Poverty continues to rise in the United States, and with it housing conditions for the poor continue to plummet. Although the federal Department of Housing and Urban Development (HUD) says that a household should not spend more than 30% of its income for rent and utilities, more than four-fifths of poor households who rent do so. An astounding two-thirds of poor renters spend at least half of their incomes for housing costs.
While the crisis in housing affordability has worsened, the federal government, through HUD, has cut its spending on housing programs. But there is one federal program to create new subsidized housing that has grown dramatically; the low-income housing tax credit (LIHTC). The credit now provides part of the financing for 90% or more of low-income construction, accounting by some estimates for as many as 100,000 units a year.
Across the United States hundreds of developers make their livings arranging the complex deals necessary to construct and rehabilitate buildings using the tax credit. While this housing is undoubtedly a boon to the poor, fully half the money goes not to those in need, but to the corporations who profit from investing in such projects, and to the lawyers and other experts who do the arranging.
Meanwhile, the money all comes from the federal budget, at a time when the budget deficit is a primary obstacle to greater spending for all human needs, including housing, health care, education, and job creation. Yet, despite its wastefulness, many progressives support the LIHTC, and make their livings developing housing projects that involve it – because without the credit one cannot build affordable housing today.
A Drop in the Bucket
All federal and state housing programs combined provide only a pittance relative to the need. Michael Stone, a housing expert at the University of Massachusetts – Boston, estimates that one-third of Americans, or about 30 million households, live in overcrowded or substandard conditions, or are paying more than they can afford.
Providing adequate, affordable housing for all these people would take investments on the order of $50 billion a year for ten years, said the Institute for Policy Studies in its Blueprint for Housing the Nation. Yet HUD programs, including Community Development Block Grants (CDBG) and the new HOME grants to the states, are now only a few billion a year, while funding for new public housing has been eliminated.
At current spending rates, it would take 100 years to achieve the goal set in the 1990 National Affordable Housing Act of “a decent home and suitable living environment for every American family,” according to Chester Hartman, the director of the Poverty and Race Research Council in Washington, DC.
Small wonder, then, that affordable housing advocates try to maximize their use of whatever monies the federal government does make available, even if they come through the back door of the LIHTC. But the credit is only funded at about $2 billion a year – a trivial amount compared to programs that serve the more affluent. Mortgage interest deductions, for example, cost the government $47 billion annually. As of 1991, about 80% of the tax benefits from these deductions went to the wealthiest 20% of taxpayers, with the poorest 20% getting only .02% of the benefits.
There was a time when the government actually built and owned housing itself, charging low rents to those who could not afford more. Then there were federal programs to directly subsidize the construction costs of projects built by local government agencies or non-profit development corporations.
But with the 1980s bias against public involvement in the economy, such direct spending went out of favor. Instead, the costs are hidden in tax losses. The Internal Revenue Service (IRS) gives huge tax breaks to wealthy investors who are willing to lend funds for housing development.
The Tax Reform Act of 1986, which eliminated certain tax subsidies for inexpensive housing, created the LIHTC. Anyone who invests in housing intended to serve families with incomes below 60% of the median in their local area can get this tax credit, which is then used to reduce income taxes owed on other business ventures. For new housing, the credit may be equal to or greater than the funds invested over a ten-year period, with lower benefits for rehabbed units.
But since non-profit organizations, including community development corporations, don’t make profits or pay income taxes, they cannot directly use such credits. Recent changes in the tax laws also limit the use of credits by individuals. As a result, the LIHTC is mainly of value to corporations who want to shelter their profits from federal income taxes.
Corporations can also treat the housing as an asset that loses its value over time. This “depreciation” is then a deductible expense on their taxes. Between the credit and depreciation, the total tax savings can be as much as one and a half times the money a corporation invests!
Such corporations, however, have no interest of their own in developing low-income housing. So the LIHTC has created strange bedfellows: non-profit, community-oriented developers (and for-profit developers who don’t have other business ventures to avoid taxes on) creating partnerships with corporations of every size and variety.
