Candice Horbacz
America’s housing affordability crisis, a pervasive challenge impacting millions of households nationwide, is fundamentally rooted in an insufficient supply of available homes. Esteemed analysts from diverse think tanks, including the American Enterprise Institute and the Center for American Progress, concur that the nation requires an infusion of several million new housing units to rectify historical imbalances. These imbalances manifest as elevated vacancy rates, suppressed household formation, persistent overcrowding, and a general erosion of housing affordability across various socioeconomic strata. A critical, yet often overlooked, contributor to this supply deficit is the federal tax code itself, which has historically favored homeownership while inadvertently penalizing the construction of new rental properties. One straightforward, pro-growth legislative approach to counteract this inherent tax disincentive is the implementation of expensing for new residential structures.
The Pervasive Housing Affordability Crisis: Context and Causes
For decades, the United States has grappled with a burgeoning housing affordability crisis, a complex issue exacerbated by a confluence of economic, demographic, and regulatory factors. The core problem, as highlighted by various studies, is a significant shortfall in housing supply relative to demand. Estimates vary, but organizations like the National Association of Realtors (NAR) have suggested a deficit of 5.5 million housing units, while others, like Up for Growth, place the number around 3.8 million. This shortage stems from several interconnected issues.
Firstly, stringent local zoning regulations, often driven by Not-In-My-Backyard (NIMBY) sentiments, severely restrict the construction of higher-density housing, such as apartments and townhouses, particularly in high-demand urban and suburban areas. These regulations can include large minimum lot sizes, height restrictions, and complex permitting processes, all of which drive up development costs and timeframes. Secondly, rising material costs, labor shortages in the construction industry, and increasing interest rates have made building new homes more expensive and less profitable for developers. The lingering effects of the 2008 financial crisis, which led to a significant slowdown in construction, also contributed to the current deficit, as the pace of building never fully recovered to meet subsequent population growth. Demographic shifts, including an increasing number of millennials entering prime home-buying and renting ages, and a growing number of single-person households, further intensify demand for housing units. This persistent supply-demand imbalance translates directly into escalating home prices and rental costs, pushing homeownership out of reach for many and burdening renters with an ever-larger share of their income dedicated to housing.
The Tax Code’s Role: Disincentivizing Rental Construction
While local regulations and market dynamics play a significant role, federal tax policy quietly contributes to the housing supply problem, particularly concerning rental properties. The current tax code, in its traditional structure, creates a substantial disincentive for developers to construct new multifamily rental housing. This disincentive largely stems from the rules governing capital cost recovery.
Under prevailing tax law, businesses that purchase equipment, such as machinery for manufacturing or computers for office use, are generally permitted to deduct the full cost of that equipment immediately in the year it is placed in service. This "expensing" approach, recently made permanent for certain assets, is widely recognized as a pro-growth policy because it reduces the effective cost of investment, encouraging businesses to upgrade and expand. However, the treatment for real estate, specifically apartment buildings, is starkly different. A developer constructing a new apartment building cannot immediately deduct the full cost. Instead, they are required to "depreciate" these costs over a lengthy period, typically 27.5 years for residential rental property. This means that the deductions are spread out over nearly three decades, significantly diminishing their present value. When accounting for the time value of money, these deductions effectively amount to roughly 50 cents on the dollar in present value, according to analyses by organizations like the Tax Foundation.
This protracted depreciation schedule creates a "phantom income" problem. Developers effectively pay tax on income that, in real economic terms, does not exist because their true economic costs are not fully recognized in the year they are incurred. This constitutes a tax penalty on multifamily residential projects, making many otherwise viable ventures financially unfeasible. Projects that "would otherwise pencil"—meaning they would be profitable under a more neutral tax regime—never get built, leading to a smaller housing stock and a reduction in overall economic welfare. This bias in the tax code effectively subsidizes existing capital (by not taxing it at its true economic cost) rather than incentivizing new investment and growth. Historically, the tax code’s preferential treatment for homeownership, through deductions like the mortgage interest deduction and the exclusion of capital gains on primary residences, further entrenches this imbalance, prioritizing individual home buyers over the developers building the rental units that house a growing segment of the population.
Introducing the Rental Housing Investment Act (RHIA): A Targeted Solution
Recognizing the detrimental impact of this tax code bias, policymakers have explored various legislative remedies. Among these, the Rental Housing Investment Act (RHIA) stands out as a promising, targeted solution. Introduced in March by Senator Lisa Blunt Rochester (D-DE) and subsequently gaining bipartisan support with a House companion bill in May, RHIA aims to directly address the disincentive for new rental construction.
The core mechanism of RHIA is to allow developers of new rental housing—defined as buildings with two or more units—to immediately deduct a substantial portion of their construction costs. Specifically, it proposes an immediate deduction of up to $150,000 per unit. For projects that meet certain affordability tests, borrowed from the well-established Low-Income Housing Tax Credit (LIHTC) program, this immediate deduction cap would increase to $250,000 per unit. This contrasts sharply with the current 27.5-year depreciation schedule, effectively moving towards a system of "bonus expensing" for new rental housing. The inclusion of affordability criteria is a strategic move to ensure that the tax relief not only spurs general supply but also specifically addresses the critical need for affordable housing options. This approach is lauded for its precision; nearly every dollar of forgone federal revenue under RHIA would directly translate into benefits for new housing units, rather than being diffused across the existing housing stock.
