Abstract: Paper No. 160

The Preferential Income Tax Treatment of Owner-Occupied Housing: Who Really Benefits?

James R. Follain, David C. Ling, and Gary A. McGill

March 1993

This paper examines the size and distribution of federal tax expenditures to owner-occupied housing across and within homeowner income classes with a model of expenditures that is more comprehensive than those currently in use. The analysis builds on a clear and specific statement of homeowner tax preferences and includes a discussion of their relation to other elements of the income tax and to mortgage debt. A novel element of the analysis is the explicit consideration given to net implicit rental income. The estimation of tax expenditures is based on 1989 American Housing Survey data and a fairly complicated set of procedures which are succinctly described.

The authors focus their analysis on the size of the tax expenditure benefits and the vertical and horizontal equity of their distribution. They highlight three major conclusions. First, on net, the inclusion of net implicit income in the measure of homeowner tax savings adds a substantial amount to the estimated tax expenditure to owner-occupied housing: the aggregate tax expenditure is estimated to have been $109 billion in 1989. This is approximately two and one-half times larger than the estimates of the Joint Committee on Taxation and the Treasury's Office of Tax Analysis. Second, the interaction of recent changes in the standard deduction with the tax treatment of non-housing itemized expenses has rendered the mortgage interest deduction worthless, or nearly so, for many low and moderate income households. As a result, they have introduced an anti-mortgage debt bias to the federal income tax code. Third, although the bulk of the tax expenditure benefits high-income households, the distributional effects of its elimination depend upon the manner in which the attendant savings are distributed.

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