Tax Preferences and Housing Affordability: Explorations using a Life-Cycle Model

Michael Keane and Xiangling Liu

Abstract: We present a dynamic life-cycle model of demand for housing, including owner-occupied housing, investment property and liquid assets. Households face down-payment requirements and liquidity constraints, and a progressive tax system where owner-occupied housing is subsidized. The model replicates key facts about home ownership, financial assets, debt and consumption. Our model predicts that taxing imputed rent would raise enough revenue to fund a 9.15% income tax rate cut, and lead to substantial efficiency gains. We also find that replacing the mortgage interest deduction with a refundable 24.6% mortgage interest credit would increase the ownership rate by 5.9%. Gains are concentrated among low to middle income households and young households, as housing becomes more affordable for them.