What Tax Policy Center Gets Wrong about LIHTC, NMTC, HTC, and OZs and Why it Matters
The Tax Policy Center (TPC) recently released a paper titled "Are Tax Expenditures Worth the Money?" that critically misunderstands housing and community development tax incentives and as a result mischaracterizes their value. While it is reasonable to research tax expenditures to understand if they’re worth the lost revenue, the TPC criticisms are based on common misconceptions about the LIHTC that lead to the same faulty, underlying conclusion that has been incorrectly levied in the past: The LIHTC does not benefit low-income renters enough to validate the loss of foregone tax revenue.
Without any quantitative or qualitative evidence, the TPC paper comes to the same erroneous conclusion about the historic tax credit (HTC), the new markets tax credit (NMTC), and Opportunity Zones (OZs) incentive. However, there is research and clear evidence that the LIHTC, HTC, NMTC and OZs, create direct and indirection benefits that are worth much more than the foregone tax revenues.
This evidence matters, as does correcting the record, as Congress considers several pieces of legislation that could expand and enhance these important incentives.
Misconception #1: LIHTC subsidy amount is too high and benefits only intermediaries
One of the TPC’s critiques is that the “the federal subsidy per unit of new construction is higher than it needs to be because of the various intermediaries involved in its financing…as a result, a significant part of the federal tax subsidy does not go directly into the creation of new rental stock.”
The notion of “over-subsidizing” a LIHTC property is a myth –LIHTC allocating agencies are required by statute (IRC Section 42(m)(2)) to review all sources of funding, including federal, state and local subsidies, and only allocate enough LIHTC to ensure financial feasibility of the property over the long term. The review process ensures that developments are not over-subsidized.
The amount of subsidy is driven by cost and the state agency’s estimation of financial feasibility. The TPC provides no data to support the claim that the new rental stock suffers due to the amount of intermediaries. In fact, research has illustrated the savings renters enjoy because of the LIHTC. According to a study completed in 2018 by Freddie Mac, average restricted rent payment was 38 percent lower than the average market-rate rent and demonstrated a more stable and predictable rent growth.
Moreover, it is clear that LIHTC is providing ample societal benefits to justify its tax expenditure costs. Beyond the direct output of more than 3.5 million affordable homes, there are many indirect benefits that all communities enjoy due to LIHTC:
- Research has shown that LIHTC properties increase property values, reduce poverty concentration, provide access to better schools, and decrease local crime rates.
- The LIHTC boosts the economy and saves the government money, and children who grow up in LIHTC properties achieve higher rates of education and enjoy higher wages in adulthood.
- Beyond metropolitan areas, the LIHTC greatly serves rural populations, as it encourages direct investment in areas that may not otherwise be appealing to developers.
While there are multiple players in the LIHTC process that do benefit those benefits are generally less than those players would receive from market-rate development, and are closely tied to performance. Once developers secure a tax credit award, they work with a tax credit investor or syndicator who provides the necessary capital. Not a single cent of federal subsidy is issued until the property is placed in service and occupied by an eligible household, when investors start to claim the LIHTC.
Investors generally accept a 4 to 6 percent after tax internal rate of return (IRR), which is much smaller than the double-digit return many market-rate properties receive. Additionally, because the LIHTC equity market is competitive, investors and syndicators are motivated to offer the highest equity price. Market-rate developers are compensated through a significant portion of the rental income and property appreciation. Because LIHTC buildings are rent restricted and do not appreciate in value like market-rate properties (due to the minimum 30-year deed restriction on the land) affordable housing developers are compensated through modest fees set by the state agencies. The cash flow from LIHTC properties is mostly reserved to pay operating expenses and debt service.
The property also is subject to potential tax credit recapture during the 15-year compliance period. Because their private capital is at risk for such a long period of time, investors and syndicators are strongly incentivized to practice sound underwriting and act as a responsible asset manager. To protect their investment, investors and syndicators must ensure nothing goes wrong during the first 15 years. Thanks to this responsible asset management role, LIHTC properties have enjoyed an extremely low rate of foreclosure: less than one percent throughout the history of the LIHTC, which is far less than market rate residential rental properties.
TPC also neglects the fact that in appropriation based housing federal subsidies, such as the Community Development Block Grant (CDBG) program, a “significant part” of the funds may be diverted from the housing stock into administrative fees – as much as 20 percent of funds.
Misconception #2: LIHTC encourages segregation
In its paper, the TPC states that the LIHTC “concentrates low-income communities where they have historically been segregated and where economic opportunities may be limited.” While simply glancing at a map and noting all LIHTC properties locations could lead to this conclusion in some jurisdictions (not all), doing so without considering deeper context is a mistake. First, LIHTC properties are located in land zoned for multifamily housing. Zoning dictates where affordable housing can be built, and most residential land is zoned for single-family housing, which is more typically located in higher opportunity areas.
