The american way

There is a black hole in social housing finance if anything like the number of affordable homes is ever to be created. Social housing grant funds made available in the Spending Review will mostly go to section 106 agreements, so it is still not clear how 200,000 new homes are to be funded.

Whereas other countries offer a range of financial aids – housing allowances, depreciation allowances, tax credits, preferential treatment for housing-related savings – the UK's affordable housing policy more or less limits development support to the social housing grant.

Six types of instrument could suit the UK. Four of them extend existing approaches:

• variations on the Starter Home Initiative
  
• increased employer involvement
  
• more mixed-use housing developments on non-residential sites
  
• lower VAT on renovation.

The fifth, improving savings schemes for first-time buyers, would require a reversal of general tax policy and is thus unlikely to be acceptable to the chancellor.

The policy with the best chance of boosting the stock of affordable housing is tax incentives for construction, allowing costs to be set against other income (tax relief) or offering a pound-for-pound cut in tax payable (tax credits).

The tax incentive system for almost all the USA's affordable housing construction is the federal Low-Income Housing Tax Credit. Developers that agree to build housing that will remain affordable for at least 30 years receive 10 years of credits to set against their federal income tax bill. The key elements of the system are:

• it provides dollar-for-dollar credits against tax payable
  
• the credits are received over 10 years
  
• it is cash-limited
  
• affordability must be guaranteed for a minimum period
  
• credits are tradeable – they can be sold in the market at a price reflecting expected payments.

Tradeability is important in the USA. If credits are not tradeable, involvement in projects with tax incentives is limited to large or resource-rich companies and those with tax liabilities for a long enough period to make use of tax incentives. This rules out charities and other tax-exempt bodies that do not pay corporate tax. If the credits are tradeable, small firms or charities can participate in the programme by selling tax incentives to investors. In the UK, this would help local builders and registered social landlords.

The policy with the best chance of boosting the stock of affordable housing is tax incentives for construction, allowing either tax relief or tax credits

To illustrate this, assume a dwelling costs £100,000, and must be rented out for no more than £450 a month to be accessible to low-income households. The investor has a 40% marginal tax rate and looks for a gross return of 9% on its investments.

With these figures the investor would not choose to invest in a low-income housing development, which would give a gross return of 5.4% a year (£450 × 12)/100,000.

But a tax credit of 6% of its investment a year for 10 years would have a value of 46.13% of the investment cost, discounted at 6%. This would reduce the investor's effective cost to £53,870, achieving a return of 10% (£450 × 12)/53,870. It is assumed:

• Market interest rate: 6%
  
• Tax credits: 25% of the amount invested
  
• Net interest rate: 3.5%
  
• Cost per dwelling: £100,000
  
• Amount raised from investors per dwelling: £100,000
  
• Net interest payable a year on £100,000 raised from investors (at 3.5% net): £3500
  
• Capital sum required to pay £3500 a year, if invested at 6%: £58,333
  
• So, with a margin of £10,000 for uncertainty and risk, the dwelling could be sold for £68,333.

A UK tax incentive programme could promote construction of dwellings for sale or rent. It could cover loans and equity investment. If incentives took the traditional UK form of tax relief, it would be the marginal income tax or corporation tax rate. Tax credits, which can be set up pound for pound against tax payable, would permit deeper subsidy. Tax credits are therefore more flexible and can involve more appropriate stakeholders.

The general approach is not new in the UK. The Business Expansion Scheme from 1989 to 1993 gave tax relief to provide private rented housing. Syndicates put together packages of BES developments and sold them to individual tax payers, who received relief on up to £40,000 at their marginal tax rate.

The new Community Investment Tax Credit scheme will give tax credits of 25% of the costs of investment in approved community development institutions over five years.