1. „violates the conventional wisdom!“
and who doesn‘t!
Discusses elasticity of housing supply & elasticity of substitution of housing supply between owning and renting
Answers titel graphically
Answers titel mathematically
Gives empirical estimations of the benefits
Compares assumptions and results with previous research
by Michelle J. White & Lawrence J. White
published in the Journal of Public Economics, Vol.3, 1977
Discusses elasticity of housing supply & elasticity of substitution of housing supply between owning and renting
Answers titel graphically
Answers titel mathematically
Gives empirical estimations of the benefits
Compares assumptions and results with previous research
„violates the conventional wisdom!“
Bjørn Baltzer

2. The Subsidy BUT: formal incidence vs. effective incidence
Owner-occupiers are subsidized by the US federal income tax:
mortage interests and locally paid property taxes can be deducted from taxable income
Renters are not subsidized:
you cannot deduct rent from taxable income
The formal incidence of a tax / subsidy can be different from the effective incidence because the burden can be passed on
BUT: formal incidence vs. effective incidence

3. That‘s where we will end …

4. The Demand for Housing & the Supply for Housing
Perfectly elastic? S Q P
Perfectly inelastic? S S
Somewhere in between! DT DO
Q= Quantity of housing supplied / demanded
continuous, e.g. measured in square feet
P = Price of one unit of housing, in this case of one square foot, per year
DR = The aggregate demand for rental housing
DO = The aggregate demand for owner-occupied housing
DT = Total demand for housing
Elasticity of Substitution of housing supply between owning and renting
So far: assumption of separate markets:
You either build appartment houses for renters or row houses or detached single houses for owners
Now: appartment houses are converted in condominium houses, houses can be rented
-> Whites‘ assume high substituability between housing units for renting and owning -> one market
Perfectly elastic supply?
if demand increases due to subsidy -> no change in market price
Aaron (1972) and Laidler (1969): prices of building material and wages of construction workers didn‘t fluctuate with level of construction (based on empirical work by Muth)
Has the subsidy to owner-occupied housing been fully capitalized (anticipated and included in the price)?
subsidy makes owning favorable compared to renting, but price of owner-occupied housing is bid up till individuals are again indifferent between owning and renting -> there is a initial benefit (value of owner-occupied houses increase), but new owners face the higher price
-> this requires perfectly inelastic supply
no, every year, about 3% are added to housing stock
Whites‘ argue upward sloping
* as 3% are added to housing stock per year, supply is not perfectly inelastic, but if demand increases more than that, it takes time till new demand is satisfied and prices may rise in the meantime
* supply of land is limited: if demand increases, city has to expand -> agricultural rent must be bid up -> rents increase all over the city
as some of the new demand is also satisfied by redevelopment at higher density within the city, more construction will take place at increasing cost
* if construction is to be increased, more capital is needed -> for this extra capital, higher interests have to be paid: to replace non housing investments or to induce households to save more money DR

5. The Subsidy Comes into PlayQ P DR DO DT S
Let‘s not forget …
DO,
DT,
Deadweight Loss = welfare loss of society due to economic inefficiency
Intersection of S and DT determines the price which must be the same for owning and renting
Now: Subsidy to owner-occupiers proportional to unit price reduces their effective price -> DO increases -> DT increases
Some renters will become owners, so that the rental demand curve should shift to the left and the owners demand curve even farther to the right, but this effect is omitted for simplicity (by the authors, not by me!)
Market price rises -> renters consume less at higher price
Let‘s not forget that the effective price for owner-occupiers is below the market price: they consume more at lower price P, P
QO,
QT,
QR,
PO, QR QO QT

6. The Traditional Deadweight Loss
DO,
DT, P
P ,
PO, QR QO QT Q DR DO DT S
QO,
QT,
QR,
Traditional Deadweight Loss =
the quantity the owner-occupiers consume more at a higher price due to the artificially induced extra demand by the subsidy
minus the producers surplus from providing this extra quantity of housing

7. Loss to renters LR 1 LR 2 DO, DT, P P , PO, QR QO QT Q DR DO DT S QO,DR DO DT S
QO,
QT,
QR,
LR1: higher rent they have to pay for less housing=gain of landlords
LR2: loss of consumer surplus
In addition to that, renters help as general taxpayers to pay for the subsidy

8. Gains to Owner-Occupiers
GO 1
GO 2
DO,
DT, P
P ,
PO, QR QO QT Q DR DO DT S
QO,
QT,
QR,
GO 3
GO1: decrease in price of their initial housing consumption
GO2: increase in consumer surplus
GO3: increase in potential rental value of their old housing consumption

9. More Gains: Gain to producers GP Gains to landlords GL1 = LR 1 DO, DT,
PO, QR QO QT Q DR DO DT S
QO,
QT,
QR,
GL2
GP= Producers build more housing and sell at higher price, we deducted this to calculate the traditional deadweight loss
GL1= higher rents paid by renters, identical with renters loss LR1
GL2= housing that was rented before and now sold to owner-occupiers

10. Total annual cost of the subsidy program
DO,
DT, P
P ,
PO, QR QO QT Q DR DO DT S
QO,
QT,
QR,
In 1970, it was estimated that the subsidy program to owner-occupiers cost 10 billion dollars a year as foregone federal income tax

11. The Generalized Deadweight Loss
… compared to the traditional deadweight loss
As promised, that‘s where we end:
RED = deadweight loss on ressources transferred into the housing section
BLUE= deadweight loss on reduced consumption by renters
GREEN= the deadweight loss from an extra consumption by owner-occupiers
The relative and absolute sizes of those areas depend on the slope of the supply curve, and thus on the elasticity of supply
Comparison with the traditional deadweight loss:
The traditional deadweight loss obviously underestimates the true consequences

12. Conclusions
The Traditional Deadweight Loss underestimates the (true) Generalized Deadweight Loss
Reason: a large part of the deadweight loss is generated by the transfer of ressources among different demander groups
Consequence: whenever a tax or subsidy program applies differentially to participants in a market (here owner-occupiers vs. renters), then one has to take substitution into account when measuring the societal deadweight loss
Authors‘ claim: renters are disadvantaged against owner-occupiers, they should be treated more equally taxwise