day one project

Exempt Affordable Housing from Private Activity Bond Volume Cap

02.23.24 | 7 min read | Text by Rachel Fee & Shakti Robbins-Cubas

Tax-exempt Private Activity Bonds (PABs) are one of the primary financial tools to build and preserve affordable housing as they generate as-of-right Low-Income Housing Tax Credits (LIHTC). However, the federal cap on those bonds creates a significant barrier to expanding overall affordable housing supply. By exempting affordable housing from the state volume cap, we can build more housing in states that are fully utilizing their volume cap. 

The Housing Shortage Drives Up the Cost of Rental Housing 

The United States faces a severe housing affordability crisis due to a shortage in housing supply that has been exacerbated by the pandemic. This shortage places pressure on households across the housing market but disproportionately impacts low-income households. The National Low 

Income Housing Coalition found a shortage of over eight million homes affordable to very low-income households, those at or below 50% of the area median income (AMI). In New York State, this shortage is over 712,000 homes, contributing to soaring rents and a homelessness emergency. A renter in New York State needs to make over $40 per hour to afford a two-bedroom apartment at fair market rent as determined by the Department of Housing and Urban Development (HUD). In New York City and the surrounding suburbs, they would need to make over $47 per hour.

In a growing number of states, low-income renters are being priced out of the market with few housing options, forced to pay a large portion of their income towards housing costs and/or living in substandard housing. As renters compete for limited housing options, rent prices increase as a result of this demand. 

Tax-Exempt Private Activity Bonds Fuel Affordable Housing Production and the Economy 

LIHTC is the single largest and most significant tool to finance affordable housing and often works with tax-exempt PABs. Tax-exempt PABs are state and local bonds for certain “qualified private activities” that exempt the interest earned by holders from federal income taxes. When they are used to finance at least 50% of an affordable rental housing project – a requirement referred to as the “50% test” – they come with as-of-right LIHTC. This provides equity for the development and preservation of affordable housing for low-income households. These federal tax credits leverage additional project funding, including a commercial mortgage, and often other state or local subsidies. At marginal expense to the federal government, PABs boost our country’s housing stock while also creating thousands of jobs and generating new tax revenue and billions in economic spending – in the process shortening economic crises and reducing their severity. 

LIHTC generated by PABs help finance most new low-income housing and are critical to meeting affordable housing supply needs. They produce affordable housing that serves incomes from 30 to 80% of AMI, with all LIHTC units in a development averaging at 60% AMI. Since its creation in 1986, the program overall has developed or preserved almost four million homes, generated $257 billion in tax revenue and over $716 billion in wages and business income.

Volume Cap Is a Financing Barrier to Expanding Affordable Housing Supply 

Unfortunately, PABS are a finite resource, artificially limited by the federal “volume cap,” which limits the number of tax-exempt private activity bonds each state can issue. The volume cap was imposed as part of a larger effort to restrict the supply and demand for PABs through the Tax Reform Act of 1986. These restrictions were primarily intended to address concerns around cost and tax equity. 

Every year, a new cap is allocated to each state based on population using a formula set by Congress. New volume cap that is not used by the end of the year may be carried forward for three years. New York already uses all its cap on affordable housing, financing the creation or preservation of about 10,000 units of affordable housing annually. Demand for additional volume cap is great, outstripping supply. As a result, some shovel-ready projects must wait three or more years before receiving financing, a significant delay that deters affordable housing development. 

Volume cap allocation has not kept pace with the growing demand for affordable housing, increasing just 25% over the past decade, even as the nation produced 5.5 million fewer homes in the last 20 years than it did in the previous 20. Meanwhile, construction costs have skyrocketed. The cost of building materials increased over 20% in just one year in 2022, and developers have seen insurance rates double and triple over the past five years.

While PABs have several uses, most recent analysis shows 88% of issuances in 2020 went to multi- and single-family housing, continuing an upward trend of almost a decade, most of which is attributed to the increased demand for affordable rental housing. Nationally, the total amount of multifamily bonds issuances nearly doubled in only a few years from $7.2 billion in 2017 to over $13 billion in 2020. The number of apartments expected to be built from PABs increased by almost 20% from 2019 to 2020. 

