Housing Tax Reform and Foreclosure Rates

Abstract

Since the housing market collapse of 2008 and the ensuing economic recession were amplified by rising foreclosure rates, we study the potential impact of housing taxation reform on foreclosures. Two ways in which housing receives preferential treatment are the tax deductibility of mortgage interest payments and the non-recognition of imputed rents. We employ a recursive equilibrium model in which heterogeneous agents make housing tenure choices and in which mortgage default occurs in equilibrium. We calibrate the model and use the calibration results to quantify the effects of reforming these parts of the tax regime. We find that elimination of the mortgage interest tax deduction reduces the foreclosure rate by 12.4 percent. Alternatively, taxing imputed rents would reduce it by 32.5 percent.