Additionally, the LIHTC is often used as a preservation tool, meaning it is used to recapitalize existing affordable housing, some of which is in lower-income neighborhoods as a result of siting decisions made by other federal housing programs. Preserving existing affordable rental homes in lower-income areas is important, because it improves the lives of those already living there and maintains existing federal investments.
Much of LIHTC stock are affordable homes being preserved using the recapitalization method. According to the National States Housing Council Agencies Factbook, a total of 36,279 affordable homes were preserved in 2018 using LIHTC financing. This is very close to the net new construction units receiving initial allocation in 2018, which is 44,104 homes.
Focusing on the siting of new construction LIHTC properties only provides a more accurate evaluation of whether LIHTC is exacerbating racial and poverty concentration. Recent research shows that locations of LIHTC homes are more often being placed in higher opportunity areas. State housing agencies have been actively encouraging this outcome. By including specific provisions in their policies (such as basis boosts), state housing finance agencies are incentivizing more and more developers to produce new affordable homes in higher opportunity areas.
Moreover, LIHTC does not create racial segregation any more so than other affordable housing subsidies. According to a Freddie Mac study, tenant-based Housing Choice Vouchers, Project Based vouchers, and public housing are less frequently located in areas of high opportunity areas than LIHTC properties.
Misconception #3: LIHTC properties excessively struggle to maintain affordability
TPC also wrongly claims that LIHTC “may help construct new affordable housing, [but] maintaining that affordability is challenging once the required compliance periods are over.” A HUD study completed in 2015 determined that “most LIHTC properties remain affordable despite having passed the 15-year period of compliance.” Additionally, it is important to note that the 15-year compliance period is not the minimum requirement for affordability use restriction. By statute (IRC section 42(h)(6)), LIHTC properties must maintain an additional 15-year extended affordability use restriction for a total of a minimum of 30 years, and many states incentivize or require affordability periods beyond 30 years. States are required to monitor for compliance on the affordability use requirement during the extended use period, and when underwriting the properties, they must ensure financial feasibility over the entire affordability period, not just the initial 15 years.
Misconception #4: LIHTC does not adequately serve the lowest income households
Although not specifically stated in the TPC piece, a criticism related to the claim that LIHTC properties struggle maintain affordability is LIHTC properties do not adequately serve the lowest income households, and some critics of the LIHTC have argued that other affordable housing subsidies are more effective than the LIHTC. However, as the TPC paper states, LIHTC is the biggest financing source for the construction and preservation of affordable rental homes. There is currently a severe lack of affordable rental homes - the National Low-Income Housing Coalition (NHLIC) finds that there are only 37 affordable and available rental homes for every 100 extremely low-income renter households. NLIHC also finds a total shortage of seven million affordable and available homes for the lowest-income households.
Contrary to critics’ claims, the LIHTC provides housing stock for some of the lowest-income populations, as the statute (IRC section 42(m)) requires states to include a preference for properties serving the lowest income households for the longest period. Many state housing agencies incentivize income limits lower than 50 percent of area median income (AMI). According to the most recent LIHTC tenant report provided by HUD, 44 percent of LIHTC tenants nationwide have a total household income of 0 to 30 percent AMI. Over half of the tenants (60.5 percent) have incomes below 40 percent AMI.
Misconception #5: NMTC, HTC, and OZs are not worth the expenditure
The NMTC, HTC and OZ incentive are all listed at the end of a paper in an appendix that labels the tax incentives as “subsidies with insufficient benefits to society to justify their cost.” However, the costs and benefits are not detailed, nor is any evidence provided to support the claim.
Critics should consider that the NMTC brings much needed capital into areas that lack investment, and the economic and societal benefit outweighs the tax expenditure cost.
- According to the CDFI Fund, approximately 80 percent of the NMTC projects financed in 2018 were in communities exhibiting severe economic distress, and 20 percent of NMTC projects were completed in rural areas.
- According to a survey consisting of 74 CDEs, the NMTC served 4 million people in 2018 alone. NMTC investments funded 286 projects and created 58,300 jobs.
- The projects completed were diverse, ranging from schools and housing to grocery stores and industrial projects.
- The dollar amount of investment varied as well, illustrating the NMTCs ability to serve large- and small-scale projects.
- The smallest investment in 2018 was a $50,000 investment to support an urban farming project, and the largest was a $47.7 million low-cost loan to a multipurpose social services campus for children. Recently, the Joint Committee on Taxation released a report stating that nearly $2 billion of the total $48.3 billion in NMTC investments went towards infrastructure projects – ranging from investments in broadband access, water treatment and disposal, parking, and more.
