A flat tax would boost housing values by as much as 1.5 percent in the first year after enactment, with the increase reaching 7 to 14 percent by the fifth year, an analysis finds. This contradicts a study commissioned by Realtors last year that claimed a single-rate income tax without the mortgage deduction would cause housing values to drop by 15 percent.

The newer analysis used the historical relationship between personal income growth and the value of owner-occupied housing, combined with estimates of faster economic growth under a flat tax, to project that home values would rise.

Historically, when incomes rise consumers spend more on almost all goods and services, including housing. Incomes would rise because a flat tax would boost the rate of annual growth in gross domestic product by at least 1 percentage point for five or more years, according to experts.

In addition, other experts, including the Kansas City Federal Reserve Bank, estimate interest rates would drop by 25 percent to 35 percent.

The analysis suggests there are major flaws in the 1995 DRI/McGraw-Hill study for the National Association of Realtors, including:

• Assuming an initial tax rate of 25 percent, gradually phasing down to 21 percent, a much higher rate than any proposed flat tax plan.

• Underestimating the extent of the likely decline in interest rates from a flat tax by comparing municipal bond rates to 10-year federal bonds rather than bonds with an equal risk, such as high-grade corporate bonds.

• Overestimating by 30 percent the average marginal tax rate homeowners now pay, which overstates the tax benefits of the deduction.

• Assuming that financial assets would lose value under a flat tax, an assumption at odds with academic analyses that have found lower taxes on savings and investment would boost the value of financial assets.

• Failing to include the impact of higher disposable incomes on home values.

Source: William W. Beach and Daniel J. Mitchell, "Worst Case Scenario: Flat Tax Would Boost Home Values by 7 Percent or More," FYI No. 87, February 12, 1996, Heritage Foundation, 214 Massachusetts Avenue, NE, Washington, DC 20002, (202) 546-4400.