Economic Rationale: Why Target New Capital?
The economic theory underpinning RHIA’s approach of targeting new capital is crucial for understanding its potential effectiveness. Economists widely agree that tax policies designed to spur investment are most efficient when their benefits are concentrated on new capital formation. As the Tax Foundation points out, expensing, which allows immediate deduction of investment costs, stimulates significantly more investment per dollar of revenue than a general corporate rate cut. A rate cut, while broadly beneficial, also provides a windfall to existing capital, meaning a portion of the tax relief goes to assets that would have existed regardless of the policy change. This dilutes the policy’s impact on new investment.
The distinction between "new" and "old" capital is paramount in the housing sector. Many popular housing programs, while well-intentioned, often function more like a broad rate cut, benefiting both new and existing housing equally. Examples include first-time homebuyer credits, tax-preferred home purchase accounts, and rental assistance programs. While these programs provide direct financial relief to individuals, their impact on increasing the overall housing supply is often limited. When government subsidies are provided for home purchases, for instance, a significant majority of the funds typically go towards existing homes. Data from the National Association of Realtors consistently shows that existing home sales vastly outnumber new home sales, often by a ratio of six to one or more. This means that for every dollar spent on these broad programs, approximately six out of seven dollars effectively bid up the price of existing homes rather than incentivizing the construction of new ones. Similarly, cheap credit policies, whether from the Federal Reserve or government-sponsored enterprises like Freddie Mac and Fannie Mae, do not discriminate between new and old housing stock, thus failing to specifically address the supply deficit. RHIA’s focus on "original use"—meaning the deduction applies only to property whose first use commences with the taxpayer—is therefore a critical design element.
The "Original Use" Distinction: Preventing Unintended Consequences
The "original use" provision within RHIA is a cornerstone of its effectiveness and a safeguard against unintended consequences. By limiting the neutral tax treatment to properties where the "original use… commences with the taxpayer," the bill ensures that existing buildings are not eligible for the immediate deduction. This is a vital distinction, especially when considering the significant volume of transactions involving existing multifamily properties.
In 2023, for example, investors spent an estimated $166 billion purchasing large apartment properties. This figure dwarfs the approximately $115 billion spent on building new multifamily housing during the same period. If the expensing benefit were extended to purchased used property without an "original use" test, it could effectively double the tax revenue cost without generating any additional incentives for new construction at the margin. Such a policy could inadvertently encourage "churning," where owners frequently trade existing buildings simply to accelerate tax deductions, siphoning off valuable tax relief that should be directed toward increasing the overall housing stock. The "original use" restriction protects taxpayers from providing favorable treatment to investments that do not directly contribute to new supply. Furthermore, it creates a powerful, indirect incentive for local governments to ease building restrictions. A city that permits more new construction naturally attracts more of this favorable tax treatment, effectively pushing in favor of "upzoning" and reducing regulatory barriers to development.
Illustrative Impact: Austin vs. San Diego – Rewarding Growth
To illustrate the tangible impact of RHIA’s targeted approach, a comparison between two major metropolitan areas, Austin, Texas, and San Diego, California, proves illuminating. These two metros possess a similar number of homes—Austin with approximately 1.13 million and San Diego with 1.27 million—and experience comparable levels of home sales annually, with around 36,000 in Austin and 32,000 in San Diego. However, their approaches to new housing construction diverge dramatically. Austin, known for its relatively permissive regulatory environment, permits roughly three times the new multifamily housing units compared to San Diego, approving approximately 20,100 units per year against San Diego’s 6,800.
Under a broad housing program, such as a general homebuyer subsidy, the financial relief would be absorbed by the existing housing stock and home purchases, meaning both metros would receive roughly equivalent benefits. For instance, a $10,000-per-purchase homebuyer subsidy would cost between $300 million and $400 million in each metro. In contrast, RHIA’s tax relief, which exclusively benefits new construction, transparently rewards Austin for its higher building volume. Assuming complete uptake and certain reasonable parameter assumptions (such as a $150,000-per-unit cap, a 26.6% average marginal tax rate, and a present value of 27.5-year straight-line deductions at 56 cents per dollar), the Austin metro could benefit by an estimated $353 million per year from RHIA. San Diego, however, would only see benefits of approximately $120 million. This direct correlation—three times the building yields three times the benefit—underscores how RHIA incentivizes and rewards the actual expansion of housing supply.
Maximizing Impact: From 1% to 93% – The Efficiency of Targeted Relief
Extending the Austin-San Diego comparison to a national scale reveals the profound difference in efficiency between various housing policies. National housing policy can funnel support towards homes that already exist (an estimated 147 million homes), homes that are traded annually (approximately 4.8 million sales, split between 4.1 million existing and 0.7 million new), or homes that are newly constructed (about 1.5 million units per year).
