The dynamic efficiency cost of not taxing housing

Traditional welfare cost estimates of tax subsidies for owner-occupied housing are less than 0.5% of GNP in the United States and Canada. This paper argues that these static measures understate the true cost of the tax subsidy. Increasing the capital income tax makes untaxed housing more valuable, delivering a windfall bonus to existing homeowners at the expense of future generations. This intergenerational transfer has real efficiency effects in the presence of pre-existing tax distortions. When housing is in fixed supply, the dynamic efficiency cost of preferential tax treatment for housing is as much as 2.2% of GNP, or $120 billion dollars in 1990.