Research Discussion Paper – RDP 8907 Tax Policy and Housing Investment in Australia
November 1989
Abstract
This paper develops a simulation model of the Australian housing market which incorporates many of the important features of housing. The use of an intertemporal framework allows us to examine the relationship between house prices, land prices, rental return on housing and investment in housing. We use the model to examine the consequences for the housing market of the removal of the capital gains tax, a cut in income tax rates, a rise in real interest rates and an increase in the rate of goods price inflation. One key result is that changes in the inflation rate will cause changes in real prices and in housing investment even when real interest rates and demand are constant. This is due to the distortions caused by taxing and allowing tax deductions based on nominal interest. We simulate a policy change where the tax base is altered so that tax is levied on real interest only and find that under this regime real prices and activity are not influenced by changes in the inflation rate.