Abstract
Heavy taxation of interest income becomes a structural driver of property prices in a low-interest-rate environment. Inflation-adjusted price appreciation in 1996-2017 is approximately 200 basis points higher in 14 countries allowing no exemptions on interest income than in 37 countries that tax interest income at favorable rates or provide exemptions. Results for average returns over long-term periods are confirmed in models with annual frequencies, city-level data, and in a sample of 39 OECD countries for which price/rent ratios are available. It appears that investors view direct real estate, a heavily tax-favored asset, as an inflation hedge and/or alternative to fixed income asset. Higher interest income taxation may be fueling demand for direct real estate investments by retail investors. Separately, my empirical findings suggest that easy monetary policy effects can be magnified through the housing channel in countries that do not allow exemptions on interest income. Consequently, we should expect larger investment misallocations due to asset prices departure from fundamentals in some geographies. 
 JEL Classification Codes: E3, E4, F3, G1, G5, H2.
Highlights
The global financial crisis has clearly demonstrated the macroeconomic imbalances the housing market can cause
This could be due to momentum behavior – the bull market can be triggered in a low-interest rate regime, but spillover effects may be felt in its aftermath
Lower significance in model 5 is a consequence of a smaller sample size – when building permits and household credit are tested interchangeably, more observations are used, leaving heavy tax variables significant at a ten percent level
Summary
The global financial crisis has clearly demonstrated the macroeconomic imbalances the housing market can cause. In the aftermath of the crisis, the IMF established the Global Housing Watch, and the Federal Reserve Bank of Dallas created the International House Price Database. Rapid price run-up and collapse of house prices in the United States raised questions regarding the rationality of investor behavior in the real estate markets (Fu & Qian, 2014). A growing real estate finance literature attempted to explain variation in price dynamics prior to and after the implosion of the subprime mortgage market in the United States in 2008. Several papers have documented changes in housing demand during the business cycle (Demary, 2010; Inglesi-Lotz & Gupta, 2013). This study examines the differential impact of https://www.cribfb.com/journal/index.php/ijafr
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