Housing taxation and capital accumulation

This paper studies the impact of the preferential tax treatment of housing capital in a dynamic general equilibrium life-cycle economy populated by heterogeneous individuals. The model includes the main housing tax provisions currently in place in the U.S. and a minimum downpayment requirement upon purchasing non-divisible houses. The tax code makes the return on housing capital larger than that on business capital, which distorts the lifetime profile and composition of individuals’ savings. The wedge between the two rates of return emanates from the failure to tax imputed rents and is amplified by the presence of mortgage interest deductibility. Simulations show that individuals at all income levels would rather live in a world where imputed rents are taxed or one where mortgage interest payments are not deductible. Furthermore, distributional effects are much smaller than conventionally believed.