Issue Bulletin #175
June 25, 1992
(Archived document, may contain errors)
June 25, 1992
TEU, TO LET TM LOW-INCOME HOUSING TAX CREDrr PROGRAM
INTRODUMON Congress soon must decide whether to continue the biggest tax incentive for builders of low-cost housing in America. Enacted as part of the 1986 Tax Reform Act, this incentive, the Low-Income Housing Tax Credit (LIHTC), finances the construction and rehabilitation of low-cost rental housing. Under this program, in- dividuals and corporations may receive a credit against their income tax for invest- ments in certain rental housing. The LIHTC incurred a loss to the federal Treasury of about $600 million last year. If permanently reauthorized, it eventually could incur an annual revenue loss of some $3 billion. The program has been reauthorized by Congress three times on a temporary basis, most recently for the six-month period ending this June 30. One bill (H.R. 5150), sponsored by Representative Charles Rangel, the New York Democrat, would make the program permanent. Two other bills, one in the House (H.R. 5240), sponsored by Representative Frank Guarini, the New Jersey Democrat, and another in the Senate (S. 2773), sponsored by Senator John Danforth, the Nfis- souri Republican, would extend the LIHTC for another eighteen months. Instead of extending the credit, however, Congress should end it. Supporters of the LIHTC claim that tax credits make rental housing more af- fordable for a great many low-income families. They note that the program thus far has financed some 420,000 rental units over the past five years, an average of over 80,000 annually. IBut the claim is misleading, since much of the housing would have been built anyway. More important, the L1H`X is an inefficient way to enable low-income families to obtain decent, affordable housing. The Congressional Budget Office (CBO) calculates that providing familis! with vouchers to offset rent payments, for instance, is far more cost-effective. Supporters of the program retort that the LIHTC, which encourages new con- struction and rehabilitation, is needed to alleviate a nationwide shortage of afford- able rental housing. Since the LIHTC is but one of many federal tax credit pro- grams, and since housing is a basic human need, supporters argue, the least Con- gress can do is extend the program. But inflation-adjusted rents, as well as home prices, generally have been levelling off, and in some local markets even falling, since mid- 1990.3 Yet, even in the absence of this trend, there are four good rea- sons why the Low-Income Housing Tax Credit program is not the way to tackle housing needs. REASON #1: The tax cost of the program Is less than one-third of the total cost. Most of the cost consists of tenant rental assistance. Thus the approval of the use of tax credits for construction and rehabilitation projects at rents affordable to low- income households triggers additional spending by the Department of Housing and Urban Development (HUD) or some other housing agency. REASON #2: Much of the housing subsidized through tax credits would have been bulk anyway. The history of federal housing subsidies demonstrates that building or rehabilitating housing directly for low-income households often merely displaces units that would have been created anyway for other households. The subsidies do not necessarily lead to an increase in the total stock. The princi- pal housing problem for low-income households is not a shortage of housing, but insufficient income to afford the available housing. The LUITC does little to ad- dress this. REASON #3: The LIHTC serves to restrict the supply of affordable housing by functioning as federal rent control. By requiring that eligible tenants pay no more than 30 percent of their incomes on rent, the program has the perverse effect of taking housing off the general market because artificially low rents in LIHTC-sup- ported projects depress the supply of unsubsidized housing for low-income fami- lies. REASON #4: The program Imposes substantial administrative costs. Under the LIHTC program, state housing agencies determine the eligibility of proposed pro- jects, and cer* project sponsors, for the allocation of credits. This cumbersome review process imposes substantial costs upon the state agencies, developers- and ultimately, taxpayers. Instead of extending this wasteful program, Congress can make housing more affordable for low-income Americans in three more efficient ways:
Of Cut taxes for low-income Americans. A person supporting a family of four, making $16,000 per year, pays around $2,000 in federal taxes. That is $2,000 not available for housing and other necessities. Congress should enact tax cuts for families with children, paid for by holding down the rate of increase in federal spending. Such a proposal is out- linef by Heritage Foundation scholars in A Prosperity Planfor Amer- ica. Of Use housing vouchers to help poor Americans afford housing. Compared with the LIHTC, vouchers are far more efficient. But to avoid vouchers becoming an open-ended entitlement and a disincentive to leave wel- fare, the receipt of vouchers should be tied to a -work requirement, an important element of welfare reform. Such a work requirement can help to break the cycle of dependency for able-bodied welfare recipients. Lot renters deduct at least a portion of their rent from their taxable In- come. Congress allows homeowners to deduct mortgage interest pay- ments and property taxes from their taxable income. It should allow renters some deduction for their housing costs as well. The poorest renter households face real obstacles in finding decent, affordable housing. Yet although the LIHTC has supported many worthwhile projects, it is not the answer to their needs. The main problem facing these households is a lack of income, and more specifically, a lack of work-related income. Congress needs to address that problem, not continue an inefficient and costly housing subsidy program.
