Housing Taxation and Capital Accumulation

This paper studies the impact of the preferential tax treatment of housing capital in a model economy that includes the main housing tax provisions currently in place in the U.S. and a minimum downpayment requirement upon purchasing non-divisible houses. Distortions arise because the tax code makes the return on housing capital larger than that on business capital. 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 either taxing imputed rents or eliminating mortgage interest deductibility substantially increases welfare. Moreover, welfare gains accrue to individuals at every income level and distributional effects are much smaller than conventionally believed.