- In addition, NMTC investments are a great financial leveraging tool – the CDFI Fund estimates that for every $1 invested by the federal government, the NMTC generates over $8 of private investment. Compared to the TPC’s calculated cost of $1.3 billion, the benefits the NTMC brings is much larger.
Similarly, the historic tax credit (HTC) has benefited a diverse group of communities.
- According to Rutgers University, more than 50 percent of HTC projects are in low- to moderate-income census tracts, and 75 percent are in economically distressed areas.
- For more specifics on the location of projects, see Novogradac’s Historic Tax Credit Mapping Tool.
- Studies conducted by Rutgers University have shown that in many parts of the country, a $1 million investment in historic rehabilitation yields markedly better effects on employment, income, GDP, and state and local taxes than an equal investment in new construction.
- Rutgers University has also estimated that 2.7 million jobs have been created since fiscal year (FY) 1978 due to the HTC, and has contributed $176.2 billion in GDP (after adjustments for inflation).
- The HTC has helped fund 44,341 projects since FY 1977, with 166,210 low- and moderate-income housing units being produced.
These benefits outweigh TPC’s estimated calculation of $0.1 billion loss in tax revenue due to the HTC in 2019.
A relatively new financing tool, Opportunity Zones exist to attract more capital into needy areas.
- Out of the census tracts chosen by governors, 294 contain Native American lands (which are historically underfunded) and 23.3 percent of the zones are in rural areas.
- According to the Economic Innovation Group, the designated opportunity zones are areas where funds are most needed, and the demographics of the opportunity zones reflect that.
- The poverty rate of nationwide Opportunity Zones (27.7 percent) is much higher than the U.S. rate (14.1 percent).
- Additionally, Opportunity Zones are lower-income, minority-majority areas.
- The median family income in the United States if $73,965 per year, whereas nationwide Opportunity Zones have a median family income of $47,316 per year.
- The share of minorities in Opportunity Zones are much higher than the U.S. share (56.5 percent to 38.9 percent).
Due to the infancy of the program, the data regarding the specificities of the investments are still being collected, which leads to questions about how the TPC collected the data needed to perform a cost-benefit analysis. So far, more than $7.57 billion in private capital has been raised to serve these needy communities.
Why This Matters
The TPC article illustrates that there is still misunderstanding about not only the intricacies of community development tax incentives, but a miscalculation about the widespread positive impacts the tax incentives bring.
The LIHTC not only creates more affordable homes, it also lowers crime rates, boosts economies and increases property values.
The NMTC not only helps fund important community development projects, it also creates jobs and provides the additional funding required to complete projects in low-income areas.
Without the HTC, not only would the preservation of historic sites be jeopardized but states would lose out on the increases in GDP and affordable housing created through the incentive.
This matters because there is current legislation pending that builds upon the success of these incentives and would improve them. The Affordable Housing Credit Improvement Act (AHCIA), H.R. 1680, and HTC-GO Act all include provisions that would improve the LIHTC, NMTC and HTC and would address many of the concerns that the TPC piece lists.
The AHCIA (H.R. 1730/S. 1703), originally introduced in 2016, 2017 and then once again in 2019, contains many provisions to improve the LIHTC:
- A basis boost provisions would incentivize developers to produce more housing for extremely low-income renters
- A phased in 50 percent LIHTC allocation would create more housing stock, and
- A permanent four percent floor would also drive more development.
These provisions would expand the LIHTC, bringing more affordable homes to low-income renters at a time when the shortage is immense.
Unlike the LIHTC, the NMTC is not a permanent part of the tax code, and must continuously be extended. President Donald Trump signed a one-year extension of the NMTC in the end of 2019, but H.R. 1680, introduced in Congress last spring, would make NMTC permanent, increasing its efficiency for each tax credit dollar.
The Historic Tax Credit Growth and Opportunity Act (HTC-GO) would increase the value of HTC transactions, making more small investment projects possible and benefitting more communities. The bill would create greater flexibility for nonprofits to partner with developers by:
- eliminating the HTC basis adjustment requirement,
- increasing the HTC from 20 percent to 30 percent for properties with rehabilitation expenses of less than $2.5 million, and
- expanding the types of buildings eligible for rehabilitation by decreasing the rehabilitation threshold from 100 to 50 percent of project expenses.
Low-income communities suffer from a lack of capital, which makes progress and community development difficult to achieve. The LIHTC, NMTC, and HTC have generated significant direct and indirect benefits to the communities they serve. Expansion and continuous efforts to improve these tax incentives is crucial to ensure that low-income communities do not get left behind.