"Tax Entitlements" for Housing : When Tax Expenditures Finance Inequality Part 2

 The federal tax breaks for middle class home ownership and renters are sharply different in size: they are just as dramatically different in how they are delivered.

The largest federal source of funding for increasing the supply of rental housing is the Low income housing Tax Credits (LIHTC). These are subsidies to developers of apartment complexes granted in the form of federal income tax credits. In exchange, the developer agrees to rent a portion of the apartments in the development to low-income families. Provided the property complies with all requirements, investors receive a dollar-for-dollar credit against their federal tax liability each year for 10 years. This program represents about half of the bar in the graph labeled Tax Expenditures for Rental Housing in Part 1.

Primary among the requirements for obtaining the credits are the resident income profiles. The receipt of tax credits depends on the developer reserving units for low-income tenants. Federal code requires that a minimum of 20% of the apartment units in every development be reserved for the very poor - those with incomes at 50% or less of the Area Median Family Income (AMFI); or that 40% be occupied for households with incomes at 60% or less of AMFI. The process includes a public comment process, whereby community organizations can support or object to proposed low income housing developments.

Proponents of LIHTC point out that the program is responsible for about half of the low income rental housing built nationally. But that reflects the withdrawal by the federal government from the low income housing construction business since the beginning of the Reagan administration. It was introduced as a provision of the Tax Reform Act of 1986 when it was realized that with dramatically reduced federal construction money and removal of tax shelter incentives for building rental housing, that there would probably be an end to new low income housing and that the “affordable housing” situation was not likely  to solve itself. In other words, LIHTC is praised for producing a high fraction of the low income housing built when it is essentially the only game around.

From: Government Accountability Office, GAO/GGD/RCED-97-55 Low-Income Housing Tax Credit

Following the numbered lines on the diagram:

(1) Internal Revenue Service Apportions Tax Credits to the Allocating Agencies, typically the state housing finance agency: the allocation is currently limited to $1.75 per state resident,
(2) Developers Apply to the state allocating Agencies for Tax Credits

(3) Allocating Agencies in each state Award Tax Credits to Selected Housing Projects: according to their state’s qualified allocation plans.
(4) Tax Benefits Provide a Return on Equity Investments:
syndicators (investment partnerships) are the primary source of equity financing for tax credit projects. They recruit investors who are willing to become limited partners in housing projects based on expected tax advantage.

As tax advantaged limited partnerships, LIHTC deal structures are not exceptionally complicated but as a source of capital for financing low income apartment complexes, they have some important disadvantages.

The LIHTC is at the core of a very shaky business model.

Untimely funding source

Allocating, awarding, and then claiming the LIHTC is complex and time consuming. On average, only one application in five submitted by developers receive a tax credit allocation. As a result, a lot of administrative capacity (grant writing, and all the follow-up responsibilities) is wasted on failed applications. Generally, developers exchange the tax credits with a real estate investor for equity. Since the tax credits cannot be claimed until the development is operating, more than a year or two can pass between the time of tax credit allocation and the time the credit is claimed.

Uncertain value of the credit is determined by developers and investors.
 

LIHTC investors who buy the credits do not expect their real estate developments to generate income. Their returns on investment come from offsetting their income tax liabilities. The value of the
tax credit is therefore dependent on the prevailing effective corporate tax rate and not the demand for low income housing. Financial institutions are typically the best candidates as investors
because, among profitable corporations, they have relatively few ways to shelter their profits from taxation. Banks are also motivated by the fact that investing in LIHTCs gets them points for their Community Reinvestment Act rating, one of the hurdles for moving branches or engaging in mergers or acquisition with other banks. When banks are unprofitable the value of the credits decline. The market for these credits collapsed in 2008 when the sub prime problems started to hit the bottom line of the large banks.

Bare Bones Construction Budgeting

There are a lot of forces that prevent subsidized rental units from ever resembling a luxury complex. Limited access to funds restricts unit size and amenities that any given project can build. The  uncertain LIHTC is a partial source of equity capital to be complemented with debt. Restrictions on the ability to raise rent reduce the ability to absorb any unexpected costs. Constraints on tenant income mixes and upper limits on rent rates make adjustments to uncontrolled variable operating costs such as utilities and insurance encourages unconstructive measures such as deferring maintenance. Although there no limits on the rents charged to tenants in “unsubsidized units”, the tendency is to maximize the number of low income dedicated units to make the application for the credits more competitive. This is why, among other factors, so many low income apartment complexes are in disrepair.

Housing projects, especially the urban variety have the reputation of being physically unattractive, even resembling Stalin era soviet apartment blocks, validating “Not-in-my-back-yard” community resistance. To avoid this, sponsors  may rely on help from private foundations or the participation of a community development bank to help with the financing.

Required local government approvals and cooperation can invite corrupt practices in some jurisdictions. Local elected officials have been known to expect to be compensated for their necessary support of the project application.

A recent case involved Dallas city council officials and a Texas state legislator taking payments from a low income housing developer, Southwest Housing in exchange for facilitating approvals for their development projects.

Is LIHTC productive from the federal government's point of view?

1. In other words, is the program efficient? How many of the tax credits dollars handed out by the government actually end up in the construction of  homes?
2. How effective is the program in addressing the shortage of affordable housing?
3. Is there equitable treatment among citizens seeking housing assistance?

Efficiency

From the time that the IRS  allocates the credits to the states, we know how much the federal government has spent: about one hundreds cents on each dollar of the credits distributed to the states. Some of that money will be returned to the IRS if it has not been awarded to housing projects or was awarded to projects that subsequently failed. What’s much less clear is how many of those dollars get used in construction expenses.
First, investors never pay 100 cents on the dollar for the credits. Second, the transaction costs incurred by fees to syndicators, consultants and the paperwork involved in applying for, and complying with the tax credit process are unavoidable. It’s not a popular way for program proponents to look at the program, but it’s hard to see how more than 50 cents on each tax credit dollar winds up in construction. During 2008 and 2009, the demand for the tax credits collapsed along with the taxable profits of the usual customers: large commercial banks, Freddie Mac and Fannie Mae. The tax credits that had been awarded to housing developers became unsaleable.

Is it an effective solution?

Some critics argue that LIHTC simply enhances the profits of developers and that the housing that gets built would have been built without the tax credit. Since there are a wide variety of developers – for profit, non profit, government agencies – with different priorities, the conclusion that LIHTC does not add to the volume of housing built is not so obvious. The arguments are based on a lot of assumptions about developer behavior, but it raises legitimate questions about how effectively the funds actually reach the target areas. These critics also compare the tax credit form of supply subsidy unfavorably to a more market-oriented demand subsidy such as Section 8 vouchers.

What about Equity?

But the more interesting contrast is with the type of tax subsidy available to  middle class homeowners. In addition to the generous and politically unassailable tax deductions on mortgage interest payments there are other tax-derived subsidies for middle class home ownership: the first-time home buyer credit, the exclusion for capital gains on the sale of the home, and the deductibility of state and local property taxes. The mortgage interest deduction represents about 65 percent of the tax expenditures for home ownership in the Federal Support for Housing chart, shown in Part 1. The process to claim these benefits is simple and takes a matter of minutes when filing your tax return.

Conclusion
When congress visits the tax code for solutions to the federal deficit, will tax breaks built into our social welfare system be a serious part of the check list? Should we be subsidizing home ownership for the well-housed while low income families scramble to avoid homelessness? Shouldn’t  we at least expose the hidden ways in which federal government programs actually increase the economic inequality that has been expanding over the last three decades?