Further, as communities across the country face housing supply shortages, more states are reaching their maximum allowable PAB issuance. In 2019 and 2020, states like Maine, North Carolina, South Carolina, Utah, and Montana issued record levels of PABs for housing. One in three states have reached their volume cap in recent years, including California, Georgia, Kansas, Maryland, Massachusetts, Minnesota, Nebraska, New York, New Mexico, Nevada, North Dakota, Oregon, Rhode Island, Texas, Tennessee, Utah, Washington, and Washington DC. Further, the Infrastructure Investment and Jobs Act (IIJA) created two additional uses for PABs – broadband projects and carbon capture facilities – that could compete with housing for usage.

Volume Cap Exemptions Help Achieve the Public Good 

There have been exceptions to state volume cap for 17 activities that contribute to the public good. These exceptions allow localities to build critical infrastructure without taking tax-exempt bonds away from other purposes. Congress has structured these exceptions in multiple ways. For example:

  1. Large public infrastructure such as airports, docks and wharves are exempt from volume cap.
  2. To address mounting capital needs for school construction and repair, Congress established a separate cap for financing some public educational facilities
  3. The 2004 American Jobs Creation Act authorized $2 billion in tax-exempt bonds not subject to volume cap for qualified green building projects.
  4. Congress authorized $15 billion in tax-exempt bonds not subject to volume cap for highway and surface freight transfer facilities to address challenges in our transportation systems. 
  5. For three uses, only 25% of bonds contribute to the cap. This includes high-speed intercity rail facilities, private projects to expand broadband access to underserved areas and facilities that capture carbon dioxide from the air.

Legislative Recommendations 

Given the scale and urgency of the housing affordability crisis and the precedent for volume cap exemptions to address public priorities, we recommend that Congress enact legislation to exempt the development and preservation of multifamily rental housing affordable to low income-households from state volume cap. 

There is political will to address the supply shortage. Recent increases in the HUD budget are helpful, but a significant HUD expansion to address our supply shortage will likely not gain congressional support in the immediate future, and the discretionary budget is constrained by the debt ceiling agreement. 

We believe a tax-side solution is possible. LIHTC has enjoyed bipartisan support and legislation to meaningfully expand it, the Affordable Housing Credit Improvement Act (AHCIA), has bipartisan co-sponsors in both the House and Senate. There are several tax side proposals to allow more efficient uses of PABs that would produce meaningful increases in supply. The SAVE Act would create an exception to volume cap for the preservation, improvement, or replacement of federally assisted buildings to aid public and other HUD-assisted housing. The “50% test” unnecessarily limits volume cap as projects often have to allocate more bonds than are needed to finance the project to meet this requirement. The AHCIA would decrease the percentage of bond financing required to generate LIHTC from 50% to 25%, freeing up volume cap for states. However, exempting affordable housing from volume caps would address the underlying issue and have the greatest impact in this housing emergency. 

There is also opportunity to provide volume cap relief through tax extenders or “must pass” bills that maintain government funding. Tax changes are often attached to broader bills. For example, we saw changes to LIHTC in the 2015 Protecting Americans from Tax Hikes Act, the 2018 omnibus spending bill, and the Consolidated Appropriations Act of 2021

Even though LIHTC expansion has bipartisan support, the cost to the federal government from increased use of tax credits is a challenge. To limit or offset the costs of the tax credit (which is quantified by a reduction in future tax revenue, not direct federal spending), there are two options: (1) limit the exemption for a 10-year period, or (2) tie the exemption to revenue-generating reforms that are proven to add to the tax base, such as requiring state or local action on removing zoning barriers to access the state volume cap exemption for affordable housing. There has been no analysis on the cost of a complete exemption from volume cap, but AHCIA provisions to reduce the 50% test and expand LIHTC included in an early version of Build Back Better were estimated to cost about $12.7 billion in reduced revenue over 10 years. That investment, a small percentage of the $1.75 trillion proposal, could have housed 1.9 million low-income people while generating more than 1.2 million jobs, $137 billion in wages and business income, and more than $47 billion in tax revenue

The housing shortage is an emergency affecting the lives of millions of Americans and the stability of our communities. Affordable housing is a public good, and the federal government has an obligation to respond to the needs of millions of low-income Americans. Adding affordable housing to the list of PAB uses exempt from volume cap would allow localities to build and preserve more desperately needed affordable housing.

This idea of merit originated from our Housing Ideas Challenge, in partnership with Learning Collider, National Zoning Atlas, and Cornell’s Legal Constructs Lab. Find additional ideas to address the housing shortage here.