Eliminating Housing Tax Preferences: A Distributional Analysis

We examine the distributional impact of potential changes in the tax treatment of owner-occupied housing in this paper. In particular, we focus on the removal of mortgage interest and local property tax deductibility. A theoretical model of the demand for housing is developed that captures the impact of removing these deductions on housing demand. Then, we use a large cross section of individual income tax returns from the Internal Revenue Service for 1990 to estimate the distributional effects of removing housing deductions. Taxpayers are ranked by income and tax liability, both with and without the housing deductions. By comparing tax liability under the alternative regimes, and composing measures of the distributional impact of removing housing tax deductions using the classic Suits index, we assess both revenue neutral and nonrevenue neutral distributional effects. Results in both cases indicate that the removal of the tax deductibility of mortgage interest and property taxes would increase the progressivity of the income tax substantially.