In a process known as “syndication,” developers hire lawyers and other consultants to help them sell the tax credits to investors. Since the investors usually know nothing about low-income housing, and may be suspicious of it, this requires marketing expertise. Developers also need lots of legal help to write complex contracts that will make the partners feel secure in a relationship that federal law mandates will last 15 years. In the end, developers get the money needed up-front for building construction, and investors get tax breaks for 10 years.
What is wrong with this system? In Chester Hartman’s words: “For one, it is unseemly and redistributively unjust to help the poor by helping the rich…Low-income folks, their advocates and technical assistants court these rich investors; are terribly grateful for their ‘largesse’; and those at the way upper end of the income scale come off like socially beneficial heroes…Second, there’s an unbelievable amount of waste in paying all those middlemen: the lawyers, syndicators, accountants and other $200+/hour types to structure these fantastically complicated deals.
Of every $1 spent by the government in lost tax revenues, only about 50 cents actually goes to the “hard” costs of buying property and constructing buildings. Of the other 50 cents, about 30 cents is eaten up in profits, at rates of 15% to 18% or more, that investors in these deals demand and are able to get. The remaining 20 cents goes to the “soft” costs of hiring consultants to arrange the deal.
Why is the profit rate so high? Joe Guggenheim, author of a widely-used guidebook on the credits, says there are risks involved for the investors, who can lose their tax benefits if the project fails to house tenants who fall within the income limitations. Guggenheim adds, though, “I don’t think it [the profit rate] is a justified number myself.”
But Carla Young, the director of SWAP (Stop Wasting Abandoned Property), a non-profit developer in Providence, Rhode Island that recently completed a development using tax credits, believes that the risks are great for investors in affordable housing. “I don’t find 16% to 18% [profits] too high,” says Young.
Complexity Without End
The “soft” costs of developing new affordable housing include fees to planners, designers, marketers, developers, syndicators, and lawyers. These costs arise in part because neither the tax credit alone, nor any of the other federal or state programs available, are sufficient to fully fund the capital for most projects. Instead, developers must package together funds from many sources – an average of eight per project for those included in the HUD study.
A 1993 study for HUD of 15 low-income projects developed by non-profits in five cities, found that the average housing unit costs $104,000 to produce, of which 12.6%, or about $13,000 per unit, went for syndication, developers, and legal/organizational costs. Of the 15 projects, three, all in Washington, DC, used government subsidies but not the tax credit. For these projects the soft costs above averaged about 7.1% of the total.
The LIHTC alone provided only a quarter of the up-front costs for those projects studied. Within this portion, 21% of the money went just to pay syndicators – and that doesn’t count profits for the investors.
On the Other Hand…
But defenders of the tax credit, many of who are in the business because they care about the housing needs of poor people, cite several arguments on its behalf. First, while transaction costs for LIHTC projects may appear high, the administrative costs of other housing programs can be just as high. Benson Roberts, the director of policy and program development for the Local Initiatives Support Corporation (LISC) says that projects funded by Community Development Block Grants (CDBG) also spend as much as 20% of their money on soft costs.
LISC is the largest non-profit housing syndicator in the country. In 1993 it obtained $230 million of financing for community development corporations, primarily by finding investors who want tax credits. These deals yielded 5,000 units of low-income housing last year, according to Roberts.
Second, Roberts and Paul Grogan, the President of LISC, believe that having corporate partners improves the development and management of projects: “If a project with only direct subsidies gets in trouble, the owner with no investment at stake will just mail in the keys and walk away. But if a Credit project falters within the first 15 years, investors must rescue the housing or lose a portion of their tax benefits. That kind of performance incentive means that housing will be planned, built and managed to last.”
Carla Young, for whose project LISC was the syndicator, agrees, saying that with investors involved each step of development was scrutinized carefully. “This is better than the government handing us money,” argues Young. But she admits that arranging the financing – from seven sources – was a tremendous amount of work. “It will be a while before this organization does another tax syndication deal, because of all the complications involved. We are still reeling over this one.”
