Real Rents and Household Formation: The Effect of the 1986 Tax Reform Act

Although the economic literature has analyzed some components of the headship decision, study of household formation has been primarily in the realm of demography. We begin with a pure demographic model and expand it to include additional determinants of the decision to remain with parents or not, to marry or not, and to live with a group or separately. Our results, based on a sample of 2355 youth in their twenties, indicate that (1) rental costs, wealth, and the potential wage that a youth could earn are important variables in explaining the outcomes of these choices am (2) including the economic variables significantly changes the estimated impacts of the demographic variables. One insight that the expanded economic model allows is the prediction that some public policies will affect headship rates of youth. This prediction is of interest because choices of living arranqements often have implications for demands upon public services and housing. We use as an example the 1986 Tax Reform Act and focus on a single outcome: the expectation of higher rental costs. If rentals rise by 20 percent, as predicted by some tax analysts, we estimate a half million reduction in the number of 1986 households formed by youth ages 21 to 29.