HOW THE LOW-INCOME HOUSING TAX CREDIT PROGRAM WORKS
When Congress created the Low-Income Housing Tax Credit in 1986, it re- stricted or eliminated various existing tax incentives designed to boost rental con- , . 5 - struction and rehabilitation. Legislators felt that the existing incentives were costly to taxpayers because they allowed investors in low-in _ gome housing pro- jects to put up little cash and yet enjoy large tax deductions. Congress also felt that lower-income households got little help from the programs, while builders and investors received huge benefits.
In his 1992 State of the Union add s, President Bush called for restoring passive tax loss investment incentives for real estate.
The LIHTC was intended to remedy these shortcomings. The program allows an investor to reduce his income taxes by a certain percentage of the amount in- vested in an eligible project. Specifically, individuals and corporations are able to invest in rental housing construction or rehabilitation, and take as a tax credit the portion of the building or the project value reserved for occupancy by low-income households.
The main features of the LIHTC include: State administration. While the Internal Revenue Service (IRS) formally is in charge of the program, the IRS designates a housing agency within each state to determine eligibility for the credits, and to monitor compliance with federal rules governing income eligibility and financial accountability on the part of the devel- oper. It is the states that decide whether a rental housing development qualifies for a credit, and how large the credit will be. States have a total annual allocation of credits, according to a federally designated formula. The allocation is based on a per capita rate that applies to all states-currently $1.25-times its total popula- tion. For example, a state with a fopulation of 4 million would receive $5 million worth of annual credit authority. Federal determination of the duration and size of the credit. A private investor re- ceives a tax credit over a ten-year period on low-income rental dwellings that are constructed, rehabilitated, or purchased for rehabilitation. While corporations in most instances do not face an annual limit on the total value of credits they can re- ceive, individual investors do face a limit equivalent of a $25,000 tax deduction. Thus, a person in the 28 percent tax bracket can obtain up to $7,000 worth of cred- its each year.8 Federal rent restrictions. A household living in a rental unit assisted under the program pays 30 percent of its income toward rent. This requirement is similar to other federal housing programs, such as public housing, and the Section 8 rent cer- tificate and voucher programs. LIHTC @wellings must be available for occupancy by low-income tenants for thirty years. After fifteen years, the owner may termi- nate his commitment to keep units affordable to low-income households only, but must offer the project for sale at a price no greater than his original price, adjusted for inflation. Any new owner must agree to operate under the same restrictions on rents. If the state housing agency cannot find a buyer willing to accept these re- strictions, the project may be converted to non-low-income use, but tenants can re- main in their dwellings with restricted rents for at least three years.
Federal eligibility standards for rental projects. To qualify for the credit, a rental project must meet one of two criteria. At least 20 percent of the dwellings in the project must be rented to households with incomes below 50 percent of the area median income. Or, at least 40 percent of the dwellings in a project must be rented to households with incomes below 60 percent of the area median income. Area income standards are based on Census Bureau figures. The tax credit is available only for the low-income units in a project, although frequently all units in a project will qualify. Federal rules governing the portion of project costs eligible for credits. For con- struction or renovation costs borne by the developer, credits are available to the in- vestor for up to 70 percent of the capital cost-or present value-of the eligible property. When the developer purchases existing rental housing for renovation, or buys certain rental housing already receiving a federal subsidy, the credits are available for up to a maximum of 30 percent of the property's present value. The Low-Income Housing Tax Credit thus should be seen as a federal-state part- nership that uses the federal tax code to compensate people for investing in pro- jects to build or renovate housing for low-income households that otherwise might be financially unattractive. In one major sense, it is like HUD rent subsidy programs. It reserves housing over long periods of time for households whom HUD deems too poor to afford it. Supporters of the program want to tie it as much as possible to rent subsidies. For example, a 1989 report from a congressional task force headed by Senator George Mitchell, the Maine Democrat, and Senator John Danforth, the Missouri Republican, called for tenant assistance to be given on top of these tax credits wherever possible. The Mitchell-Danforth task force saw the LIHTC as especially useful in preventing the conversion of projects reserved for low-income families into projects available to families with higher incomes. That r isport alleged that a I , diminishing stock of affordable housing justified the credits. Thereportwas very influential in the federal government expanding the states' authority in run- ning the program.
