Originally published on Forbes.com.
There is a concern that comprehensive tax reform might have a bad effect on the supply of affordable housing and it is not the home mortgage deduction I am talking about. It is the low-income housing tax credit, which is turning thirty this year. And even the prospect of comprehensive tax reform is already having an effect. In a post titled What Does Equity Market Uncertainty Mean for Recent, Upcoming LIHTC Awards, Mark Shelburne wrote:
If substantial tax reform is enacted, it will undoubtedly result in lower corporate rates, which in turn reduces the value of some tax benefits. Because of this distinct possibility, some low-income housing tax credit (LIHTC) investors have paused activity, and others are making decisions based on less equity per dollar of credit (sometimes referred to as the “price”).
According to the Joint Committee on Taxation Estimates of Federal Tax Expenditures (download), the LIHTC will reduce revenue by $8.6 billion, almost all of which is taken up by corporate income tax. By contrast the home mortgage interest deduction, which by definition reduces individual income tax, is pegged at $84.3 billion for 2017. An intriguing question is how much of the $8.6 billion translates into sticks and bricks dedicated to housing people affordably. Whatever that has been in the past, Shelburne implies it might be less in the future and the effects are being felt now by projects in the pipeline.
Consider a hypothetical 80-unit new construction development with $10 million in total sources awarded LIHTCs in 2016. If the price drops from $1.00 to $0.85, there will be a funding gap of $950,000 or more.
Towards the end of December Dirk Wallace and Michael Novogradac analyzed in some detail how different tax proposals might affect the credit yield.
Since the LIHTC does not get a lot of exposure outside certain circles, a little bit of background might be in order.
Some Background
For as long as I have been aware of issues surrounding poverty which goes back to my student volunteer days and stint in VISTA in the seventies, there has been talk of a housing crisis. There still is as you can see from this site on “Mapping America’s Rental Housing Crisis”.
Frankly, something that has lasted as long as the “housing crisis” can’t really be considered a crisis. It is more of a long-standing condition. Probably an extreme advocate of the free market would argue that it is the result of government interference with the invisible hand that is the real source of the perceived “housing crisis”. A counter-argument to that would be that a pure free-market approach combined with extreme inequality can produce results that we are uncomfortable with – something that looks more like the Pottersville of It’s a Wonderful Life rather than Bedford Falls.
Some Ancient History
Alongside the housing crisis, there have been federal tax subsidies to encourage affordable housing longer than I have been public accounting, which is edging toward 40 years. That was the major preoccupation of the first half of my career. Originally they were based on the IRS not applying the “activities not engaged in profit” rule of Section 183 to affordable housing and a five year write-off of rehabilitation expenses.
What made the shelters work was deferral and conversion. Back when the marginal rates were 50% or more and money earned interest (in the early eighties money market accounts were often paying more than 10%), deferral was a big deal. Of course, since your deductions were funded by non-recourse borrowing, eventually the losses in excess of negative cash flow would turn into income in excess of positive cash flow. That was when you bailed out at lower capital gains rates. In the projections they always showed how you would invest your excess tax savings in tax exempts yielding something like 4% and have money left over after you paid the tax on your phantom gain. A lot of people forgot to do that. Go figure.
The Tax Reform Act of 1986 put an end to all that allowing for transitional relief for deals that were still in the payment period. The replacement was the Low Income Housing Tax Credit. The credit is spread over ten years and subject to recapture for another five years. For a variety of reason, it is more attractive to corporations than to individuals.
It also rationed. Each state designates an agency that hands out the credit allocated to that state – based on population – to projects. The sponsors of the project, in effect, sell the credits for project equity. Technically the entities that buy the credit will be partners in a partnership that owns the property.
And It Gives People Work
One of the implications of this system is that every year, in each state, there will be new projects, each of which will require tax returns and financial statements for the next seventeen years or so. This is the reality that inspired Reilly’s Third Law Of Tax Practice – “Any reasonably complex tax matter involving significant dollars, regardless of whatever else it might be, is a white collar jobs program”. And here is a lesson for bright lads and lasses with a few years in public accounting.
A few of the earliest LIHTC syndications in Massachusetts just fell into my lap and I saw the implications of the steady growing work from the annual allocation. Not only that, the projects, once up and running, were pretty much immune to the business cycle. I was inside a seventy-year-old large local firm, though.
Michael Novogradac, on the other hand, started a brand new firm to exploit the growing opportunity. His firm is about more than the low-income housing credit now, but that was its genesis. There are now over twenty offices and it is ranked as the 30th largest firm in the country. Of course, there are qualities of character and willingness to take risks that I and most others who go into accounting lack that probably account for Mr. Novogradac’s great success, but if you have a few years in and you are wondering if the game of making partner in your particular firm is worth the candle, you might take note of this other path. I think it is particularly apt for women who now make up over 50% of all CPAs.By my admittedly imprecise anecdotal computations, they do 90% of the actual work in the larger firms while representing 20% of the partners, but this post is more about tax policy than public accounting gossip, so I will move on.
The Swiss Army Knife Of Social Policy
You will find quite a few of us in the more practical section of the tax blogosphere who think using the tax code for anything other than raising revenue is a bad idea. Joe Kristan wrote:
The tax law is a mess because politicians see it as the Swiss Army Knife of public policy. Even if it is already too unwieldy to be of much use, they always have a new gadget to add.
The low-income housing tax credit, which, frankly, is pretty convoluted falls in this category. One of the things that makes it work politically is the odd coalition of strange bedfellows that benefit from it – developers and housing advocates for example. It helps the poor, we think. It is a tax break for corporations. It has an air of federalism as allocation decisions are made at the state level. And it is a white-collar jobs program. Everybody’s a winner.
So in the pure revenue-raising model, the credit should go. But not so fast. What if we need that extra capital the credit provides flowing into the rental housing market in order to avoid more communities turning into Pottersville. Will the credits be replaced by spending? This thought inspired Reilly’s Second Law of Tax Policy – “Anything worth giving a tax incentive for should be worth spending money on.”
But you might not be able to create the same coalition to support a spending program, which by its nature seems to compete with all other spending programs, while tax incentives seem like a free lunch. And to take the argument one step further, it may be that tax incentives, while not a free lunch, might be a bargain lunch. The assumption in the concept of tax expenditures is that if you eliminate them revenue will rise by a corresponding amount, by I am a little skeptical of that. It might be that some of those responding to tax incentives would engage in flakier behavior of less social utility than whatever the tax incentives were pushing them toward.
The last comprehensive tax reform is credited by some, including our President-elect with having created a reals estate crisis. It will be interesting to see what this round does.