What Were They Thinking?

The Bush Administration’s $720 billion-plus tax plan has many backers and many detractors. However, not enough has been written about a possible “ripple effect” of the tax plan that has triggered alarms for community development corporations and others concerned with affordable housing: The administration’s intention to exempt corporate dividends from taxation will undermine the Low Income Housing Tax Credit (LIHTC) and result in the most draconian cut in affordable housing production in over a generation.

What were they thinking? That’s the question affordable housing practitioners are asking themselves. The LIHTC is responsible for production and preservation of 110,000 affordable apartments annually, amounting to more than 30 percent of all multifamily housing production in a given year. Moreover, as the LIHTC has matured, it typically has been used to help shelter very low-income households. At latest count, a typical LIHTC resident earns approximately 38 percent of median income. Indeed, the program has a significant amount of bipartisan support on Capitol Hill and strong industry backing from major Fortune 500 corporations. These corporations use the credit to offset corporate taxes. Tax credits are also used for other community development programs and eco-friendly enterprises, namely the New Markets Tax Credit, the Historic Tax Credit, the Homeownership Tax Credit proposed by the Bush administration, and Ethanol and wind credits.

Credits or “Gimmicks”?

Why threaten a popular affordable housing program? The answer lies, in part, on the rigid tax views of the administration’s economic team, who argue that tax credits of all shapes and stripes “distort” economic behavior. That behavior is made rational, in their view, when corporations don’t engage in “tax gimmicks” to avoid taxation. In their opinion, such tax gimmicks include the LIHTC, the Ethanol credit, wind and energy credit, etc. This overlooks the fact that these credits were specifically enacted to spur socially responsible innovation and development.

So, unwilling or unable to hold the credits harmless, the administration is pushing hard for the House Ways and Means Committee to pass the unadulterated tax bill soon. The Senate Finance Committee is another matter but, depending on the pace and media coverage of the war in Iraq, the administration appears to be betting it can wipe out Senate opposition by May.

In early March the national accounting firm Ernst & Young produced a report that effectively demonstrates the danger ahead for affordable housing production unless low-income housing tax credits are somehow “carved out” from the administration’s proposal. According to the report, pricing on low-income housing credits will diminish approximately 21 percent, and 35,000 fewer affordable units will be produced annually if the administration’s proposal is adopted in its present form. Approximately $1.1 billion in “gap equity” grants currently provided by the LIHTC will be lost on an annual basis. Recently, the National Association of Homebuilders (NAHB) testified on Capitol Hill that adoption of the tax exemption without amendment would “have a significant adverse impact on the supply of rental housing for low-income families.”

How Debt is Affected

The administration’s tax proposal threatens housing and community development in yet another way. In effect, it makes tax-exempt debt more expensive.

Almost every affordable housing development takes on some sort of debt. Tens of thousands of affordable dwellings are produced each year using tax-exempt debt issued by a local or state municipality. The cost of such tax-exempt debt is typically lower than taxable debt. Because pricing is lower, the developer pays less for such debt and correspondingly can charge a lower rent to families or elderly households who live in the building. Indeed, use of tax-exempt debt comes with a legal quid pro quo: Those using tax-exempt debt must rent to lower-income households.

However, the administration’s tax proposal runs smack into tax-exempt debt. By making dividends tax exempt, investors will presumably be more attracted to stocks than tax-exempt debt, because dividend free stocks hold both the promise of appreciation and tax exemption. In turn, municipalities and states will raise tax-exempt yields to attract investors. That means a developer will have to pay more for tax-exempt debt than is currently the case. In the end, a housing developer will have to charge higher rents to pay for the increased debt. This also spells trouble for affordable housing.

Some within the administration believe that holding tax credits harmless under the dividend proposal would distort economic behavior. However, there are a number of influential Republicans and Democrats who vehemently disagree. They recognize the policy and social purpose behind the LIHTC and other credits such as incentives for alternative energy and research and development.

While the value of the president’s overall dividend tax proposal has been and continues to be debated, the bottom line for the housing community has been that the LIHTC must be protected. It’s time for all affordable housing stakeholders to become familiar with the potential consequences of this administration’s tax proposal.