Let 421-a Die!

If you notice fewer posts than usual here this week, it's because I'm off on a trip, to Russia of all places.  On finding out that I'm from New York, some of my travel companions have immediately asked, why is it so corrupt, and is there anything to be done about it?  My answer is, our politicians are no more corrupt than those anywhere else, but our unique situation is our particularly large collection of government programs of handouts and crony capitalist giveaways.  New York has gone well beyond other states in seeking to use the levers of government supposedly to make the world more fair and just.  Instead of achieving fairness and justice, the handouts and giveaways get manipulated by the pols' friends and hangers-on to make themselves rich, while poverty never goes down and perfect fairness somehow always eludes us.  Meanwhile, once in place, the handouts and giveaways are fiercely defended by the alliance of the politicians who give them and their cronies who get them, and thus the giveaways are exceedingly difficult to eliminate, even as they never solve the problem they were supposed to solve, and even as they breed a steadily increasing level of corruption.   

One of the best examples of the genre has been in the news lately, and for the highly unusual reason that this major giveaway program recently expired, and then was unexpectedly not renewed in the recently-concluded session of the New York State legislature.   The program in question is a type of real estate tax abatement, and goes by the name "421-a."  Even if you live in New York, you may well not have heard of 421-a.  That's because, as a big crony-capitalist giveaway, it's arcane and complex, and it's only worth the time to figure it out if you're an insider getting rich off it.  From the perspective of the insiders -- pols and cronies alike -- the less the public knows about it the better.  To the public, the pols say something like, "we're fighting to get affordable housing built."  Who could be against that?  But perhaps you might think to ask, why, despite 421-a, housing in New York is so expensive, while meanwhile they have lots of affordable housing in places like Houston and Las Vegas and Orlando without having any comparable program of tax giveaways to real estate developers.

It started in New York with the idea that leaving the real estate market to operate on its own without government meddling would lead to unfair results for many tenants, who would be gouged by greedy landlords.  So New York City adopted the program known as "rent control" shortly after World War II (a detailed history can be found here).  As originally set up, that program basically allowed tenants to remain for life in their apartments with minimal yearly rent increases; however, new construction after 1947 was specifically exempt from the controls.  Thus, new construction was not severely hampered by the program, and continued at a reasonable pace through the 50s and 60s.  In the 60s some units were even removed from the controls.  However, the late 60s and early 70s were a period of high inflation, and rents in the unregulated sector of the housing market began to soar.  In a series of steps from about 1968 to 1974, New York City imposed a new program called "rent stabilization" on all the units in buildings 6 units and larger that had previously been specifically exempted or removed from controls.  In other words, New York double-crossed a big group of real estate investors who had thought that they were exempt from the restrictions.  Contemporaneous with this double-cross, new housing construction in New York City promptly fell off a cliff.  According to data at Habitat NYC here, New York City building permits fell from about 34,000 units in 1972 to about 4,000 in 1975, and then remained at a seriously depressed level of around 10,000 per year or less into the 80s.

But not to worry.  In 1971 New York also enacted 421-a as a way to bribe real estate developers to build new housing in the face of the otherwise overwhelming disincentive of the rent regulations.  The program has near infinite complexities (details available here), but in summary, depending on when and where in the city you build, you can get a complete exemption from real estate taxes on any increased value of the property that results from development for 10 or 15 years, and then a phase-in of the increased real estate taxes over several more years after that.

So is 421-a a cost-effective way of providing so-called "affordable housing" to New Yorkers?  Of course not.  To answer the question, what you want to know is the cost per unit to the taxpayers of "affordable housing" constructed; and of course, they make it absolutely as hard as possible for you to figure that out.  But when you put in some effort, you find that this program is exactly the opposite of a cost-effective way to provide housing -- it's an unmitigated disaster, at least for the taxpayers and for the intended beneficiaries (people looking for reasonably-priced housing).  A Manhattan Institute study in 2015 found that in its 44 years of operation up until that point 421-a had provided subsidies to some 150,000 housing units (only 37,000 of which were deemed "affordable"), but that as of that year the program was costing the City some $1.1 billion annually in foregone real estate taxes.  How much does that come to per "affordable" unit created?  Recognize that most of the units developed under the program are at the highest end of the market and would have been built anyway without the program, and that for the small number of "affordable" units the annual tax subsidy has to be paid not once, but ten or fifteen times.  A 2015 study by the Community Service Society here put the cost per "affordable" apartment at over $1 million!   -- a number that is about in line with my own back-of-the-envelope estimates.  From the CSS report:

