This paper, authored by J.M. Poterba and published in 1983, examines the impact of inflation on the tax subsidy to owner-occupied housing. The study uses an asset-market model to analyze how changes in the expected inflation rate affect the real price of houses and the equilibrium size of the housing capital stock. Key findings include: 1. **Inflation and Homeownership Costs**: Inflation reduces the effective cost of homeownership and increases the tax subsidy to owner-occupation. This is because nominal mortgage interest payments are tax-deductible, while capital gains from house appreciation are essentially untaxed. 2. **Housing Market Dynamics**: The model predicts that a significant increase in real house prices during the 1970s, attributed to the user cost decline due to high inflation, could have been as much as 30%. This suggests that inflation played a crucial role in making homeownership more attractive. 3. **Empirical Analysis**: The study estimates a quarterly model of aggregate investment in one-family owner-occupied structures and compares it with previous housing studies. The results support the asset-market theory, showing that the real price of houses is driven by expected future user costs. 4. **Policy Implications**: The paper discusses the potential consequences of changes in tax policies, such as indexing the tax system for inflation or taxing imputed rent from owner-occupation. These changes could significantly affect the real subsidy to homeowners and the relative size of the residential and non-residential capital stocks. 5. **Conclusion**: The study concludes that the tax provisions for mortgage interest deductibility, combined with rising inflation rates, could explain most of the 30% increase in real house prices during the 1970s. The findings highlight the importance of adapting tax policies to reflect changes in the inflation rate to avoid large distortions in the housing market.This paper, authored by J.M. Poterba and published in 1983, examines the impact of inflation on the tax subsidy to owner-occupied housing. The study uses an asset-market model to analyze how changes in the expected inflation rate affect the real price of houses and the equilibrium size of the housing capital stock. Key findings include: 1. **Inflation and Homeownership Costs**: Inflation reduces the effective cost of homeownership and increases the tax subsidy to owner-occupation. This is because nominal mortgage interest payments are tax-deductible, while capital gains from house appreciation are essentially untaxed. 2. **Housing Market Dynamics**: The model predicts that a significant increase in real house prices during the 1970s, attributed to the user cost decline due to high inflation, could have been as much as 30%. This suggests that inflation played a crucial role in making homeownership more attractive. 3. **Empirical Analysis**: The study estimates a quarterly model of aggregate investment in one-family owner-occupied structures and compares it with previous housing studies. The results support the asset-market theory, showing that the real price of houses is driven by expected future user costs. 4. **Policy Implications**: The paper discusses the potential consequences of changes in tax policies, such as indexing the tax system for inflation or taxing imputed rent from owner-occupation. These changes could significantly affect the real subsidy to homeowners and the relative size of the residential and non-residential capital stocks. 5. **Conclusion**: The study concludes that the tax provisions for mortgage interest deductibility, combined with rising inflation rates, could explain most of the 30% increase in real house prices during the 1970s. The findings highlight the importance of adapting tax policies to reflect changes in the inflation rate to avoid large distortions in the housing market.