How sensitive are homeownership decisions to tax subsidies? The role of housing supply conditions and lending standards

In this paper we examine the impact of the combined state and federal mortgage interest tax subsidies to homeownership on homeownership attainment, using panel data from 1984 to 2007 and exploiting the fact that the value of these subsidies may vary by income group across states and over time and depending on local housing market conditions and lending standards. We also exploit the fact that households move across states, which generates another source of variation in tax subsidies. We test our proposition that capitalization of tax subsidies into higher house prices offsets the positive effect of tax subsidies on homeownership attainment by exploiting data on regulatory restrictiveness in the late 1970s/early 1980s as a proxy for the inelasticity of local housing supply. Controlling for household, MSA, state and year fixed effects as well as time-varying household and location characteristics, we find that in more restrictive places tax subsidies have a negligible effect on homeownership attainment whereas in less regulated places mortgage interest tax subsidies have a meaningful positive impact for all income groups except the lowest quartile. We also explore whether mortgage lending conditions affect the link between subsidies and homeownership attainment but find no supporting evidence. Our findings cast serious doubt on mortgage interest deduction as a policy for boosting homeownership and improving social welfare. JEL classification: H22, H24, H71, R21, R31, R52