A Policy Alchemy for the Housing Crisis
Two horses yoked together can pull not twice, but four times the weight that either could alone. The combination of their strength is multiplicative; the whole is greater than the sum of its parts. In a similar way I believe we can produce more affordable housing in American cities by combining two policies than the sum of what either policy would produce on its own. Let’s call it Inclusionary Abundance.
In housing policy circles, “affordable housing” doesn’t have a universal definition. To one camp, “affordable housing” refers to housing that has been publicly subsidized or required by law to be made available at sub-market rate prices. To another camp, “affordable housing” is a shorthand for market-rate housing that has been made accessible by increasing the supply of housing.
Inclusionary Abundance is a special housing policy alchemy that (theoretically) creates more of both kinds of affordable housing by strategically fusing two policies. The first policy is a common regulatory solution; inclusionary zoning. The second is a market-based solution found elsewhere in the world but rare in the United States; land value tax. There’s good reason to believe we’d see a special interaction effect that happens when you enact both of these policies together.
What is Inclusionary Zoning?
New York, Boston, San Francisco, Portland, Denver, and many other major US cities have some form of inclusionary zoning. While the details vary widely, inclusionary zoning generally enforces the following rules on real estate developers: For multifamily housing developments above a minimum project size (usually expressed in # of units), a minimum percentage of “set-aside” units must be made affordable (meaning the renter or homeowner spends no more than 30% of their income on housing) at prices relative to a percentage of area median income (AMI).
Consider a hypothetical city with a median income of $100,000. Its inclusionary zoning policy kicks in for multifamily developments larger than 6 units, and requires that 20% of units be made affordable at 60% AMI (meaning someone with an income of $60,000 would need to spend no more than 30% of their income).
If a developer in this city wants to build a 10-unit rental building, then 2 units must be rented at $1,500/mo to qualified renters (since $60k AMI is $5k in income a month, and 30% of $5k is $1,500). The remaining units can be leased at market rates.
In practice there are plenty of other complexities, but these are the basics of how inclusionary zoning works.
What’s the problem with Inclusionary Zoning?
Let’s revisit our horse metaphor. Setting the parameters of inclusionary zoning policy is like packing a horse’s wagon to cross a long trade route. We want to pack as much as the horse can pull, but if we pack an ounce too much, we risk overburdening the horse and having it collapse. If it collapses, we don’t get anything to our destination.
We’d better be really confident about whether the horses can handle that last bag.
We can think of real estate developers as our horses, and affordable housing units as the packages we’re loading on their backs. If we require too many affordable housing units, the cost of development is too high relative to expected returns and we get no housing at all—affordable or otherwise!
What numbers “pencil” for housing developers will vary widely from city to city depending on factors like land prices, construction costs, and market demand. Debates over the extra “burden” of affordable housing requirements and how to get the most housing possible recently led San Francisco to cut their inclusionary zoning requirements roughly in half, from 21.5% to 12% of rental units. If this cut induces more housing development, it’s possible that it will result in a total increase of affordable housing units (in the regulatory sense of the term) even though the required percentage is lower.
Inclusionary zoning risks backfiring on us. If the percentage of affordable units required is too high (i.e. real estate developer’s projects no longer pencil) we end up with even less housing than we would otherwise.
What is Land Value Tax?
The term ‘land value tax’ is generally used to describe a revenue-neutral shift in property tax from the total value of real estate to a tax on only the land value of the property. Wonky, right? Here’s why it matters.
In the US, property tax is applied to the total value of real estate (land value + “improvements” which are usually buildings). This has a couple downstream effects.
First, our property tax structure makes it possible to make lots of money by purchasing valuable urban land and keeping it vacant. Since there’s no improvements, the tax bill on a vacant lot is low. As long as others are developing nearby and increasing the value of the vacant lot, a land speculator can make a handsome profit by holding the lot ransom until its market value covers the tax bill and returns the profit margin they want. All of this happens without the land speculator ever lifting a finger.
Henry George first proposed a land value tax in his book Progress and Poverty (1879).
Second, our property tax structure reduces the supply of housing. In some cases this is due to speculators taking buildable urban land off the market. In other cases, the tax bill that would be incurred by building the maximum number of possible units incentivizes developers to build less efficiently than they otherwise would. The current property tax structure doesn’t just encourage land speculation, it encourages underdevelopment. It also contributes to sprawl, as housing developers must leapfrog speculators in search of cheaper land further from the city center.
What happens when you shift property tax from buildings to land?
