Tax Incentives, Portfolio Choice, and Macroprudential Risks

We calibrate a lifecycle portfolio-choice model of homeowners facing uninsurable income risk to show that tax deductions for mortgage interest payments and voluntary pension contributions have sizable effects on household portfolios and macroprudential risks. The deductions reduce the after-tax cost of debt and increase the after-tax return of pension savings so that the mortgage incidence increases and portfolios shift from home equity and liquid assets towards pension savings. Because the consumption responses to a house-price decline are heterogeneous, the distribution of household debt shapes the quantitative effect of the tax deductions on the homeowners' resilience after a house price bust.