Candice Horbacz
The escalating crisis of housing affordability across America is fundamentally driven by a severe and persistent shortage in housing supply. This critical deficit has garnered consensus from diverse economic analysts, including the conservative American Enterprise Institute (AEI) and the progressive Center for American Progress (CAP), both of whom agree that the nation requires millions more homes to address key housing objectives. These goals encompass restoring historical vacancy rates, facilitating healthy household formation, alleviating overcrowding, and ultimately, improving overall housing affordability for millions of Americans. While numerous factors contribute to this supply-side challenge, a significant, yet often overlooked, impediment lies within the federal tax code itself. The current system notoriously favors homeownership through various incentives, yet simultaneously penalizes the construction of new rental housing, a crucial component of a balanced and accessible housing market. A straightforward, pro-growth legislative solution to counter this embedded tax penalty is to implement expensing for new residential structures, allowing developers to immediately deduct the cost of their investments.
America’s Housing Deficit: A Deep Dive into Supply Shortages
For decades, the United States has underbuilt housing relative to population growth and demand. Experts at the American Enterprise Institute’s Housing Center have estimated a national shortage of at least six million homes, with states like California at the epicenter of this crisis. The Center for American Progress echoes this sentiment, advocating for a "build, baby, build" approach to alleviate the strain. This housing deficit isn’t merely an abstract number; it translates into tangible hardships: soaring rents, escalating home prices, increased competition for limited units, and a growing burden on household budgets. Young families struggle to find entry-level homes, essential workers are priced out of the communities they serve, and economic mobility is stifled as people are forced to live further from job centers.
The roots of this supply problem are multifaceted, extending beyond federal tax policy to include local zoning restrictions, lengthy permitting processes, rising material and labor costs, and a general reluctance in many communities to embrace new development—often termed "Not In My Backyard" (NIMBYism). However, even with these local hurdles, federal policy plays a crucial role in either exacerbating or ameliorating the situation. The current tax framework, by disincentivizing new rental construction, inadvertently contributes to the supply crunch, making it harder and more expensive to bring new units to market.
The Federal Tax Code: An Unintended Barrier to Rental Development
A cornerstone of sound tax policy is allowing businesses to recover the costs of their investments. For most business equipment purchases, the tax code permits immediate deduction of the full cost, a pro-growth approach known as "full expensing" that was recently made permanent for certain assets. This means a manufacturing company buying a new machine can write off its entire cost in the year it’s placed in service, stimulating investment and economic activity.
However, the treatment for real estate, particularly multifamily rental housing, is starkly different and less favorable. A developer constructing an apartment building cannot deduct the full cost immediately. Instead, they must "depreciate" these costs over a lengthy period of 27.5 years. This protracted depreciation schedule significantly diminishes the present value of the deductions, effectively reducing their value to roughly 50 cents on the dollar when accounting for the time value of money and inflation. In essence, the developer is compelled to pay taxes on "phantom income"—income that is not truly profit but rather a portion of their capital investment that has not yet been fully recovered for tax purposes. This disparity creates a substantial tax penalty specifically on multifamily residential projects. Projects that might otherwise be financially viable ("pencil out") are consequently deemed unprofitable, leading to fewer new apartments being built, a smaller overall housing stock, and ultimately, a less affordable market for everyone. This uneven application of cost recovery principles distorts investment decisions, steering capital away from critical rental housing development.
Historically, the federal tax code has provided numerous benefits for homeownership, such as the mortgage interest deduction and capital gains exclusions on primary residences, contributing to the "American Dream" narrative. While these policies aim to encourage personal wealth building, their existence alongside a punitive framework for rental housing creates an imbalance that skews investment away from a segment of the market desperately needing supply.
The Rental Housing Investment Act (RHIA): A Bipartisan Approach to Stimulating New Construction
Recognizing this critical flaw and its impact on housing affordability, policymakers have begun exploring legislative remedies. Among the most promising is the Rental Housing Investment Act (RHIA). Introduced by Senator Lisa Blunt Rochester (D-DE) in March, with a bipartisan House companion bill sponsored by Representative Claudia Tenney (R-NY) in May, RHIA proposes a targeted reform to address the depreciation disincentive for new rental housing.
