Background
At a time in the United States when there is a shortage of affordable rental housing one would think that good tax policy would favor the construction and preservation of more affordable housing not less. Tax-exempt bonds have been successfully used for decades to reduce the costs of building and renovating affordable housing. Because interest income on tax-exempt bonds is not included in the income of investors, they are willing to accept a lower interest rate on tax-exempt bonds than investor in taxable bonds. Lower cost of debt allows affordable housing developers to reduce their debt service costs and provide lower rents to tenants. Why then are two recent tax and budget proposals either reducing the benefits of tax-exempt bonds or proposing their elimination outright?
Elimination of housing bonds
First, on February 26, 2014, Ways and Means Committee Chairman Dave Camp (R-MI) released a draft tax reform proposal that would eliminate all private activity bonds beginning in 2014. Tax-exempt bonds used to finance affordable housing are part of the list of private activity bonds to be eliminated because as stated as one of the considerations, “The Federal government should not subsidize the borrowing costs of private businesses, allowing them to pay lower interest rates, while competitors with similar creditworthiness but that are unable to avail themselves of [private activity bonds] must pay a higher interest rate on the debt they issue.” See http://tax.house.gov.
Reduction of housing bonds tax benefit to 28%
Second, on March 4, 2014 the Obama Administration proposed in its Fiscal Year 2015 budget to limit the tax rate at which high income taxpayers can reduce their tax liability to a maximum of 28 percent. This limit would apply to tax benefits such as tax-exempt interest on housing bonds. The Budget proposal explains that the limitation would affect only the top three percent of families in 2014 and is characterized as a reduction of a tax breaks for the wealthy.
Policy considerations
To be fair, not just housing bonds have been singled out for elimination or reduction. All private activity bonds are subject to elimination under Chairman Camp’s plan and the Administration’s cap on tax-exemption is for all tax-exempt bonds. However, the rationale given by Chairman Camp’s plan for elimination of private activity bonds does not apply to housing bonds in the current market. Today most housing developers can avail themselves of private activity bonds and they do not create any unfair competition. Finally, when the Administration states that the limitation of tax-exempt benefits only affects the top three -percent of families, it does not take into account all of the low-income families who will pay higher rent and be unable to find affordable housing because of the reduced benefit of tax-exempt financing. In this author’s opinion, the rationale for elimination of housing bonds or reduction of their economic benefit does not outweigh their benefit to society under the current legal structure.