Low-Income Housing Tax Credit Has Raised Housing Costs (Analysis)

The Low-Income Housing Tax Credit (LIHTC) is a federal program established in 1986 under the Tax Reform Act aimed at incentivizing the development and rehabilitation of affordable housing for low-income households. It provides developers with tax credits that can be sold to investors to raise capital for housing projects.

The Department of Housing and Urban Development touts the LIHTC as “the most important resource for creating affordable housing in the United States today.” Yet it’s quite costly: The credit is estimated to cost the government an average of $14.4 billion annually. The Treasury estimates that over the coming decade (2024-2033), the total cost of this tax credit will be $175 billion.

Moreover, empirical research and data show that the LIHTC doesn’t actually provide a greater amount of affordable housing than the market would otherwise provide. Instead, the program raises housing costs and crowds out market-based housing development. As policymakers begin to discuss tax policy and consider reauthorizing provisions of the Tax Cuts and Jobs Act, it is crucial to reevaluate the LIHTC. Eliminating this tax expenditure could save resources and allow lawmakers to focus on more effective and less market-distorting solutions for addressing the affordable housing crisis.

LIHTC Housing Costs More Than Market-Rate Housing

Importantly, LIHTC allocations to developers are based on estimated costs. Developers therefore have an incentive to inflate their estimates, and then as projects proceed, there is little reason to revise costs downward.

One study published in the Journal of Urban Economics uses an administrative data series of LIHTC-subsidized properties in California to show the program encourages developers to construct housing units that are an estimated 20% more expensive per square foot than average industry estimates.

Another 2011 study of housing projects in San Diego looks at three different affordable housing developments where both LIHTC and market-rate apartments were developed. The study found that construction costs for market-rate apartments were 13% to 41% lower than the costs for LIHTC apartments. Further, on the basis of total costs per square foot, market-rate apartments were 23% to 37% cheaper than LIHTC units.

Studies have also found that approximately 60% of LIHTC projects are subject to prevailing wage agreements, which are the minimum wages that must be paid to employees working on “public works projects,” often set by the government and labor unions. These agreements can inflate costs by $53,000 per unit, or 13%, compared with projects not subject to prevailing wage agreements.

In cities such as San Diego, basic prevailing wages for laborers and pile drivers are $44 and $61 per hour, respectively, while total prevailing wages (which add on pension, health, vacation and training costs) are $70 and $96 per hour. It is easy to see how prevailing wage requirements could massively inflate housing production costs for LIHTC projects.

It isn’t just California where LIHTC housing costs substantially more than market-rate housing. A 2022 cost containment report found that Minnesota LIHTC project costs in 2017 were notably higher than non-LIHTC costs. New-construction costs in metro areas were 25% higher, while in the greater Minnesota area, including rural parts of the state, they were 11% higher. For rehabilitated properties, the costs for LIHTC units were 46% higher in metro areas and 41% higher in Minnesota as a whole.

The LIHTC isn’t particularly effective even by comparison with other government affordable housing programs. For example, the Government Accountability Office found that LIHTC units cost 19% to 44% more than units subsidized using housing vouchers. Other academic studies have found that LIHTC housing units were up to 66% more expensive than units aided with housing vouchers in some metro areas.

LIHTC Crowds Out Market-Based Housing Development

LIHTC doesn’t just make affordable housing projects less affordable—this tax subsidy also has serious market-distorting effects, crowding out the private provision of housing.

Economic theory suggests that when the government intervenes in a market by providing subsidies, it distorts the natural supply-and-demand equilibrium. By providing tax credits to specific developers, the LIHTC program artificially inflates the attractiveness of certain projects over others. This misallocation of resources leads to inefficient outcomes where capital is directed toward subsidized projects at the expense of potentially more efficient market-driven developments.

In fact, just six years after the creation of the LIHTC in the 1986 Tax Reform Act, the Congressional Budget Office noted: “The low-income housing credit, like other supply subsidy mechanisms, is unlikely to increase substantially the supply of affordable housing. Subsidized housing largely replaces other housing that would have been available through the private, unsubsidized housing market.”

Studies that attempt to measure the relationship between LIHTC and housing stock find no significant relationship between the number of LIHTC units built in each state and the size of the current housing stock, suggesting that LIHTC units are substituting (crowding out) market-rate units rather than adding to the affordable housing supply.

One 2005 study published in the Journal of Public Economics finds that as many as 70% of units produced with LIHTC funding (combined with other subsidy programs) would have been built by the market in the absence of these programs. Similarly, a more recent study published in 2015 found that as many as 74% of units built with LIHTC funding would have been constructed by the market in the absence of the tax credit, suggesting substantial though not complete crowd out.

Another Journal of Public Economics study from 2010 finds that the LIHTC program substantially displaced private rental housing construction. Specifically, the most robust estimates suggest that nearly all LIHTC development is offset by a corresponding reduction in unsubsidized construction of rental housing units.

Options for Reform

As Congress begins to debate reauthorizing provisions of the Tax Cuts and Jobs Act, the LIHTC should be one of the many market-distorting tax expenditures considered for elimination. The substantial costs and inefficiencies associated with the LIHTC demonstrate that it benefits businesses and investors far more than the low-income populations it is supposed to serve.

Moreover, the program’s inherent design flaws lead to inflated construction costs and significant crowding out of market-based housing development. This credit not only fails to address the affordable housing crisis effectively, but it exacerbates the problem by misallocating resources and discouraging private-sector investment in housing.

To genuinely address the affordable housing issue, policymakers should focus on removing regulatory barriers that hinder housing development. Reassessing zoning rules, land-use regulations, density limits and permitting requirements will pave the way for a more efficient and market-driven solution.

By reducing these constraints on housing construction, we can foster an environment where the private sector can more effectively meet the demand for affordable housing, ultimately benefiting low-income households without the negative market distortions associated with the LIHTC.

This article is part of an ongoing series of (Discourse) pieces that focus on individual tax expenditures that policymakers should consider eliminating or reforming to address America’s dire fiscal trajectory.

Originally published by Discourse. Republished with permission.

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