Residential Energy Demand and the Taxation of Housing*

Abstract

This paper examines how the favorable tax treatment of housing capital in the U.S. affects the demand for residential energy. Relative to a tax system that is neutral between different investments, the current taxation of housing lowers the cost of housing capital by 23%. The tax subsidy for housing capital increases the demand for housing services and the concomitant energy demand and creates an incentive for the substitution of capital for energy in the production of housing services. Eliminating this tax subsidy for housing would lower the demand for housing services by 11.8% and residential energy demand by 6.8%. Alternatively, the same reduction in residential energy demand could be obtained through a 20% tax on residential energy.