m . S 203 Memorial Union

This paper studies the impact of the preferential tax treatment of housing, including the mortgage interest deduction, on equilibrium house prices, rents, and homeownership. We build a dynamic model of housing tenure choice that features a realistic progressive tax system in which owner-occupied housing services are tax-exempt, and mortgage interest payments and property taxes are tax deductible. We simulate the effect of various tax reform proposals on the housing market, and find that repealing existing tax deductions causes house prices to decline and also increases the homeownership rate. Our results challenge the widely held view that the mortgage interest tax deduction promotes homeownership. ∗We would like to thank Timothy Erickson, Jonathan Heathcote, Mark Huggett, Fatih Karahan, Weicheng Lian, Ellen McGratten, Victor Rios-Rull, and participants of the 2013 HUML Conference at the Federal Reserve Bank of St. Louis, the Applied Microeconomics Seminar Series at the Federal Reserve Board, Georgetown University, and the Federal Reserve Bank of Atlanta for helpful comments and suggestions. The analysis and conclusions contained in this paper are those of the authors and do not necessarily reflect the views of the Board of Governors of the Federal Reserve System, its members, or its staff. †Federal Reserve Board of Governors, email: [email protected] ‡email: [email protected]