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Article Excerpt
INTRODUCTION
Much of the federal tax code, particularly the numerous carve-outs of credits and deductions from the personal income tax, was created to support various social policy goals. Currently, the tax code provides favorable treatment toward energy efficiency, education, and homeownership, to name just a few. The federal government clearly understands the power of using fiscal inducements to achieve its social policy goals and often favors this approach over direct subsidies. The use of these fiscal inducements works to achieve social goals in one of two ways--either by directly altering the behavior of a target group or by re-aligning the economic allocation of resources. At its disposal, the federal government has two fiscal policy tools: taxation and expenditure. Taxation is an effective tool to induce either of these effects, while the spending of government revenues is mostly effective only for re-aligning resources between uses, unless designed as a negative tax, which could also serve to induce behavioral changes. This approach of using tax policy to achieve social goals was the motivation behind the creation of the Low-Income Housing Tax Credit (LIHTC) in the Tax Reform act of 1986. Its intention was to induce private resources toward the development of affordable rental housing, differing from the direct subsidy programs on which the federal government had previously relied.
The Low-Income Housing Tax Credit (LIHTC, 26 U.S.C. 42) is the federal government's largest program for subsidizing the production of affordable rental housing for low-income tenants. Within the Tax Reform Act of 1986, Congress eliminated a variety of tax provisions that had favored rental housing and replaced them with a program of tax credits. Under the LIHTC Program, 58 state and local agencies are authorized, subject to an annual per capita limit, to issue federal tax credits for the acquisition, rehabilitation, or construction of affordable rental housing. The credits can be used by property owners to reduce federal income taxes and are generally taken by outside investors who contributed initial development funds for a project.
Arguably, the LIHTC program has been successful in fulfilling its purpose. Since its inception, over 27,000 projects containing over 1.5 million units, mostly low-income, have been placed-in-service. Many of these leverage other U.S. Department of Housing and Urban Development (HUD) grant programs, such as HOME, CDBG and HOPE VI. (1) Further, the per-unit subsidy cost of properties financed by tax credits is quite low compared to other subsidy programs. (2) However, the LIHTC program, suffers from an inherent flaw not present in direct rental housing subsidy programs. The LIHTC subsidy amount is determined before the housing project begins operation, and depends on forecasts of projected costs and rental income for the entire 15-year compliance period, with no mechanism for ex-post adjustment in the subsidy to reflect unforeseen changes. To accommodate this problem, HUD instituted a hold-harmless policy in setting its Income Limits for subsidy programs, ensuring rental income, which is tied to the Very Low Income Limit (VLIL), does not decline. Recent changes to HUD's Income Limits methodology, however, show that the hold-harmless policy may not be enough to keep LIHTC projects operating. This paper outlines the problems facing the LIHTC program and discusses legislative policy options for ensuring LIHTC projects can continue to operate in these situations while maintaining affordability.
BACKGROUND AND MECHANICS OF THE LIHTC PROGRAM
Although the concept of effectively subsidizing low-income housing through the tax code originated prior to the Economic Recovery Tax Act of 1981 (ERTA), the vastly expanded allowances for accelerated depreciation in rental housing contained in this legislation caused the concept to take off. Specifically, the depreciation period for low-income real estate was shortened from 40 years to 15 years. The allowance of accelerated depreciation greatly increased the use of low-income tax shelters and produced a boom in the production of rental housing. (3) In the spirit of the current tax credit program, developers financed their projects by selling limited-partner equity interests to syndicators, who not only received the excess depreciation deductions, but also received tax benefits on any capital gains realized. Because maximizing the value of the tax benefits was achieved by minimizing net operating income, these projects tended to operate at rents affordable to low-income households.
Despite the boom in rental housing, the control of important policy variables remained out of the control of the federal government, particularly maximum rent levels and tenant income limits. This prevented the federal government from ensuring that the rental housing produced with this tax subsidy was initially, and remained, affordable and served a low-income population. The budgetary impact also could not be controlled or limited as any project built would be eligible for the depreciation deductions.
The Tax Reform Act of 1986 ended much of the favorable treatment toward real estate investment. Tax shelters lost their value as capital gains were now treated as ordinary income (4) and the depreciation period increased to 27.5 years, lowering the value of the depreciation deductions. In order...
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