421-a is responsible for losses of more than $1 billion annually in foregone revenue to the city-- more than the combined rents of the half a million tenants living in New York City Housing Authority buildings – while producing well under 14 cents of affordable housing investment for every dollar of tax subsidies. Of the tax revenue forgone through 421-a, a majority of it is being used to subsidize buildings that would have been developed without the tax exemptions.   “As wasteful public subsidies go, 421-a has no equal,” said David R. Jones, President and CEO of the Community Service Society.

But although this program is a disaster for the taxpayers and of very limited value to the intended beneficiaries, the story is not the same for politicians, land owners, and developers.  Because the tax abatement makes a higher percentage of revenues from a development go to the developer's bottom line, it has driven land prices higher and made many owners wealthy.  Those currently in the process of trying to develop property have likely bought in at the inflated prices, and would take a substantial loss if the tax exemption were eliminated.  Thus both land owners and developers have a high incentive to do what they can -- including contributing generously to campaigns -- to get the legislators to continue the program.  The program has been structured to come up regularly for renewal, thereby providing repeated occasions for politicians to exact tribute.          

The program recently came up for renewal in June 2015.  Then something unusual happened: labor unions (the other principal group of major contributors to New York politicians) attempted to use the occasion to extract some incremental handouts for themselves, particularly a so-called "prevailing wage" requirement for any developments benefiting from the 421-a program.  It seems that the labor negotiators then seriously overplayed their hand (asking for minimum wages of as high as $50/hour), and then negotiations stalled.  The program got only a six-month renewal from June 2015 to January 2016.  When negotiations continued to languish, the program expired.  That set off a lobbying frenzy seeking to have the program renewed during the 2016 legislative session; but that session has now ended without any revival.

Naturally the real estate industry is up in arms at having its gravy train at least temporarily derailed.  So what does the head of the Real Estate Board of New York (main real estate lobby) have to say?  From the Real Deal, January 15:

“New York is a city of renters and one that continues to grow,” Banks said in a statement. “Without a program like 421-a, one can’t build multi-family rental housing with a significant below-market, or affordable, component on a scale necessary to address the City’s needs.  We are committed to working with stakeholders to fashion a program that will produce the affordable housing throughout New York City that is so desperately needed, ensures construction workers are treated fairly and creates job opportunities for City residents.”  

To put it another way, they are trying to scare the public with the idea that no housing can or will ever again emerge without vast tax subsidies.  Nonsense.  What is really likely to happen if 421-a doesn't get renewed is that developers with projects in the pipeline will take a hit; but elimination of the tax handouts over time will lower land values and thus enable housing production at lower price points without subsidies.  In other words, New York can become more like all the other cities that somehow have lots of housing built by the private sector without subsidies.  But meanwhile the industry throws around plenty of fake figures.  For example, according to real estate publication the Real Deal, in 2015 through May more than 20,000 housing units were approved for construction, while in January to May 2016 (with 421-a expired) it was only 2700 -- less than 15% as many.  Does that prove that 421-a is the only reason that most units get built?  Of course not.  All that proves is that in 2015 developers were rushing to get projects started before the handout expired, while in 2016 developers were waiting for the program to be renewed before proceeding.  Many of them may well keep waiting until they get the word that the program is dead, dead, dead and not coming back.  The best result would be for that word to be delivered forcefully, and soon.

But of course that's not happening.  In the real estate industry, hope springs eternal.  The legislature is up for election this fall, and the real estate lobbyists are hard at work to get their favorite tax break renewed.  Political contribution season is beginning.  I still think it will be a miracle for 421-a to die permanently, but hey, I'm an optimist.

So we started out to create a world of "fair" prices for tenants through a rent control system.  Eighty years on in that game, and an increasingly elderly collection of long-term tenants get some benefits from that program, at the expense even to them of never being able to move.  Almost everyone new entering the market as a tenant has to overpay.  Meanwhile a tax subsidy program that sought to modify some of the disincentives of rent regulation has bred pervasive corruption.  We end up with a system less "fair" than if the government had never meddled at all, but with lots more corruption.  Well, at least for once we have a chance to get rid of some little piece of the problem.