Legislation pending in Congress would raise the per capita credit available under the federal low-income housing tax credit (LIHTC) program from $1.25 to $1.75. IBO estimates that this increase in the value of the credit would spur the creation of nearly 1,100 additional low-income housing units each year in New York City. However, the additional federal tax credits must be matched with additional commitments of private and city funds.

The Program. The LIHTC program was enacted as part of the federal Tax Reform Act of 1986 (TRA 86). The program provides each state with tax credits equal to $1.25 multiplied by the state's population. The states allocate the credits, which are good for 10 years, to developers for affordable housing projects. New York State, which received $21 million in tax credits in 1998, turns over some of its credits to local governments to allocate. The number of credits New York City receives is negotiated each year, but in recent years generally has been in line with its population. In 1998, the city received $7.7 million in credits from Albany.

The state Department of Housing and Community Renewal (DHCR) and the city Department of Housing Preservation and Development (HPD) allocate credits to individual project developers. Credits are made available to project developers only on units occupied by low-income households-those having an income of 60 percent or less of the area median, adjusted for household size.

Intermediaries, such as the Local Initiatives Support Corporation (LISC) and the Enterprise Foundation, sell most of the ownership interest in a project, and a pro rata share of the tax credits, to corporations and syndicated partnerships of investors, who then use them to offset their federal tax liabilities. By federal law, DHCR and HPD both limit use of the credit to "gap-filling," that is, covering the shortfall in necessary financing from other sources, including other government aid such as low-interest loans, mortgage guarantees, and the like.

One key difference between the city and state programs concerns the use of credits for non-construction or "soft" costs. The state will not allow use of the credit for soft costs such as funding of operating reserves in low-income rental properties. The city, in contrast, does permit the credit to be used for such soft costs. As a result, the average per-unit subsidy is usually greater for city-aided projects than for state-aided projects.

Analysis. Between 1988 and 1998, HPD supported the development of 12,816 low-income dwelling units with a total credit allocation of $841 million. While the dollar cost in tax credits of an average unit varied from project to project and year to year, the average per-unit value of allocated credits was approximately $66,500. In 1998, the average per-unit tax credit subsidy was $65,000, and 1,188 units were financed.

A 40 percent increase in the value of the tax credit (from $1.25 to $1.75 per capita), and an average per-unit subsidy of $65,000, would allow the city to create an additional 475 units of housing annually.

In addition to the credits allocated by HPD, DHCR also directly allocates credits to New York City. In 1998, DHCR allocated over $50 million in credits to finance nearly 1,500 units within the five boroughs. The per-unit value of allocated state credits was approximately $34,000. An increase in the value of the credit to $1.75 would have helped develop another 600 units.

Thus, the combined additional low-income housing units that the proposed tax credit increase would help finance each year would be nearly 1,100-slightly lower than the Mayor's Office of Management and Budget estimate of 1,200 units.

Tax credits are only a portion of the total financing of projects, and therefore a matching commitment of private and public funds for investment would be needed in order to take full advantage of the increased credit dollars. Since financing packages vary greatly among projects, it is difficult prospectively to estimate the amount and form of additional private and public investment that would be required.

The exact number of additional units built each year will depend on the number of credits the city receives from the state and the actual per-unit subsidy, but clearly the expansion of the LIHTC could help relieve the city's affordable housing crunch and aid HPD in its goal of rapid disposition of its city-owned (in-rem) units. It will only do so, however, if the city and state increase other low-income housing support to complement the increase in the housing tax credit.

A New York State Program? Legislation also has been introduced in Albany as part of the Governor's proposed budget to create an analogous state program. The total available credit amount would be $2 million annually, to be allocated by the DHCR Commissioner. The bill does not give the Commissioner authority to allocate part of the credits to a local agency (such as HPD), or establish any allocation by county or other subdivision. The bill also sets the income cap at 90 percent of area median, in effect targeting the program more toward moderate-income households.

A Critique of LIHTC. Although low-income housing tax credits have become the Federal Government's principal program for affordable housing production, they may not be the most efficient way for the government to encourage investment in housing. The basic reason lies in the difference between the rate of return required by investors and the government's cost of borrowing. For example, in recent months, LISC generally has received approximately $0.75 per credit. On a present value basis, this is an annual return of 10.6 percent to the investor over the 10-year life of the credit. This does not compare favorably to the rates for mortgage bonds sold by the New York State Mortgage Agency. In March of this year, the Agency sold over $7 million worth of bonds maturing in 2017 at 3.85 percent.

To illustrate the difference, imagine a project requiring an additional $1 million to finalize. Given a choice between raising the funds through the LIHTC or through bond proceeds, which route should the government take? If the government provides tax credits, sold at $0.75 per credit, it would forego $166,610 in income tax revenues each year for 10 years. In contrast, if it sold $1 million worth of bonds at 3.85 percent, with a 10-year maturity, its annual outlay for principal and interest would be $122,372-a savings of $44,238 annually. Alternatively, for an equivalent annual outlay, the government could have raised nearly $1.36 million by selling bonds-an additional $360,000 that could have been invested in affordable housing development.

Despite the higher cost to taxpayers of the tax credit program, advocates advance two arguments in its favor. First, with tax-exempt interest rates at historic lows, higher returns may be the only way to draw forth the additional necessary private funding for affordable housing-although yields on housing agency offerings could be higher without reaching the recent levels of LIHTC returns. Second, because the structuring of LIHTC deals makes investors equity partners in housing projects, there is a strong market incentive for them to exercise due diligence over project financing, development costs, and management to protect their investment stakes-an incentive that might be lacking in the absence of substantial private sector participation.