The Effect of the 1986 Tax Act On Personal Interest Deductions

Abstract

For most taxpayers who itemize deductions, the 1986 tax act will increase the after-tax cost of interest paid to purchase homes, automobiles, other consumer items, and personal investment assets. Individual tax-return data are used to estimate the elasticity of interest deductions, both home moi tgage and other, with respect to the marginal tax rate and disposable income. Based on these estimates, we show that the lower tax rates and increased standard deductions in the new law can be expected to reduce interest deductions, especially among upper-income taxpayers. The findings suggest that outlays on owner-occupied housing will be more affected by the 1986 tax reform than will other types of expenditures financed with consumer credit.