Evidence from the Mortgage and Housing Markets," Journal of Finance, American Finance Association, vol. 29(3), pages 763-77, June.
  5. James G. Witte & Jr., 1963. "The Microfoundations of the Social Investment Function," Journal of Political Economy, University of Chicago Press, vol. 71, pages 441.
  6. Kearl, J R & Mishkin, Frederic S, 1977. "Illiquidity, the Demand for Residential Housing, and Monetary Policy," Journal of Finance, American Finance Association, vol. 32(5), pages 1571-86, December.
  7. Patric H. Hendershott & Sheng Cheng Hu, 1979. "Inflation and the Benefits from Owner-Occupied Housing," NBER Working Papers 0383, National Bureau of Economic Research, Inc.
  8. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  9. de Leeuw, Frank, 1971. "The Demand for Housing: A Review of Cross-Section Evidence," The Review of Economics and Statistics, MIT Press, vol. 53(1), pages 1-10, February.
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