PROBLEMS WITH THE LIHTC
Supporters of the Low-Income Housing Tax Credit program claim it to be both successful and necessary. Argues St. Paul, Minnesota, Mayor James Schiebel, "For the production of housing, the only tool we are receiving from the federal government is the LIHTC. This isn't just something we like; this is something we need."i I And according to F. Barton Harvey 111, co-chief executive officer of The Enterprise Foundation, a nonprofit homebuil Ing organization, "There is no good reason for this program not to be extended."I
The National Association of Home Builders, meanwhile, projects that continu- ing the credit would result in the con 11truction or preservation of 1.25 million af- fordable rental units over ten years. I I A report completed in 1991 for HUD by ICF Incorporated, a consulting firm based in F Ifff I ax, Virginia, gives the most comprehensive available picture of the program. The report, which evaluated the first two years of the program's opera- tion (1987 and 1988), consisted of two separate surveys. The first described the characteristics of rental properties financed-With credits. The second survey exam- ined the financial characteristics of developers using credits. ICF found that the availability of credits enabled investors to earn after-tax in- vestment returns averaging 17 percent for individuals and 19 percent for corpora- dons on LIHTC dwellings. 15 Without the credit, ICF calculated, only 12 percent of all assisted dwellings would have produced returns over 15 percent, and some 60 percent of assisted dwellings would have lost money. Supporters of the program use this finding to argue that it significantly contrib- utes to the availability of low-cost rental housing. However, supporters overlook several problems with the LIHTC. MrSt, other subsidies are usually layered on top of the LIHTC, so the cost of the program in practice is much higher than the tax credit itself. According to the ICF study, when all sources of funding are counted, the average LIHTC-subsidized dwelling incurs a public cost of $37,627 over a fifteen-year period (about $2,500 annually). But the tax credits make up only $11,739, or about 31 percent of this total. 16 Long-term federal rent subsidies usually are needed if the project is to comply with IRS requirements that units are within reach of the poor renters. Some 46 percent of tenants in LIHTC-supported units received either Section 8 rent certificates or vouchers. 17 In fact, about four of every five L114TC rental units require a rent subsidy from some federal, state, or local program. 18 Second, the program has "created," through construction or rehabilitation, hous- ing units that in large measure would have been created anyway by the unsubsi- dized private sector. According to the Congressional Budget Office (CBO), 19 the LIHTC and other production programs do not so much create housing as "crowd oue, unsubsidized housing that would have been created. 20 This is especially true for new construction. An analysis of the LIHTC by the Joint Committee on Taxa- tion notes, "Subsidies to new construction could make it no longer economic to convert some ... older properties to low-income use, thereby displacing potential low-income units."21 Some developers use the tax credit merely to enhance the profitability of a project that they would have undertaken in the first place. Exam- ple: Jack Y. Matthews, general partner of the Washington, D.C.-based W & M Associates, received a $250,000 taxcredit for a project-he finished two years ago. Admits Matthews: "I was going to do the job anyway. ,22 Third, the program is federal rent control by any other name. The rent restriction exists in order to limit "excessive" profits that developers could reap under the program. While the intent here may be laudable, two problems are created. First, tenants of LIHTC dwellings may not see them as attractive without the heavy rent subsidy. Argues the Congressional Budget Office study: "Landlords can still at- tract tenants because the rents are limited, but some tenants might leave, the proj- ect for more convenient housing if rents were increased only slightly."23 Second, like local rent control, it reduces the supply of low-cost unsubsidized housing by restricting rents necessary for upkeep and maintenance. Fourth, the program requires extensive regulation. State agencies must verify that all households in a project fall below income-eligibility ceilings. Preventing is excess profie, on individual housing projects requires state regulators to gather a large amount of information on rents, family incomes, and other household char- acteristics. Compliance by the Illinois Housing Development Authority with new IRS monitoring rules, for example, will cost an additional $30,000 to $40,000 in that agency's annual operating costs. 24 These costs are typically passed on in the form of higher fees to developers of LIHTC projects, which in turn generate a de- mand for additional government subsidies. Even with tougher regu@tion, verification of the compliance of builders and de- velopers may be difficult. Ironically, money spent on safeguarding against ex- cess profits has offset much of the potential savings to low-income tenants. Con- cludes the CBO: "[Tlhe reforms may have converted excess profits into excess overhead costs, With little or no increase in the overall efficiency of the housing credit."26 Tax credits can be a sound instrument of public policy, especially if they are tar- geted directly to the consumers of services, and are not encumbered with exces- sive regulation. But tax credits turn out to be an inefficient way of making rental housing more affordable. They require higher federal outlays as well as tax expen- ditures; they substitute "affordable" public housing for housing that likely would have been produced by the private sector anyway; they take housing off the gen- eral market; and they impose regulatory costs and delays. Congress should recog- nize these shortcomings, and look for alternative measures.