Let’s imagine a city where the property tax is 1%, applied to the total value of a real estate asset so that a $1M property pays $10k in taxes each year. That city decides to implement a revenue-neutral land value tax, shifting all of the tax burden from buildings to land while keeping the city’s total property tax revenue the same. Since the assessed value of all buildings in the city is 4x the assessed value of all land (this is fairly typical), the tax rate on land is increased to 5% while the tax on improvements is removed completely.
With this backdrop, let’s imagine two properties side by side. One is a small apartment building, the other is a vacant lot. Since they are the same size and location, their land values are the same: $200k. The assessed value of the apartment building, however, is $800k, so the total value of the property (land + improvements) is $1M, while the vacant lot’s total value is $200k.
Under the 1% property tax on both land and improvements, the apartment building paid $10k per year in property taxes while the vacant lot pays only $2k per year. The vacant lot owner doesn’t mind because he knows the value of his land is appreciating at a rate higher than $2k per year (and/or perhaps he’s making enough revenue to cover that cost by renting it out as car parking).
When we institute a 5% land value tax and remove the tax on improvements, the small apartment building pays the exact same $10k per year, since 5% of its $200k land value is $10k. (Elsewhere in town, a large apartment building on a lot with the same value pays less in taxes than it did previously).
What happens to the vacant lot? Instead of $2k in property taxes, it now pays $10k as well. Holding this lot vacant just became very expensive!
In order to cover this increased holding cost, the owner must develop the lot or sell it to someone who will. This will increase the supply of housing and put downward pressure on market-rate housing costs.
We’ve seen this effect play out in natural experiments. In the three-year period after Pittsburgh increased its tax rate on land to 5 times the rate on improvements in 1979, building construction permits in the city increased 293% compared to the national average.
Inclusionary Abundance: Combining Land Value Tax with Inclusionary Zoning
We’ve now seen how inclusionary zoning can create affordable housing in the regulatory sense (as long as the required percentage of affordable units isn’t too high). We’ve also reviewed how land value tax can create affordable housing in the market-rate sense by creating incentives to build more housing, thereby increasing supply relative to demand. But the real magic happens when we combine these two policies together to form Inclusionary Abundance.
Recall the vacant land owner whose tax bill just went up thanks to a revenue-neutral shift to land value tax. He’s probably not a developer (otherwise he would have developed it!) so he needs to sell that land to a developer who is going to build housing on it.
But he isn’t the only one. Across the city, vacant and underdeveloped land owners are now looking to offload their property, because it’s too expensive to hold it now that property taxes are falling entirely on the value of land. Land that was previously locked up in speculation floods the market.
What does that increased supply do to the price of land? Naturally, land gets cheaper to buy.
Land is an expensive part of the real estate developer’s costs. It can range from 10% to 20% of overall development costs and even higher in major urban areas where the housing crisis is most severe—in San Francisco land accounts for about 60% of total property values!
Here’s the trick of Inclusionary Abundance. By reducing land acquisition costs for developers using land value tax, we can safely increase the percentage of affordable housing units required by inclusionary zoning without discouraging housing development. We’re effectively taking those land cost savings and—rather than padding developers’ profits—allocating them to below-market rate affordable housing. Land value tax reduces market rate housing prices on its own, but it also allows us to increase the supply of below market rate housing at the same time. In this way, we create more affordable housing of both market rate and below-market rate varieties.
This sets in motion a virtuous cycle. As more development happens, the value of land goes up. As the value of land goes up, it incurs higher taxes and thus pressure for even more development. Building by building, the market rate price of housing comes down and even more sub-market rate housing units become available.
There is a spatial component to this cycle as well. At first, most development pressure would fall on vacant and underdeveloped land in the urban center where land values are highest. As this central land gets developed, land on the urban periphery becomes more valuable and therefore incurs higher taxes, incentivizing the next round of land selloffs, downward pressure on those land prices, and development in inner ring suburbs. As this process continues, the city begins to take on a more compact form with much more housing. This compactness has several unexpected benefits in addition to alleviating housing prices.
Copenhagen has a land value tax, Indianapolis does not. This policy difference influences urban form, encouraging more housing on less land.
Just how much could we increase inclusionary zoning requirements? It would vary by metro depending on how far land prices fall (we could even imagine a mechanism by which inclusionary zoning requirements are inversely pegged to land prices), but it could be significant. New York City has over 77,000 privately-owned vacant lots that we might expect to enter the marketplace fairly quickly. Austin has over 17,500. It would also depend on the tax rate set on land, as economists have determined that the price of land would fall as the tax on land increases.
Of course, no American city has ever seen a land value tax paired with inclusionary zoning. We don’t know exactly how Inclusionary Abundance would play out, but that doesn’t mean we shouldn’t try it.