Why Governments Shouldn't Finance And Build Affordable Housing

Public housing and LIHTC aren't the solution to America's housing crisis.
By Scott Beyer | Nov 09, 2020 |
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By Scott Beyer | Nov 09, 2020 |
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[This article was originally published by the Independent Institute.]

Government affordable housing policy can be separated between “demand-side” and “supply-side” solutions. I have described the demand-side ones—such as rent control policies that aim to suppress prices, or Section 8 vouchers that aim to boost spending power—and why they are problematic.

Here I will describe supply-side ones, which, per their name, are an effort to boost housing supply, rather than fiddling with the demand equation. I find similar problems with supply-side solutions, and will unpack two of the more prominent ones over the last century—public housing and low-income housing tax credits (LIHTC).  

Public Housing

Public housing became mainstream in the U.S. during and after the Great Depression, when the federal government passed several bills to construct it for the working- and middle-classes. The means to build the housing were extreme, as the bills allocated hundreds of billions in today’s dollars to tear down functioning old neighborhoods, via “urban renewal,” creating space for new towers. But the ends didn’t turn out well. Projects that were thought to be great innovations of their day became notorious within years. By 1972, St. Louis’ Pruitt-Igoe complex was already being torn down, and by the 1990s the federal government made demolition of these projects mainstream.  

A number of problems caused public housing to fail. One is that it was racially-segregated. Another was that it was poorly-designed, following the towers-in-a-park fad that created dead space and harbored crime. But the main problem was that it was government-run, subjecting it to poor outcomes.

One tenet of classical liberal economics is public choice theory. It posits that government bureaucracies don’t perform well because they are not incentivized to do so. Unlike private firms, there isn’t a unifying goal (profit) that encourages bureaucracies to act efficiently. There are instead competing actors who pursue their own interests, often at the expense of the whole. Public choice theory, rather than supporting the notion of the selfless, idealistic public servant, attributes common human traits to these workers, like the pursuit of money and power. But because civil servants aren’t subject to the corrections of the private sector—and because agencies themselves are not results-oriented—they grow infused with corruption, patronage and inertia.  

I will go more into public choice theory in a later article about government transit, because it explains many failures there. But it also explains the flaws of public housing. When HUD took control of the Chicago Housing Authority in 1995, for example, it described an agency that, despite receiving $350 million in annual federal funds, couldn’t maintain its buildings, ensure safety, or explain its millions in missing pension funds. That is because no one in the agency was set to lose financially due to those failures.

Nowadays, NYCHA still makes headlines for its severe under-maintenance of New York City public housing. The popular excuse is “underfunding,” but it has more to do with labor rules that protect entrenched unions. This prevents the agency from conducting open procurements, causing high construction costs and low service quality.

These public choice flaws have been common for decades within PHAs, and are predictable. That doesn’t mean public housing is always bad—it is, after all, still housing. But its track record should throw cold water on the renewed optimism among urbanists for “decommodifying” housing and making more of it “public” or “social.” Even if the model adequately houses some people, it is still suboptimal relative to the money spent.  

LIHTC

Due to public housing’s flaws, the federal government privatized affordable housing. In 1986, congress authorized LIHTC, a tax credit that’s given to qualified developers, who then sell the credits to financial institutions looking to reduce their tax burdens. Developers use that money to underwrite housing projects, with the stipulation that some units remain affordable. LIHTC is an $8 billion subsidy underwriting 107,000 units, making it America’s largest affordable housing finance source.  

LIHTC’s perceived benefit is that by enlisting private or nonprofit entities to run housing, it creates incentives for good quality. I can verify from experience that LIHTC accomplishes this.

One magazine I write for, Tax Credit Advisor, specializes in covering LIHTC projects. I have visited many projects and seen how well-maintained they are. Low-income units are often placed in upscale projects and locations, and are fairly indistinguishable from market-rate housing.

But this has actually fed my criticism of LIHTC. The policy produces affordable housing in the most expensive way possible, sticking units in nice neighborhoods and building them to an unnecessarily high standard. LIHTC also follows the flawed premise that affordable housing must be newly-built, whereas in a natural market process, a city’s older housing stock is what is more likely to be affordable. Many of the stories about overly-expensive affordable housing—such as the $500k+ units throughout California—involve LIHTC financing. This prevents the money from stretching further and helping more people.

LIHTC instead helps interest groups, causing the same public choice problems as government-run housing. As different critical reports have shown, developers overstate their project costs to win more allocation, syndicators lop off money from the credits by serving as middle men, and lawyers benefit from the program’s complexity. This is all money that, again, cannot be used for housing.

“LIHTC is producing fewer new units of housing each year while costing taxpayers 50 percent more in tax credit dollars—even after accounting for increasing construction costs,” wrote NPR in 2017.

For these reasons, governments should not be in the business of creating new housing, either through public processes or public-private ones like LIHTC. It is not their comparative advantage, nor something they do in a cheap and scalable manner.

The best affordable housing strategy is to allow broad market liberalization, so private developers can build enough housing to meet local demand. In U.S. metros that do this, older housing stock, often in decent locations, has in fact “filtered down” and become affordable. If some families still can’t afford housing under a liberalized model, Section 8 vouchers can fill those gaps and be used to rent the older housing. But using socialized models to finance and build new affordable units has been a public choice problem, riddled with waste, corruption, and mismanagement.

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