The proportion of forgone revenue that actually benefits newly built homes varies dramatically depending on the policy design:
- Policies targeting existing homes (e.g., broad property tax relief or general rental assistance): Only about 1% of the benefits typically reach new homes, reflecting new homes’ share of the total housing stock in any given year. The vast majority goes to existing units.
- Policies targeting home purchases (e.g., homebuyer credits or home-purchase savings accounts): Approximately 15% of the benefits are directed toward new homes, as roughly one in seven home sales involves a newly constructed unit. The remaining 85% primarily impacts the market for existing homes.
- Expensing without an "original use" test: This approach would see roughly half of the benefits go to new construction. This estimate acknowledges that investors spend at least as much each year purchasing existing apartment buildings as builders spend constructing new ones. Without the "original use" test, a significant portion of the tax relief could be claimed by the resale of existing properties.
- RHIA’s expensing, with the "original use" test: This is where RHIA shines in its efficiency. Nearly every dollar of forgone revenue—an estimated 93% or more—is directed towards new construction. A small remainder might go to "teardown rebuilds" (e.g., demolishing an old 10-unit building to construct a new five-unit one), but even this contributes to modernizing and potentially increasing density. An even more refined "incremental-units test," which would provide neutral treatment only for units added beyond those already on the parcel, could further close this small gap.
It’s important to note that these estimates often assume no behavioral response to the policy. In reality, removing the "original use" test, for example, would likely incentivize increased churning of existing buildings as owners seek to accelerate deductions, thereby further diverting relief away from new construction and making such policies even less efficient.
Dynamic Scoring and Fiscal Responsibility: Long-Term Economic Benefits
The fiscal impact of tax reform, particularly pro-growth measures like expensing, is often underestimated by conventional scoring methods. In its comprehensive guide, "Options for Reforming America’s Tax Code 3.0," the Tax Foundation estimates that full expensing for all structures would increase primary deficits by $537 billion over 10 years on a conventional basis. However, because full expensing is among the most pro-growth tax changes, it would dynamically reduce primary deficits by $434 billion over the same period. This stark contrast highlights the importance of "dynamic scoring," which accounts for the positive economic feedback loops generated by policies that stimulate investment, job creation, and broader economic activity.
RHIA-style residential expensing, as a subset of full structures expensing, would similarly exhibit a significant gap between its conventional and dynamic revenue scores. While a conventional score might project a near-term revenue loss, a dynamic analysis would likely reveal substantial long-term economic gains, including increased tax revenues from a larger, more productive economy, higher wages, and a more robust housing market. This makes expensing not just a supply-side solution for housing but also a fiscally responsible measure when viewed through a dynamic lens.
Broader Implications and the Path Forward
While federal tax policy is a powerful lever, it cannot singularly resolve America’s multifaceted housing affordability challenge. Much of the ultimate decision-making power regarding what and where to build resides with state and local governments through their zoning ordinances, permitting processes, and land-use regulations. Federal tax policy, even one as well-designed as RHIA, is unlikely by itself to compel a city like San Diego to dismantle its regulatory barriers and embrace building policies as favorable as Austin’s.
However, sound tax reform, such as the expensing proposed by RHIA, can play a crucial supportive role. It can eliminate the federal tax penalty on building new rental housing without providing an unearned windfall for existing capital. By directly incentivizing new construction and rewarding jurisdictions that facilitate it, bonus expensing for new rental housing serves as an appropriate and effective federal tool within a broader strategy. It signals a clear federal commitment to addressing the supply crisis and creates a stronger economic foundation for developers to overcome local hurdles. This policy, combined with state and local efforts to streamline regulations, reduce permitting times, and encourage higher-density development, offers a holistic approach to ensuring that more Americans have access to affordable, quality housing. The bipartisan support for RHIA underscores a growing consensus that targeted tax reform is a vital component in alleviating the national housing crisis.
Expert and Stakeholder Perspectives
Economists generally view expensing as a highly efficient tax policy for stimulating investment, particularly when targeted at new capital. Proponents like the Tax Foundation emphasize its ability to promote economic growth and productivity by removing tax distortions that penalize investment. Housing developers, especially those focused on multifamily rental properties, would likely welcome RHIA, as it directly improves the financial viability of their projects, potentially unlocking new developments that were previously marginal. This could lead to increased construction starts and a faster pace of delivery for rental units.
Housing advocates, particularly those focused on affordability, would also see significant benefits in RHIA, especially given its inclusion of affordability tests for enhanced deductions. This provision ensures that a portion of the tax relief is specifically channeled toward creating much-needed affordable housing options, aligning with broader social goals. Local governments, while retaining ultimate control over zoning, might find themselves under increased pressure or incentive to streamline their building processes if they see neighboring jurisdictions attracting more development and associated tax benefits from federal programs like RHIA. This indirect influence could foster a more competitive environment for attracting housing investment. Conversely, the U.S. Treasury and the Office of Management and Budget (OMB) would likely focus on the conventional revenue scoring of RHIA, necessitating careful consideration of its projected costs and benefits, though the dynamic scoring perspective offers a compelling argument for its long-term fiscal advantages. Overall, the Rental Housing Investment Act represents a significant step towards a more economically neutral and supply-oriented federal housing tax policy.
