THE EFFECT OF TAXATION ON RESIDENTIAL REAL ESTATE: AN EMPIRICAL ANALYSIS OF REAL ESTATE CONSTRUCTION

The Economic Recovery Tax Act of 1981 (ERTA) included generous capital recovery provisions for investment in rental real estate. Provisions of the Tax Reform Act of 1986 (TRA 86) eliminated these generous capital provisions and enacted other provisions that decreased the attractiveness of investment in rental real estate.; It was hypothesized that ERTA was associated with an increase in multi-family housing starts and increased vacancy rates, while TRA 86 was associated with a decrease in multi-family housing starts and decreased rental vacancy rates. It was also hypothesized that ERTA and TRA 86 did not have a statistically significant effect on single-family housing starts.; A pooled time-series analysis was performed on both multi-family and single-family starts. The time period covered the years 1974 through 1991 and observations for each of the four main census regions of the country--the Northeast, Midwest, South, and West--were pooled together. Separate models were also examined for each of the regions. An analysis of covariance model was used and the intercept and slopes were allowed to change over the three time periods: pre-ERTA, ERTA to TRA 86, and post-TRA 86.; The results suggest ERTA was associated with increased multi-family starts and TRA 86 was associated with decreased multi-family starts. Additionally, ERTA was associated with decreased single-family starts and TRA 86 was not associated with a change in single-family starts. The covariates with the most significant contributions were the availability of money in both models and the before-tax cost of capital in the single-family model.; Finally, a review of various graphs indicate that rental vacancy rates may have increased as a result of ERTA and then decreased as a result of TRA 86. Analysis of the results suggest that ERTA may have aided in the economic recovery of the United States in the early eighties, but that this resulted in an overbuilt real estate market, contributing to poor economic conditions in later periods. To avoid such a situation in the future, demand and supply conditions should be considered before providing tax incentives for real estate investment.