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This Congressional Budget Office Staff Memorandum assesses the cost-effectiveness and long-run budgetary impact of extending the low-income housing credit. It was prepared in response to a request from Representative Willis D. Gradison, Jr., the ranking Republican member of the House Committee on the Budget.

The memorandum was prepared by Leonard Burman of CBO's Tax Analysis Division under the supervision of Eric Toder and Rosemary Marcuss. Jon Hakken, Larry Ozanne, Carla Pedone, Pearl Richardson, and John Ross made valuable comments. Paul L. Houts edited the manuscript. Denise Thomas and Simone Thomas prepared the manuscript for production.
 

SUMMARY

The low-income housing credit is a tax incentive for individuals and corporations to invest in low-income housing. Expenditures for new construction and rehabilitation of low-income housing are eligible for a credit paid annually for 10 years. Enacted as part of the Tax Reform Act of 1986, the credit had two objectives: it replaced a variety of incentives for investment in low-income housing, and it targeted more assistance to lower-income households than did the incentives available under prior law.¹

The low-income housing credit represents one approach to providing affordable housing for poor people. The housing voucher program represents a different approach. The housing credit heavily subsidizes the construction and renovation of units that are set aside for low-income households at below-market rents. Under the housing voucher program, a low-income household receives a housing voucher equal to the difference between average rents for a suitable rental unit ("fair market rent") and 30 percent of the household's income. The voucher may be used like cash to pay for all or part of the housing costs on any rental unit that meets minimum quality standards set by the Department of Housing and Urban Development (HUD).

The low-income housing credit is intended to address two problems: the shrinking supply of affordable housing for poor people, and the substandard quality of units typically available to poor people. However, the low-income housing credit, like other supply subsidy mechanisms, is unlikely to increase substantially the supply of affordable housing. Subsidized housing largely replaces other housing that would have been available through the private, unsubsidized housing market. Moreover, while the new subsidized housing is almost certainly better than the housing it replaces, the improvement in quality is generally worth much less to tenants than its costs to the government. As a result, the government can provide assistance of equal value to tenants through housing vouchers at a fraction of the cost of credits.

The relative efficiency of housing vouchers as compared with low-income housing credits stems from the different incentives created under the two programs, as well as from structural differences. Since housing vouchers are provided directly to low-income households, they are likely to be worth almost as much as cash to these families. The primary source of inefficiency in vouchers arises from the overhead costs of administering the program. In contrast, the tax credit may allow investors to capture much of the benefits for themselves rather than their tenants. Thus, the housing that is subsidized through credits is more suited to the needs of investors than poor renters.

Although many features of the tax credit, such as limited rent levels and oversight by state housing agencies, are designed to reconcile this conflict in favor of renters, available evidence suggests that the measures are ineffective. In addition, overhead and administrative costs appear to be much greater if a low-income housing unit is subsidized with tax credits than if it is subsidized with a voucher, thereby exacerbating the inefficiency.

However, in special situations, low-income housing credits can serve objectives that housing vouchers cannot. State and local housing authorities may use housing credits as part of a program to revitalize neighborhoods. In contrast, because vouchers are portable, they may encourage low-income tenants to abandon declining neighborhoods. In addition, credits may be more effective than vouchers in certain tight housing markets.

The question of the cost-effectiveness of low-income housing credits relative to vouchers is particularly germane because current funding levels allow only a fraction of qualifying families to receive rental assistance. At the same time, the low-income housing credit is becoming a substantial housing program. The tax expenditure on low-income housing credits was $0.6 billion in 1991, compared with $1 billion spent on housing vouchers. If the housing credit is not extended beyond its scheduled expiration in mid-1992, the tax expenditure will grow to $1.4 billion by 1997. But if new credits continue to be authorized, the long-run cost of low-income housing credits could exceed $3 billion per year.

This document is available in its entirety in PDF.

1. The incentives under prior law included special accelerated depreciation, five-year amortization of rehabilitation expenses, expensing of interest and taxes paid during construction, and tax-exempt bond financing for multifamily residential rental property.