The RHIA seeks to allow developers of new rental housing (defined as buildings with two or more units) to immediately deduct a significant 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, similar to those utilized by the Low-Income Housing Tax Credit (LIHTC) program—a successful federal incentive for affordable housing development—this deduction cap would increase to $250,000 per unit. This contrasts sharply with the current 27.5-year depreciation schedule, representing a substantial shift towards neutral tax treatment for new rental housing investments.
The LIHTC program, established in 1986, has been instrumental in the creation and preservation of affordable rental housing by providing tax credits to developers. By borrowing affordability tests from this established program, RHIA aims to leverage existing frameworks to ensure that a portion of the newly incentivized construction contributes directly to addressing the affordable housing shortage. This strategic alignment underscores the bill’s intent to not only boost overall supply but also to direct incentives towards the most pressing needs within the housing market.
Targeted vs. Broad: Why Specific Incentives Outperform General Subsidies
The RHIA proposal represents a strong step towards comprehensive expensing, a tax reform principle designed to ensure that the tax system does not distort investment choices. Crucially, nearly every dollar of forgone revenue under RHIA would directly benefit the creation of new rental units. This targeted approach is a key differentiator when compared to many other popular housing programs.
Many existing federal housing programs, while well-intentioned, often function more like a "rate cut" than a targeted investment incentive. This means their benefits are spread across both new and existing housing stock, rather than exclusively stimulating new construction. For instance, first-time homebuyer credits, tax-preferred home purchase accounts, and broad rental assistance programs help individuals pay for housing regardless of whether it’s a newly built unit or an older one. The dollars allocated to these programs, or the equivalent tax dollars forgone, are diffused across the entire housing market.
Consider the distribution of sales: existing home sales typically outnumber new home sales by a ratio of roughly six to one. This means that for every dollar spent on a broad home purchase subsidy, approximately six out of seven dollars end up bidding on existing homes. While this might temporarily boost demand or affordability for certain buyers, it does little to address the fundamental supply shortage. In fact, by increasing demand for a fixed supply, such programs can inadvertently drive up prices for existing homes, benefiting current homeowners more than aspiring buyers or the broader housing market. 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, applying their influence broadly across the market.
The RHIA, by contrast, includes a crucial "original use" restriction, stipulating that the neutral tax treatment is limited to property whose "original use… commences with the taxpayer." This means existing buildings are explicitly ineligible for the immediate deduction. While bonus expensing for machinery and equipment often doesn’t require an original use test, this restriction is far more significant for buildings. The multifamily real estate market sees substantial annual investment in purchasing existing properties. In 2023, investors spent an estimated $166 billion acquiring large apartment properties, a figure approximately 45 percent higher than the $115 billion spent on constructing new multifamily housing. Without the "original use" clause, a similar expensing provision could effectively double the tax revenue cost without generating any additional incentive for new construction, as capital would merely churn through existing assets to capture the tax benefit. This protective measure ensures that the tax relief is directed where it’s most impactful: towards expanding the nation’s housing inventory.
Rewarding Growth: The Austin-San Diego Illustration of Expensing’s Impact
To illustrate the powerful, targeted incentive of expensing new construction, consider a comparison between two metropolitan areas: Austin, Texas, and San Diego, California. These two metros possess a similar number of homes—Austin with approximately 1.13 million and San Diego with 1.27 million—and experience a comparable volume of home sales annually, around 36,000 in Austin and 32,000 in San Diego.
However, their approaches to new housing development diverge sharply. Austin has consistently permitted roughly three times the new multifamily housing units compared to San Diego, with an average of 20,100 units annually versus San Diego’s 6,800. This disparity highlights different regulatory environments and political wills regarding housing growth.
Under a housing program that is absorbed broadly by the existing housing stock or by general home purchases, the financial benefit would be distributed roughly equally between Austin and San Diego, simply because their existing stock and sales volumes are similar. A hypothetical $10,000-per-purchase homebuyer subsidy, for example, would cost approximately $300 million to $400 million in each metro.
In stark contrast, tax relief that exclusively benefits new construction, such as that proposed by RHIA, actively rewards cities like Austin for their willingness to build more. Assuming full uptake and reasonable parameter assumptions (e.g., a $150,000 per-unit cap, a 26.6 percent average marginal tax rate, and the present value of straight-line deductions), the Austin metro could benefit by approximately $353 million per year from RHIA. San Diego, under the same conditions, would receive only about $120 million. This clear correlation—three times the building yielding three times the benefit—transparently demonstrates the policy’s explicit encouragement of new construction. This targeted incentive structure also provides an implicit push for local governments to adopt more permissive zoning policies, as communities that allow more building would attract a greater share of federal tax benefits, potentially fostering a virtuous cycle of supply growth.