Third, evidence exists that non-profit developers and syndicators charge far less than for-profits to arrange the deals. For the 15 projects in the HUD study, the non-profits retained an average of only 3.9% of the total costs for their expenses, compared with 9.5% by profit-making developers, as reported in another study.
Is There An Alternative?
Housing advocates insist that as long as the federal government is unwilling to provide large-scale housing funds through any other program, they must take full advantage of the LIHTC, and lobby for its continuance as a permanent program.
But there are alternatives to the tax credit that would cost the government far less, such as direct grants to low-income housing developers. Such grants could be financed through raising taxes on corporations and the wealthy, thereby not contributing to the budget deficit at all.
Or, even without new taxes, the government could sell bonds to raise the capital for making grants. Long-term U.S. Treasury debt carries interest rates on the order of 6% to 8% today, far lower than the 15% and up profit rates that the tax credit pays to investors. Paying for corporate profits rather than for bond interest increases the cost of capital obtained through syndication by about one-third.
Many affordable housing advocates acknowledge that the government’s money could be used better. Kari Brenna, head of the National Equity Fund, LISC’s syndicating division, says that if the government sold bonds instead of providing the LIHTC, “the return on the dollar could be higher.” Cushing Dolbeare, director of the National Low Income Housing Coalition, notes that “If you could abolish the tax credit and put the money directly into the HOME program [block grants to the states] you would get more bang more for the buck.”
Bob Kuehn, a for-profit low-income housing developer in Boston, believes that direct subsidies can work just as well, but that the problem is political – Congress would rather pass laws creating tax loopholes than directly appropriate money for programs. And he argues, the direct subsidies from the Urban Development Action Grant (UDAG) program worked well during Jimmy Carter’s presidency. It was only the scandals of Samuel Pierce’s tenure at HUD under Ronald Reagan that gave UDAG a bad name.
An alternative to government financing of new homes, whether through tax subsidies or direct grants, is to give low-income households rent subsidies, and allow them to find their own housing. The federal Section 8 program does precisely this, giving tenants “certificates” which they present to landlords.
In the end, the tax credit is supposed to achieve the same result as Section 8, giving poor people rents below market rates. But it is much less efficient in doing so. A 1991 study done for HUD by ICF, Inc. estimated that to achieve one dollar in rent subsidies, the tax credit costs the government $2.40.
But developers say that rent subsidy programs do not create new housing. They argue that subsidies may instead just heighten housing demand in low-income neighborhoods, allowing landlords to charge more.
For more than 15 years the federal government has been retreating from the war on poverty. Under pressure from conservatives who say poverty programs failed, and from today’s intense focus on reducing the budget deficit, funding for rent subsidies, rehabbed housing, and new affordable housing is at terribly inadequate levels.
Yet the answer is not to place our hopes on a tax giveaway program that spends half its money on private profits and administrative costs. For with government funds facing severe limits, every dollar wasted is a dollar that cannot be used to service other human needs. Programs such as the LIHTC help perpetuate a system whereby advocates for housing, health care, and education fight over the scraps that the government leaves us, while the corporations laugh all the way to the bank.
Marc Breslow is an editor at Dollars & Sense
Article reprinted from Dollars & Sense, a progressive magazine dedicated to demystifying economics.
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Resources: “Debating the Low-Income Housing Tax Credit,” Chester Hartman et. al., Shelterforce, Jan/Feb 1992; Nonprofit Housing: Costs and Funding, Final Report, Abt Associates for HUD, Nov. 1993; “The Excessive Costs of Creative Finance: Growing Inefficiencies in the Production of Low-Income Housing,” Michael Stegman, Housing Policy Debate, Fannie Mae, 1991; “The Low-Income Housing Tax Credit: Federal Help for Low Income Housing,” Jonathan Klein and Lynn Wehrli, Boston Bar Journal, July/Aug 1990.