Long-term care policy and housing market efficiency

In many countries government policy on funding long-term care for older people incentivises holding housing wealth over financial wealth through exempting housing wealth from the test for means-tested government support with long-term care costs (a “homestead exemption”). I analyse the degree to which such exemptions distort the housing demand of older people and the effects on younger people through the housing market using the UK as my setting. I build and estimate an overlapping generations model of the housing market where multiple generations trade houses over the course of their life cycles while facing income, longevity and health risk. By comparing housing market steady states with and without the homestead exemption, I find that a budget-balanced removal of the homestead exemption would reduce house prices by 23% and increase welfare by an equivalent of a £422 annual increase in consumption per household. The main beneficiaries are those with less housing wealth in the initial steady state, whereas those who lose out most are those with long-term care problems and more inherited wealth in the initial steady state.