Unwind The LIHTC, Create Tax Benefits For Builders And Families

There is no doubt that over its 36-year life that the Low Income Housing Tax Credit (LIHTC) has housed many people. But how many? As my last post showed, there are many known unknowns about how and how well the LIHTC has functioned over those years. For example, a common number offered as an answer to the question, “how many units has LIHTC created over its 36 years?” the answer is often something like 29 million. Where does that figure come from? Column V in the LIHTC “database,” a column in the Excel spreadsheet that has 3,000 blanks and 1,500 cells with “0” as the answer. It is a challenge to reform a federal expenditure when no deep evaluation is possible for lack of good data. However, I’d like to close the LIHTC portion of the look back at Paul Ryan’s critique with some ideas for reform.

I’ve concluded that the Low Income Housing Tax Credit Program isn’t really a program at all. It is behemoth, a complex of complexities that churns out billions of dollars in money for development projects that fuels an economy of “affordable housing” that has neither addressed the central problem of inflation – too much money chasing too few housing units – nor has it brought the country any closer to a resolution or end of the persistent housing “crisis.” The LIHTC is built on billions of dollars of deferred taxation, yet has no single person or department responsible for dispersing all this money, making sure it is used effectively, or evaluating if it is achieving its stated goal, the production and preservation of affordable rental housing So, how could the concept, creating an incentive to build housing that serves people with less money, be salvaged from the current system.

Use the Existing Tax Filing System

Lower Taxes for Lower Rents

Imagine if the LIHTC didn’t exist and someone in a room of people trying to solve the problem of housing inflation was excitedly raising their hand saying, “Oooo, oooo, ooo, I’ve got it!” Everyone stops and looks over, and someone says, “OK, Melvin what’s your idea.” Melvin gets up and says proudly, “Let’s solve it using the tax code!” People would either be laughing until they wet their pants, or they’d acknowledge that Melvin was an evil genius. The tax code of the United States is perhaps one of the most complex human creations in history since the pyramids of Egypt but far less edifying.

But almost everyone in the United States who has paid taxes has some understanding of “exemptions,” a claim that reduces taxable income, “deductions” a claim of expenses that reduces income, and a “credit,” an amount that is typically applied to reduce total tax obligation. Americans are familiar with the concept that the government encourages and discourages behavior using taxation or that the tax code has that effect. The simplest way to incentivize investment in building housing, especially rental housing, would be to reduce the taxes for a developer who agrees to keeping rents low in a new building and a housing provider for lowering them or keeping them low in an existing building.

It’s pretty simple. If a developer is building 100 apartment units and she promises to keep 25 of those units affordable to households earning less than 60% of Area Median Income (AMI), she can claim the lost rent as deduction, an expense, on her tax filings. The government could add an additional bonus to the dollar-for-dollar exemption to encourage people to use the deduction. If banks got involved, developers could borrow 15 years’ worth of losses when closing the financing on the building, the government could allow the interest payment on that loan as a deduction as well, enabling the developer to access the capital immediately.

This concept could easily be applied to existing buildings as well, allowing the same deduction for a housing provider who lowers rents in their building or holds already lowered rents constant. A sweetener here would also allow interest to be covered if borrowed against future loses of rent if the loan included improvements to the building that would could not be recovered in higher rents. This might incentivize improvements rather than using deferred maintenance to subsidize more competitive rents, a practice that eventually catches up to owners when a big maintenance expense or sale results in the need to boost rents.

The problem with this solution is that median incomes change, and so do housing markets. Each year, those changes would have to be applied across all the participants in the program. If incomes increased, rents in the included units could be raised, whether the income for those households had increased or not, unless the program conceived of requiring losses in specific units rather than broad application of AMI. Even though the current LIHTC does a lousy job of tracking billions of dollars allocated to states, tracking millions of units and whether taxpayers were accurately reporting would be one more thing the Internal Revenue Service would have to track.

The Cost Burden Tax Credit

I’ve posted before about the almost scandalous use of “cost burden” by jurisdictions and governments to talk about the “demand” for affordable housing. In short, cost burden is established using survey data from self-reporting, responsive households about their income and rent. This survey is ongoing, and it is unclear how reliable it is. One thing for certain is that the results are inaccurate as soon as the results are tabulated; people move, incomes and rents change, and overall economic conditions are in constant flux. At best, cost burden data is a sketch of what happened to some people somewhere with their housing costs. It isn’t the basis for massive capital investment.

But let’s call the cost burden bluff and allow anyone earning 60% or below of AMI to claim a deduction for their cost burden. If a renter earns 50% of AMI, say $36,000 a year she should pay $1000 in rent per month, 30% of her gross monthly income. If she pays more, say $1,200, she can claim that $200 as an expense, then deduct the cumulative expense in taxes she files the following year. A better approach might be a negative withholding tax. Let the cost burdened renter file a claim for March’s rent, then get the cash in her pay checks the following month. Voila! Cost burden in America is effectively over.

The beauty of this approach is it end runs all the lawyers, accountants, and bureaucrats running the current LITHC system, and it avoids developers and housing providers. It would take the idea of households paying too much rent seriously and put the governments money where politician’s mouths always are, yakking about solving the housing problem or crisis, but making more rules that choke supply, raise prices, then create more political demand for cash to be wrung from the economy to subsidize the regulatory inflation.

There are problems with this approach however. People make choices, including to pay more than 30% of their income in rent. As I have been saying for more than a decade, the 30% normative standard is a horrible way of trying to quantitatively measure a qualitative problem, people’s relationship to price. Some people pay more and are fine, others pay less and are still struggling. This sort of program would be inflationary for sure, removing the incentive to shop for deals since everyone below a certain income level would be guaranteed a subsidy wherever they lived. Imposing limits on subsidy and rents might help, but a bureaucracy would have to be stood up to do that, and more and more rules (see problems with Section 8) would follow.

Connect Tax Credits to Local Performance on Deregulation

Yes, I said it: Deregulation. The Reagan era term is anathema to those on the left and forgotten by most Republicans when it comes to housing programs at the federal level. I posted about Montana’s initial housing plan based on the recognition that pushing more and more housing subsidy to local governments not only keeps supply killing rules and regulations in place, it encourages more. The answer here is to impose discipline on state and local governments; if you increase the size and impact of your housing and land use codes, you will get fewer subsidies.

The challenge with this approach is that all 535 members of congress feed their political careers on a diet of federal dollars for their state’s needs. There’s nothing inherently wrong with this, but to go back to officials and voters of your own state to threaten loss of funding to existing programs is not a good political strategy. And the addiction to making more rules that limit housing development then subsidizing the inflation is so strong, that reduced funds from the tax credit system would likely have the addicts seeking other local sources like higher taxes, fees, and fines on new development.

Focus on the Fundamentals

In the end, the problem of housing inflation is the easiest housing problem to solve. When housing demand is going to rise because of new jobs and growth, state the local governments should get out of the way and allow as much production as possible by reducing regulatory barriers and incentivizing production. More production means more competition, a condition that benefits consumers. Subsidies should be paid in cash to households that still struggle to pay rent, and new construction should be limited to housing people who can’t earn enough money to every pay full rent and who have other issues that benefit from housing with other services. Perhaps simplifying tax incentives for reduced rents in new and existing housing is the bridge to getting us to this even more basic and efficient solution.