The Tax Treatment of Homeowners and Landlords and the Progressivity of Income Taxation

Abstract

Working Paper 2008-6 February 2008 Abstract This paper analyzes the connection between the asymmetric tax treatment of homeowners and landlords and the progressivity of income taxation using a quantitative overlapping generations general equilibrium model with housing and rental markets. Our model emphasizes the determinants of tenure choice (own vs. rent) and the household decision to supply housing services to the rental market. This formulation breaks the link between the rental price and the equilibrium interest rate and, hence, the aggregate supply of rental property responds differently to the direction of rental price changes, marginal tax rate changes, and maintenance cost changes. We show that the model replicates the key factors and the distributional patterns of ownership, house size, and landlords. The degree of progressivity in the income tax code has important implications for housing tenure and housing consumption. We find a movement toward a less progressive income tax code can generate sizeable increases in homeownership and welfare that result from the equilibrium effects and a portfolio reallocation mechanism absent in economies with a single asset (i.e. Conesa and Krueger (2006)). An examination of the removal of existing asymmetries in the tax code are found to have effects on housing that differ from those reported in the literature. We show that housing policy can increase the ownership rate of a particular segment of the population, but generate nontrivial distributional costs. The welfare increases are no larger than those found when the progressivity of the tax code is reduced. J.E.L. classification codes: E2, E6, R2 Key words: homeownership, rental markets, housing policy, tax policy Introduction The use of the tax code to promote owner-occupied housing dates back to the Civil War era. The most prominent provisions of the current tax code argued to impact housing are: the deductibility from taxable income of mortgage interest payments and property taxes; the exclusion of the imputed rental value of owner-occupied housing from taxable income; and the special treatment of capital gains upon the sale of the house. The tax treatment of owner-occupied housing introduces a wedge into the decision to invest in housing relative to real capital as well as the decision on homeownership relative to renting. The impact of tax policy on these margins has been studied by many authors. For example, Laidler (1962), Aaron (1972), and Rosen (1972) employ Harberger methods for measuring excess burden to examine the efficiency losses of tax policy. (1) Other authors have used a general equilibrium approach to study this issue. Berkovec and Fullerton (1992) employ a static disaggregated general equilibrium model to study the implications of tax policy for housing and portfolio choices. They find that when all the tax advantages to homeownership are disallowed, the total quantity of owner housing consumption decreases by three to six percent as well as the fraction of owners. The benefits to homeowners from the mortgage interest rate and property tax deduction are found to be minimal. Gervais (2002) examines the taxation of housing in the context of a dynamic life-cycle economy with housing rental services provided by a rental firm. He finds that mortgage interest deductions or the taxation of imputed rents have very small distributional effects from a long-run perspective. Most studies have ignored two important dimensions that can have implications for the quantitative assessment of these asymmetries. The first dimension is the responsiveness of the supply of rental property since renting is the alternative to owning. We argue that housing investment decisions are joint with the decision on how to use the services generated from this investment. Empirical evidence from the Property Owners and Managers Survey of the Census Bureau indicates that households or non-institutional proprietors own most of the rental property. …