VOUCHERS: A PARTIAL SOLUTION FOR RENTAL AFFORDABILITY
While HUD Secretary Jack Kemp supports extending the =C, he also agrees that housing vouchers are the best way of improving housing affordability for the poor. HUD's own research staff recently concluded that while 90 percent of vouchers distributed to tenants in non-LIHTC units go to households with "worst-case" needs, only 25 percent of "free-yanding" (unsubsidized by outside sources) LIHTC units go to such households. 7
Limitations of Vouchers
Vouchers reach more potential tenants than tax credits, or for that matter, other forms of housing subsidy, and so are preferable to the LIRTC. But vouchers raise two major concerns: First, vouchers involve budget increases rather than tax reductions. To be sure, they make more efficient use of federal money than subsidies for new construc- tion. Yet by requiring higher levels of HUD spending, the voucher program makes it harder to control total government spending and the federal deficit. Cur- rent projections show that HUD spending will go up sharply. In fiscal 1991, HUD outlays were almost $22.8 billion. The Office of Management and Budget (OMB) projects this figure to be $24.2 billion in fiscal 1992 and $28.1 billion in fiscal 1993.
A voucher is good for five years, and subsidizes the difference between what HUD deems a "fair market rene' and what the household can afford to pay, assum- ing rent is no more than 30 percent of its income. The cost thus can be enormous in expensive rental markets such as New York City and San Francisco. The dan- ger for taxpayers is that vouchers could become another open-ended entitlement program.
Second, vouchers can be as counterproductive as other welfare and *income .-sup- port programs if their receipt is unconditional. Some supporters of vouchers want them to become entitlements; that is, once a poor household demonstrates finan- cial need, it automatically gets a federal subsidy. Without imposing conditions on the receipt of these vouchers, such a policy could move America ever closer to- ward permanently subsidizing all the basic expenses of nonworking families at the expense of working families. Persons on welfare already have little incentive -either to marry.or seek full-time work, If vouchers become an entitlement, the sit- uation will become worse. If Congress wants to improve rental housing opportunities for those on welfare, it should extend the voucher program rather than the LIHTC. But receipt of a voucher should be conditioned on serious welfare reform measures, most import- ant, a work requirement for able-bodied recipients. Such a pocy should exempt the elderly poor and most mothers with pre-school children. It should not, how- ever, exempt any other type of household.
WHAT CONGRESS SHOULD DO
If Congress wishes to make rental housing more affordable to households with low incomes, without im " lawmakers .posing unnecessary costs on taxpayers, should do three things, in order of preference: Help working families with tax relief. The best way to make housing af- fordable is to lower taxes for all working households, as outlined in The Prosperity Plan developed by Heritage Foundation scholars. 29 Among other things, the Prosperity Plan would eliminate income tax liability on working families with incomes below 120 percent of the current pov- erty threshold, or roughly $16,000. This could increase the take-home in- come of these families making it easier for them to afford rents. Allow the LIHTC to expire and use vouchers for poor renters. Vouchers are a far more efficient alternative to the LIHTC. At the same time, re- ceipt of housing vouchers should be made conditional on a work re- quirement. Under no circumstances should Congress make it into an- other entitlement program. of Allow renters to deduct a portion of rent from taxable Income. As an alter- native to general tax relief, Congress should change the tax code to make rental payments tax-deductible up to a certain level, much as mort- gage interest and property tax payments are tax-deductible for home- owners. This measure would reduce the after-tax cost of rent for fami- lies, and would encourage nonworking renters to find employment, since earned income, rather than welfare payments, incurs tax liability.
Congress is under great pressure from developers and housing advocates to re- tain the Low-Income Housing Tax Credit. One House bill (H.R. 5150) would make the program permanent, while another House bill (H.R. 5240) and a Senate bill (S. 2773) would extend the program for eighteen months. But the credit pro- gram is a very inefficient method of making housing affordable for low-income families. -Lawmakers instead should. consider other ways of helping families who cannot afford decent housing, and allow the LIHTC program to expire.
Carl F. Horowitz, Ph.D. Pblicy.Analyst
I Jacqueline L. Salmon, "Housing Groups Plan Push forTax Breaks," The Washington Post, April 25,1992; Salmon,"Law-Income Tax Credits Draw Criticism," The Washington Post, June 13, IM. Some claim that the figure is even higher. The American Planning Association, which strongly supports the program, says that the LX= has made possible 120,000 low-income rental units annually, or 600,000 units during 1987-1991. See "Low-Income, Housing Tax Credit Nearing Deadline," Planning, May 1992, p. 6.