Maximizing Impact: How RHIA Directs Investment Where It’s Needed Most
The efficiency of tax relief, measured by how much of the forgone revenue actually stimulates new construction in a given year, is paramount. When evaluating different policy designs, the distinction between supporting existing homes, home sales, or newly built homes becomes critical. The U.S. housing market comprises about 147 million homes, sees approximately 4.8 million sales annually (4.1 million existing, 0.7 million new), and adds about 1.5 million new homes each year.
- Policies targeting existing homes (e.g., broad property tax relief or general rental assistance) primarily benefit the existing stock. In such cases, only about 1 percent of the forgone revenue would touch new homes, reflecting their share of the total housing stock in any given year.
- Policies targeting home purchases (e.g., homebuyer credits or home-purchase savings accounts) are slightly more efficient, with about 15 percent of the benefit reaching new homes, as roughly one in seven home sales is a new construction.
- Expensing without an original use test (meaning it applies to both new and existing structures) would see approximately half of its benefit directed towards new construction. This estimate is based on the observation that investors often spend as much, if not more, each year acquiring existing apartment buildings as builders spend constructing new ones.
- RHIA’s expensing, with its crucial original use test, stands out for its exceptional efficiency. Nearly every dollar of forgone revenue—an estimated 93 percent—would directly benefit new units. The remaining small percentage would likely go to "teardown rebuilds," where an old structure is demolished and replaced with a new one. An even more precise "incremental-units test," which would provide neutral treatment only for units added beyond those already on the parcel, could close this small gap entirely.
It’s important to note that some of these estimates involve judgment calls due to data limitations. For instance, the exact share for expensing without an original use test depends on factors like the proportion of newly built apartments purchased, land value in purchase prices, and the total value of smaller purchases. The "half" estimate is likely generous. Similarly, for RHIA, using single-family teardown rates as an upper bound for multifamily teardowns probably overstates the multifamily share, given that one multifamily teardown often yields many new units.
Furthermore, these calculations assume no behavioral response to the policy changes. In reality, removing the original use test would likely induce "churning" in the market, where owners trade existing buildings simply to accelerate tax deductions, thereby diverting even more relief away from genuine new construction. The original use test is thus not merely an administrative detail but a critical mechanism for ensuring policy effectiveness and fiscal responsibility.
Economic Principles and Fiscal Prudence: The Case for Expensing
From an economic perspective, expensing is recognized as a powerful tool for stimulating investment. The Tax Foundation, in its "Options for Reforming America’s Tax Code," estimates that full expensing for all structures, while conventionally scoring as a significant cost over 10 years, would dynamically reduce primary deficits over the same period. This seemingly counterintuitive outcome stems from expensing’s pro-growth nature: by significantly lowering the cost of capital, it spurs increased investment, leading to higher productivity, job creation, and ultimately, a larger tax base. RHIA-style residential expensing, as a subset of full structures expensing, would exhibit a similarly large gap between its conventional (static) and dynamic (growth-adjusted) revenue scores, making it a fiscally sound long-term investment. Expensing spurs more investment per dollar than a broad corporate rate cut, because its benefits are precisely targeted to new capital, whereas a rate cut also benefits existing, "old" capital without necessarily stimulating new projects.
The housing affordability problem in America is undeniably complex, with deep roots in local zoning regulations, land use policies, and community resistance to development. Federal tax policy alone cannot compel San Diego to adopt the growth-friendly regulations of Austin. However, sound federal tax reform can eliminate the existing penalty on building, ensuring that the act of creating new housing is not economically disadvantaged. Critically, it can achieve this without providing an unearned windfall for capital that already exists. Bonus expensing for new rental housing, as proposed by the Rental Housing Investment Act, represents exactly the right tool: a precisely targeted, pro-growth, and fiscally responsible mechanism to incentivize the construction America desperately needs. By aligning federal tax incentives with the urgent need for increased housing supply, RHIA offers a tangible pathway toward a more affordable and equitable housing future for all.
