THE EFFECT OF THE 1986 TAX ACT ON PERSONAL INTEREST DEDUCTIONS

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 theelasticity 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 find-ings 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. The 1986 tax act will have potentially far-reaching impactson individual taxpayer choices relating to the amount of work effort supplied, the level and composition of consumption expendi-tures, and saving-investment strategies. These impacts result from income tax rate reductions as well as from numerous revisions in the definition of taxable income. This article considers one specific aspect of taxpayer behavior that may be substantially influenced by the 1986 tax act-the deduction of interest payments on personal tax returns. Deductions for interest paid on credit cards and consumer loans to purchase cars and other items will be phased out under the new law.’ 1 Interest paid on investment loans will remain deductible, but ulti-AUTHOR’S NOTE: I am grateful to both the editor and two anonymous referees for many helpful comments