A Different Kind of Money
This month marks the 27th anniversary of the federal Low Income Housing Tax Credit (LIHTC) program. Throughout the program’s tenure, what lessons have we learned? What key components continue to make it a successful program?
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LIHTC has thrived because it, like other investment tax credits (historic, New Markets) is a different kind of money with three beneficial features no appropriated program can duplicate – true risk transfer, collectible recapture, and outcome-based compliance – that catalyze a fourth benefit – genuine market tension.
- Risk transfer. LIHTC transfer risk in a way appropriated programs do not. In appropriated programs, government pays out money before the property is completed, sometimes before it is even begun.
With investment tax credits, the government promises to pay, but only after performance; that promise is then sold in the marketplace. This cannot be duplicated in an appropriated program because an appropriated commodity is cash, which is needed up front.
- Collectable recapture. Because affordable housing delivers its benefits over time – years and decades – government faces the problem of continuing compliance. What makes you believe you will collect (say) penalties? The money given no longer exists, it’s been turned into bricks, windows, carpeting and appliances. Enforcing against the property makes the residents economic hostages, because the sponsor can always stop maintaining the property or counterclaim against the government for its alleged failure to administer the rules correctly. Such shenanigans were a decade-long Achilles heel in HUD’s efforts to rid the inventory of chronic non-performers and charlatans.
Investment tax credits bypass the human shield: they enforce against the investor, not the property or the sponsor. LIHTC investors, huge financial institutions, are 100% collectible, virtually instantaneously. Enforcement is swift and surgical, so the threat of enforcement is credible.
- Outcome compliance. What does it mean to comply? Is it process compliance – did you follow the recipe? – or outcome compliance – does the food taste good?
In practice, appropriated programs always use process compliance – something in the bureaucratic mind cannot bear to refrain from specifying not just the what of a task, but also the how. In investment tax credits, outcome compliance predominates, because that’s how the tax code works. Argue with the IRS and see how much good that does you. And outcome compliance is normally self-reported (by a CPA) so the property pays its own costs of reporting (embedded in the audited financial statements and tax returns).
- Genuine market tension. Combined, these three factors compel a fourth. Investment tax credit coupons have to be sold, because the sponsor needs cash to build the property. The investor’s natural skepticism compels a purely private negotiation, and nothing beats arm’s-length negotiation for driving hard bargains that add efficiency.
In investment tax credit programs, markets do government’s work, far more efficiently and effectively than government has ever done equivalent work itself. That’s why so many ‘relative program efficiency’ discussions are misguided – the question isn’t “What is the discount on the taxpayer’s dollar?” but rather, “How much affordability do the taxpayers get for their dollar?” When I calculated it a few years back, using a GAO study, LIHTC was 13-32% more cost-effective.
David A. Smith is the Chairman of Recap Real Estate Advisors
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