Take 2: “What do we have to do to get those darned private sector developers to build more affordable housing!?”
Affordable housing should be a public good
Preface
For those of you who didn’t like last week’s answer to this question, “Look in the mirror: It is not the developers that are causing the problem.” This week I will offer a completely different answer to the same question!
The Story
As I mentioned in my previous post, soon after the publication of my book, “How Real Estate Developers Think: Design, Profits and Community,” I started to receive invitations to travel around and do book talks. But I began to notice that no matter where I was, during Q&A, there was always a moment when a middle-aged community member in the second row would raise their hand. I would get cold with dread as they asked in a self-righteous tone, “what do we have to do the get those darned private sector developers to build more affordable housing!?” I always tried to muster a good answer, and it usually sounded something like this:
“Private sector developers are not responsible for building affordable housing. They are in business to make money, and if their projects do not earn a high enough rate of return—a profit—they will be unable to attract the investors (equity) and lenders (debt, in the form of a mortgage) required to secure funding for the project, and it will not get built. The only affordable housing projects that are profitable are those that are supported by government subsidies, like grants, tax increment financing, tax abatement, discounted property, or other incentives that lower development costs. By the way, there is no way to build an affordable unit of housing without these forms of assistance, because, in fact, a unit of affordable housing costs as much to build as a market-rate unit of housing. Sure, you can shave down the square footage and switch out a few fixtures and finishes— plastic laminate instead of granite countertops and enameled appliances instead of stainless steel—but these are rounding errors on the cost of building a new, code-compliant unit of housing in the US.
If that wasn’t enough, I would continue into deeper policy and cultural waters, and mention that,
“The bigger problem is that we Americans are steeped in a culture of individualism, as exemplified by the myth of the American cowboy conquering nature and needing little help from government (a recurring theme in Heather Cox Richardson’s “Letters to an American”). We see ourselves as a country of independent boot-strappers who need little help, and we expect other people to take care of themselves. In terms of tax policy, it means we are not willing to pay very much to take care of the vulnerable, the sick, the disabled, and, more specifically, the unhoused.
Now deep into my hole, I would keep shoveling:
“The affordable housing shortage and crisis is a problem of market failure: The private sector is unwilling to build, own, and operate housing that won’t earn a profit. The reason we have governments is to solve for market failure, and to provide directly—or through subsidies—goods and services that the private sector won’t provide, like roads, the postal system, passenger rail, and national defense. The way we provide for those goods and services is by paying taxes. We could choose to tax ourselves at a rate that generates enough funding for the federal government to produce affordable housing. We could also increase the $7.25 per hour minimum wage, unchanged since 2009, to $20.00 or $30.00 per hour, which would give people more income with which to pay for housing, a topic for a future post. Yet these are both things that American taxpayers and business owners are unwilling to contemplate, which is why we don’t help our citizens the way other developed countries like those in Asia, Europe, and particularly Scandinavia do. We don’t like the idea of people being unable to find or afford housing, and we like even less the encampments in our cities and the unhoused sleeping on our streets. But when the rubber hits the road, we are unwilling to pry open our wallets to pay to fix it, and that leads us back to that question of why private sector developers aren’t solving the affordable housing crisis, Well, the answer is that they are not responsible for the problem, and they couldn’t begin to solve it anyhow because it is a problem of market failure.
By this point the audience’s eyes would be glazed over, as yours probably are by now, so I was grateful when after one talk, in Winter Park Florida, where a local developer and I formed a panel, the developer stopped me as I took a breath from all of that blathering and said something like this:
“Hey Peter, let me help you out here,” and then he turned the lady in the second row and said, “the answer, ma’am, is, a 70% marginal tax rate. If you want to solve the affordable housing shortage, that’s what it will take.”
A much better answer than my own, if I do say so myself.
The Theory
Let’s get back to the basic idea I was trying to get across: The shortage of affordable housing is a classic example of “market failure.” Market failure occurs when the market fails to distribute goods and services efficiently, leading to an imbalance between supply and demand and an outcome that is suboptimal for society. In cases of market failure, governments step in to provide goods and services that the private sector will not provide. “Pure” public goods, which are characterized by non-excludability and non-rivalry, include national defense, clean air, flood control, policing, infrastructure, education, lighthouses, and, in other countries, public health.
In a book called Markets or Governments, Charles Wolf Jr., a senior economic advisor at the Rand Corporation, set out to study how we make choices between markets and governments for the provision of goods and services. While the weaknesses of markets and a theory of market failure had been well-developed, Wolf wanted to explain how governments fell short, by developing a corresponding “theory of non-market failure.” His larger goal was to show that there are few pure choices between markets or government, but rather,
“a choice between imperfect markets, imperfect governments, as well as imperfect combinations between them.”
