Regressive Welfare Effects of Housing Bubbles

We analyze the welfare effects of asset bubbles in a model with income inequality and financial friction. We show that a bubble that emerges in the value of housing, a durable asset that is fundamentally useful for everyone, has regressive welfare effects. By raising the housing price, the bubble benefits high-income savers but negatively affects low-income borrowers. The key intuition is that, by creating a bubble in the market price, savers’ demand for the housing asset for investment purposes imposes a negative externality on borrowers, who only demand the housing asset for utility purposes. The model also implies a feedback loop: high-income inequality depresses the interest rates, facilitating the existence of housing bubbles, which in turn has regressive welfare effects.

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Tax Policy and Toxic Housing Bubbles in China

The B E Journal of Macroeconomics ◽

10.1515/bejm-2019-0155 ◽

2020 ◽

Vol 0 (0) ◽

Author(s):

Pengfei Jia ◽

King Yoong Lim

Keyword(s):

Social Welfare ◽

Tax Policy ◽

Economic Transition ◽

Welfare Effects ◽

Output Growth ◽

Tax Rate ◽

Aggregate Consumption ◽

Optimal Tax ◽

Speed Up ◽

Housing Bubbles

AbstractThis paper explores the effects of a government tax policy in a growth model with economic transition and toxic housing bubbles applied to China. Such a policy combines taxing entrepreneurs with a one-time redistribution to workers in the same period. Under the tax policy, we find that the welfare improvement for workers is non-monotonic. In particular, there exists an optimal tax at which social welfare is maximized. Moreover, we consider the welfare effects of setting the tax at its optimum. We show that the tax policy can be welfare-enhancing, comparing to the case without active policies. The optimal tax may also yield a higher level of welfare than the case even without housing bubbles. In addition, our simple numerical exercise shows that the optimal tax rate is about 23%;, and social welfare is significantly improved with such a tax policy. Finally, we extend the benchmark economy to a multi-period setting and calibrate the model to China. Our results show that a 20%; tax rate can speed up economic transition and increase output growth. Between 1998 and 2012, aggregate consumption is 4.86%; higher under active tax policies.

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