Tax Reform and Real Estate

U.S. Department of the Treasury, Office of the Secretary, Tax Reform for Fairness, Simplicity, and Economic Growth, 2 Volumes, November 1984 (processed). Executive Office of the President, The Presidents Tax Proposals to the Congress for Fairness, Growth and Simplicity, May 1985, (Washington, DC: U.S. Government Printing Office, 1985).

For example, in a front page report, The New York Times quoted extensively from a study prepared by the staff of Secretary of Housing and Urban Development, Samuel R. Pierce. That study concluded that passage of the November 1984 tax reform proposals would lead to a 30 percent increase in rental prices. See: Pear Robert , “Tax Plan Termed Threat to Housing at Lower Incomes,” The New York Times, April 21, 1985, pp. 1, 19. Similarly, the San Francisco Chronicle, reported the results of studies suggesting that enactment of the May 1985 tax reform proposals would increase rents by 20 to 24 percent and home ownership costs by 10 to 12 percent. See: “Real Estate Industry Rallies to Preserve its Tax Benefits,” The San Francisco Chronicle, July 15, 1985, p. 22. The latter reportage is evidently based upon two recent large-scale studies: “Impacts of the President's Tax Proposal on Housing,” National Association of Home Builders (NAHB), Division of Housing Policy and Mortgage Finance, July 1, 1985, mimeo; Apgar William C. Brown H. James , “Assessment of the Likely Impacts of the President's Tax Proposal on Rental Housing Markets,” prepared for Tax Fairness for Housing Coalition, July 15, 1985, mimeo.

This paper was initially drafted during the fourth week of July, 1985.

For examples of similar models and explanations of their operations, see Fisher J. S. Lentz G. H. Stern J.J. , “Tax Incentives for Investment in Nonresidential Real Estate,” National Tax Journal, Vol. 37 (January 1984). The NAHB and Apgar-Brown studies (see footnote 2) are evidently structured using similar models.

The model also replicates the estimates presented in the NAHB and Apgar-Brown studies. See Footnote 2.

Some evidence on efficiency and targeting issues is presented in Durning Dan Quigley John M. , “On the Distributional Implications of Mortgage Revenue Bonds and Creative Finance,” National Tax Journal (December 1985, forthcoming).

This assumes that the real after-tax interest rate (r*) is determined by the supply and demand for saving and investing in the economy. The nominal pre-tax interest rate (i) equals the after-tax rate plus an inflation adjustment (p^e), corrected for the tax rate (t):

These tax reforms are not expected to change the after-tax real interest rate substantially. This rate equates the quantity of savings with the marginal efficiency of capital (MEC). The MEC is derived from the production function in the economy and the stock of capital. Tax rate changes which differentially affect costs across industries may greatly influence the distribution of marginal investment among sectors in the economy. However, such changes only influence r* as they affect the total stock of capital. See Friend Irwin Hasbrouck Joel , “Saving and After-Tax Rates of Return,” Review of Economics and Statistics, Vol. 65, No. 4 (November 1983): 537–543.

See Peek Joe Wilcox James A. , “Taxable and Tax-Exempt Interest Rates: The Role of Personal and Corporate Tax Rates,” Working Paper #146, Research Program in Finance, Graduate School of Business, University of California, Berkeley, January 1985. Empirical evidence documenting the relationship between marginal tax rates and market interest rates appears in Peek Joe Wilcox James A. , “The Degree of Fiscal Illusion in Interest Rates: Some Direct Estimates,” American Economic Review, Vol. 74, No. 5 (December 1984): 1061–1066.