2 Congressional Budget Office, The Cost-Effectiveness of the Low-Income Housing Tax Credit Compared with Housing Vouchers, CBO Staff Memorandum, April 1992.
3 See Alan Finder, "A 50-Year Rise in Rents Ends in Many New York City Areas," The New York Times, November 28, 1990; Ann Mariano, "New-Renter Discounts Anger Longtime Tenants," The Washington Post, April 27, 199 1; Kirstin Downey, 11igher Rents Forecast As Vacancies Dwindle," The Washington Post, October 5, 199 1.
4 See Scott A. Hodge, ed., A Prosperity Planfor America: How to Strengthen Family Finances, Revive the Economy, and Balance the Budget (Washington, D.C.: Heritage Foundation, 1992).
5 Major incentives under prior law included special accelerated depreciation for rental housing, five-year amortization of rehabilitation expenses, and tax-exempt bond financing for multifamily residential properties.
6 Real estate projects in which investors are not involved with management activities frequently are referred to as "passive" investments. See Richard Bourdon, "Rental Real Estate: Passive Activity Loss Limits," CRS Issue Brief, Library of Congress, Congressional Research Service, April 8, 1992.
7 Additional credit authority is available for projects financed with tax-exempt bonds. The 1989 reauthorization lowered the per capita allocation to $9375. The 1990 reauthorization, however, restored the rate to $125.
8 Projects generating more than this amount per person in credits are typically syndicated. Under syndication, a pawn sells part of his interest in a property to outside investors.
9 Originally, the minimum period was fifteen years. Pressure from housing advocacy groups resulted in Congress lengthening the period to thirty years.
10 Report of the Mitchell-Danforth Task Force on the Low-Income Housing Tax Credit, prepared for Senator George J. Nfitchell (D-IME), and Senator John C. Danforth (R-MO), January 1989. See pp. 3-7.
11 Quoted in Joseph A. Haas, "Despite Strong Support, Low-Income Housing Tax Credit Extension Seems Unlikely This Year," Housing and Development Reporter, October 14, 1991, p. 459.
12 Quoted in ibid.
14 U.S. Department of Housing and Urban Development, Office of Policy Development and Research, Evaluation of the Low-Income Housing Tax Credit: Final Report, prepared by ICF Incorporated, Fairfax, Virginia, February 28, 1991.
IS Ibid., pp. 14-15.
16 Ibid., p. 16.
17 The ICF report also found that households receiving a voucher or certificate had an average income of $5,981 compared to $11,400 for qualifying households not receiving such assistance. Rents (including utilities) for both groups were low: $347 and $317, respectively. See ibid., p. 8. Projects can be supported with state or local, as well as federal, rent subsidies.
18 Ibid., pp. 6-7. The ratio in 1988 was three of every four units, a slight decrease.
19 Congressional Budget Office, op. cit., p. 2.
20 For evidence that this tendency generally has occurred in federal supply-oriented housing programs, see Michael P. Murray, "Subsidized and Unsubsidized Housing Starts: 1961-77,"ReWew ofEconomics and Statistics, Vol. 65, No. 4 (November 1983), pp. 590-97; John C. Weicher, "Private Production: Has the Rising Tide Lifted All Boats?," in Peter D. Salins, ed., Housing America's Poor (Chapel I-Ell, NC: University of North Carolina Press, 1987), pp. 45-66.
21 Joint Committee on Taxation, Description and Analysis of Tax Provisions Expiring in 1992 QCS-2-92) (Washington, D.C.: U.S. Government Printing Office, January 27,1992).
22 Quoted in Christina Del Valle and David Greising, "Low-Income Housing: IsThere a BetterWay?" Business Week, June 22,1992, p. 62.
23 Congressional Budget Office, op. cit., p. 8.
24 See "State Agencies Seek Changes in Compliance Monitoring Rules," Housing and Development Reporter, March 16,1992, p. 849.
25 See U.S. General Accounting Office, Rental Housing: Observations on the Low-Income Housing Tax Credit Program, GAO/RCED-90-203, August 1990, p. 21.
26 Congressional Budget Office, op. cit., p. 19.
27 U. S. Department of Housing and Urban Development, Office of Policy Development and Research, Priority Housing Needs and Current Housing Assistance Program, prepared for the Senate Committee an Appropriations, Subcommittee on VA, HUD and Independent Agencies, April 30, 1992, pp. 3, 7.
28 See Robert Rector, "Strategies forWelfare Reform," Heritage Lecture No. 378, January 31,1992,p. 10.
29 Hodge, op. cit.