His book starts by comparing the arguments of two titans of economics, John Kenneth Galbraith and Milton Friedman, who, in 1977 and 1980, respectively, laid out their arguments for markets and governments in TV shows and books. While both were interested in “the cardinal economic choice: that between the market and the government as the predominant regulator of economic activity,” that was where the resemblances ended. While Galbraith acknowledged the strengths of the market, he also outlined its major failings as instability, inefficiency, and inequity. He felt that governments needed to play a role in regulating markets to avoid or at least minimize these downside effects. Friedman saw it the other way around, claiming that a freely functioning market results in economic and technological progress, efficient use of resources, and a rising standard of living that is equitably distributed. He argued that governments should be minimized and should get out of the way of markets. Which is it, and is the choice that simple? Wolf goes on to list examples of both successful and unsuccessful markets and governments as he begins to build the case for why we must better understand both market and non-market failure, and choose combinations of private enterprises and governments. For example, Wolf illustrates the inefficiencies of government production by summarizing a number of studies showing that private enterprises are typically more efficient at producing goods than their public counterparts, and citing one study that found that in 40 of 50 case studies, market supply was more efficient than public supply. Specifically related to housing, and in terms of construction costs per constant unit of housing, public agencies spent 20% more than private enterprises for the same unit of housing. Which explains why affordable housing in the US is provided by a combination of markets and governments: The private sector (and sometimes the nonprofit sector) produces the housing—with government subsidies—combining market efficiency and non-market resources.1
So back to that lady’s question, “What do we have to do to get those darned private sector developers to build more affordable housing!?” and that developer’s reply, “Ma’am, the answer to your question is, a 70% marginal tax rate.” The problem is that the shortage of housing and affordable housing is a market failure: The private sector alone cannot solve it because it cannot profitably provide what is a public good. If we truly wanted to provide housing for all of our citizens, we would have to agree to tax ourselves at higher rates to generate enough in subsidy to allow the private sector to provide more housing profitably. Let’s compare US tax rates to those in Scandinavian countries: Denmark's top statutory personal income tax rate is 55.9 percent, Norway's is 38.2 percent, and Sweden's is 52.3 percent. Scandinavian countries, however, levy their highest rates on the middle class, not just high-income taxpayers. American tax brackets are 10%, 12%, 22%, 24%, 32%, 35%, and 37%, and the top personal income tax rate in the US is 43.7% (federal and state), on incomes around $530,000 and up. But that is 8.5 times the average U.S. income, so a comparatively smaller share of taxpayers is subject to the top rate than in Scandinavian countries. This is a long way around of saying that, on average, Scandinavians pay significantly higher taxes than Americans, yet they have comprehensive social welfare systems—and significantly lower housing shortages and rates of homelessness. That developer was saying that if we want to provide enough affordable housing, we need to be willing to pay a lot more in taxes, something that lady probably didn’t want to hear. Why is it that we Americans always think we can get something for nothing?2
The Lesson
I can’t speak for anyone else, but I will speak for myself: I would like to live in a country where we consider the housing of all our fellow citizens to be a public good, not a market-driven commodity and a costly option that we are unwilling to pay for. This would require us to acknowledge that some people will never be able to pay market rents and purchase prices for housing, which means our governments—federal, state, and local—would need to step in and subsidize the provision of housing. This would, in turn, require us to be willing to pay higher taxes. While we are at, I would like to live in a country where health care is also considered a public good, and not the preserve of private sector profit-seeking corporations. Oh, and one more thing: I’d like a pony, too.
Markets can be efficient or inefficient; so, can governments. Thus, market failure is a counterpoint to government failure.
- Nicholas Barr
British Economist
Nothing rectifies out-of-control market failures like a healthy dose of
government intervention and mountains of bureaucracy.
- George Carlin
Wolf, Charles Jr., Markets or Governments: Choosing between Imperfect Alternatives, 2nd Ed., Cambridge: The MIT Press, 1993.
Bunn, Daniel, Sean Bray, and Joost Haddinga, “Insights into the Tax Systems of Scandinavian Countries,” in Tax Foundation, 20 April 2023. https://taxfoundation.org/blog/scandinavian-social-programs-taxes-2023/#:~:text=Top%20personal%20income%20tax%20rates,and%20Sweden's%20is%2052.3%20percent.