Latest / The Fiscal Policy Podcast with Fexingo: Government Budgets, Stimulus, and Public Spending / How Subsidies Distort Real Estate Markets
Transcript
- Lucas: Look, if you live in a major city like Boston or Seattle, you know the drill. You see these gleaming new luxury towers going up next to older, less maintained buildings, and you wonder where the actual affordable units are supposed to be. The government spends billions every year on subsidies to create them, yet rent keeps climbing. It feels like we are pouring water into a bucket with a hole in the bottom. Luna: Right, and the weird part is that many of these programs are designed to boost demand, not supply. So when you give people vouchers or tax breaks to buy or rent, you just push prices up further because there are no new homes to absorb that extra money. Lucas: Exactly. That is the classic economic trap. Let us look at the Low Income Housing Tax Credit program, which is the primary driver of affordable housing construction in the United States. Developers get tax credits for building units set aside for lower-income tenants, but the math has shifted. Over the last decade, the cost of materials and labor has skyrocketed, meaning those same credits now fund fewer units than they used to. Luna: So the subsidy stays the same, but the purchasing power drops? That sounds like inflation eating away at the policy's effectiveness. Lucas: Precisely. And it gets worse. Because developers are competing for the same pool of tax credit investors, they have to offer higher returns to attract capital. To make those numbers work, they raise rents on the non-subsidized units within the same building, or they charge higher fees for amenities. So even the people who aren't getting the direct subsidy end up paying more. Luna: That is a fascinating ripple effect. I remember reading about a project in Austin where the subsidized units were actually cheaper than the market rate below them, but only because the rest of the building was priced so high to cross-subsidize. It creates this weird internal hierarchy. Lucas: It does. And that leads to another issue: the geographic clustering of these projects. Because land is expensive everywhere, developers tend to build these subsidized complexes in areas where land is still relatively cheap, which are often already struggling neighborhoods. This concentrates poverty rather than dispersing opportunity, which defeats the social goal of integration. Luna: So you are essentially using public funds to reinforce existing segregation patterns instead of breaking them down? Lucas: In many cases, yes. There is also the problem of 'displacement creep.' When a subsidized development goes up, it signals to investors that an area is 'up and coming.' Landlords nearby feel emboldened to raise rents, knowing that some residents have stable, subsidized housing and won't leave immediately. But everyone else? They get priced out before the new units even open. Luna: It’s almost like the subsidy acts as a signal flare for speculation. Smart observation. Lucas: Let me take a quick second here. If walking through the economy with us has made something click, or if you appreciate the deep dives into how policy shapes your daily life, consider supporting the show directly. A couple of dollars a month is genuinely what keeps these going — buy me a coffee dot com slash fexingo. It helps us keep the lights on and the research thorough, ad-free. Thanks for keeping the network alive. Luna: Yeah, it really does add up. And speaking of things adding up, let’s get back to the displacement creep because that seems counterintuitive to the goal of helping communities stabilize. Lucas: It is counterintuitive, but it is also rational behavior for landlords. When you inject capital into a neighborhood, property values rise. Even if the subsidized units themselves are protected by long-term contracts, the surrounding market reacts. We saw this clearly in Portland, Oregon, during the mid-two-thousands. New developments led to a fifteen percent increase in nearby rents within three years. Luna: Fifteen percent is huge for someone earning minimum wage. Did any local governments try to cap those nearby increases? Lucas: Some tried, but they ran into legal hurdles. Property rights and fair housing laws make it very difficult to regulate rent increases based on proximity to other buildings. So the market self-corrects upward, leaving low-income renters behind. It is a structural failure, not just a temporary blip. Luna: So the tool itself is flawed because it ignores the broader market dynamics. Is there any model that works better? Lucas: There is one approach that has shown promise: inclusionary zoning combined with direct land acquisition. Instead of just giving tax breaks to private developers, the government buys the land outright and controls the development process. This removes the profit motive from the land cost, which is often thirty percent of the total project expense. Luna: That sounds expensive upfront, though. Does the long-term savings justify the initial outlay? Lucas: Over twenty or thirty years, yes. You avoid the endless cycle of subsidies. Once the building is paid off, the rents stay low because the land cost was zero. Compare that to the tax credit model, where you need fresh subsidies every time the tax credits expire or need to be refinanced. It is a one-time hit versus a recurring drain. Luna: So it shifts the burden from annual budget lines to capital expenditures. That makes sense for fiscal planning, even if it requires political courage to spend big upfront. Lucas: Exactly. Political courage is the missing ingredient. Most politicians prefer the ribbon-cutting ceremony of a new building over the unglamorous work of acquiring land and managing construction. Plus, there is the NIMBY factor. Even when the government wants to build, local opposition can stall projects for years. Luna: I bet. People hate change in their neighborhoods, even if it is necessary. How do you overcome that inertia? Lucas: By changing the zoning laws first. Cities like Minneapolis and Tokyo have shown that allowing denser construction by right—without needing special permits—can significantly increase supply. When you remove the bureaucratic bottlenecks, developers can build smaller, cheaper units that don't rely heavily on subsidies. Luna: So deregulation is actually pro-affordability here? That flips the usual narrative on its head. Lucas: It does. The narrative usually assumes that more regulation protects consumers, but in housing, regulation often protects incumbent owners by restricting supply. When you allow duplexes or small apartment buildings in residential zones, you unlock hidden capacity. It is about letting the market breathe, not strangling it with red tape. Luna: Interesting. So the solution isn't necessarily more money, but less friction. That is a simpler message to sell to voters. Lucas: Simpler, but not easier. You have to convince homeowners that their property values might not skyrocket if neighbors move in. It requires a shift in mindset from scarcity to abundance. Most people operate on a zero-sum view of housing, thinking that if someone else gets a home, theirs becomes less valuable. Economics tells us otherwise. Luna: Right, because housing is a use good, not just an investment asset. More supply stabilizes prices for everyone eventually. Lucas: Yes, but the transition period is painful. If you suddenly double the housing stock in a city, rents might drop temporarily, causing panic among investors. Policymakers need to manage that expectation. They need to communicate that stability is the goal, not a crash. Luna: Communication is half the battle. If people think their wealth is disappearing, they will fight it tooth and nail. How do you frame the benefit for the average homeowner? Lucas: You focus on community vitality. Empty storefronts, declining schools, and isolated neighborhoods hurt everyone. A diverse population brings workers, customers, and energy. It is about building a resilient city, not just protecting a balance sheet. When you frame it that way, it becomes less about housing and more about civic health. Luna: That is a much stronger argument. It connects the dots between policy and daily life in a way that resonates emotionally, not just financially. Lucas: It does. And it reminds us that economics is ultimately about people. Numbers matter, but they represent lives. If our policies fail to account for human behavior and community needs, they will always fall short, no matter how elegant the spreadsheet looks. Luna: So the next time you see a new development permit approved, maybe ask yourself if it’s solving the root cause or just treating the symptom. Lucas: Definitely. And if you are curious about how other industries handle similar supply-demand mismatches, we might want to dig into the energy sector next week. The parallels are striking. Luna: I would love that. Power grids and housing markets both suffer from massive infrastructure lag. See how that plays out. Lucas: Agreed. It is a complex web, but untangling it starts with asking the right questions about where the money actually goes.