Transaction costs, capital-gains taxes, and housing demand

Abstract

The paper considers the effect of transaction costs—particularly in the form of capital-gains taxes—on the aggregate demand for owner-occupied housing. The framework is an overlapping-generations model, where consumers can avoid the transaction costs (taxes) by keeping the same house for both periods of life. The first part of the paper analyzes the consumer's choice problem. It distinguishes between costs that are fixed irrespective of the size of the house bought or sold, and costs such as capital-gains taxes that are related to the house value. It is shown that higher transaction costs have lock-in effects, inducing consumers to keep the same house for both periods. Also it is found that under a wide variety of circumstances the amount of housing demanded will increase as the household is being locked in. Finally, the paper looks at the effects on aggregate demand from an increase in capital-gains taxes. It is shown that an increased rate of taxation decreases demand for low tax rates. But for high tax rates, when lock-in effects become important, one generally gets the opposite effect; high tax rates tend to increase housing demand.