Legislators across the country are scrambling to develop policies that will lead to more affordable housing. (Affordable housing means that a family is paying 30 percent or less of its income on housing.) One of the most popular schemes is to provide tax credits for developers who agree to set aside a percentage of their housing units for affordable housing. While these incentives will lead to more affordable housing units, it is the wrong incentive.
America has a severe shortage of affordable housing for low-income families. Indeed, the National Low-income Housing Coalition estimates that there is a shortage of about seven million housing units that are affordable and available for low-income families.
In most industries, when the demand far exceeds the supply, capital is invested to increase production to take advantage of the higher profit potential. The increased production brings the supply in line with the demand, and prices decline. But that isn’t happening with housing, and so, legislators are resorting to tax credits to incentivize developers.
The primary goal of any business—including developers—is to make a profit. But it is extremely difficult, and often impossible, to profitably build housing for low-income families. The primary cause for the lack of profitability is government regulations, particularly zoning and land-use regulations. In most cities, a large percentage of land is designated for single-family homes. By arbitrarily restricting the land available for higher density housing, single-family zoning drives up the cost of housing. In addition, the process to obtain the approval of zoning officials to proceed with a project can be lengthy and expensive. These delays and costs are also reflected in the cost of housing.
In short, developers can’t build housing for low-income families because government regulations make it unprofitable. But rather than repeal those regulations so that affordable housing is profitable to build, legislators resort to tax credits to make projects profitable.
To remain eligible for the tax credits, a developer must regularly submit a mountain of paperwork to government officials, as well as commit to keeping the units affordable for an extended period of time (ten years is common, but some credits require a thirty year commitment). Large developers have the resources to deal with this bureaucratic nightmare, but smaller developers don’t have those resources and can’t build projects large enough to qualify for tax credits.
When tax credits are used to incentivize the construction of affordable housing, the result is large apartment complexes with hundreds of units, but no projects consisting of duplexes, fourplexes, or small apartment buildings. However, when the profit motive serves as the incentive, developers will build housing of all types.
If legislators truly want to incentivize developers to produce more affordable housing, the profit motive, not tax credits, is the only incentive needed.