Working Paper

Capital Income Taxation with Housing


Abstract: This paper quantitatively investigates capital income taxation in the general-equilibrium overlap-ping generations model with household heterogeneity and housing. Housing tax policy is found to affect how capital income should be taxed, due to substitution between housing and non-housing capital. Given the existing U.S. preferential tax treatment for owner-occupied housing, the optimal capital income tax rate is close to zero (1%), contrary to the high optimal capital income tax rate found with overlapping generations models without housing. A low capital income tax rate improves welfare by narrowing a tax wedge between housing and non-housing capital; the narrowed tax wedge indirectly nullifies the subsidies (taxes) for homeowners (renters) and corrects over-investment to housing. Naturally, when the preferential tax treatment for owner-occupied housing is eliminated, a high capital income tax rate improves welfare as in the model without housing.

Keywords: Incomplete Markets; Capital Income Taxation; Heterogeneous Agents; Overlapping Generations; Housing; Life Cycle; Optimal Taxation;

JEL Classification: E21; H21; H24; R21;

https://doi.org/10.21799/frbp.wp.2020.02

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Provider: Federal Reserve Bank of Philadelphia

Part of Series: Working Papers

Publication Date: 2020-01-07

Number: 20-02