Taxing solutions: Rethinking policy to stimulate housing construction

The centerpiece of economics is the concept of supply and demand. Simply stated, if the quantity demanded exceeds the quantity supplied for some good or service, the price of that good will rise; and vice versa. In a well-functioning market, that price adjustment process will continue until the quantities supplied and demanded come into balance – an equilibrium price in the language of economists.

We can readily see this process at work in the real world when we observe actively traded financial markets.  Consider the stock market, for example.  In this market, bids and offers are publicly disseminated – the bid being the highest price prospective buyers are willing to pay and the offer being the lowest price sellers are willing to receive. 

While the difference between the best bid and the best offer for stocks may be pennies, for the sake of an example assume the best bid is $50 and the best offer is $51 – i.e., the highest price any buyer is willing to pay is $50, and the lowest price a willing seller will accept is $51.  Under these conditions, no transactions will occur unless or until some buyer was willing to pay at least $51 or some seller is willing to accept $50 or less.  Moreover, the price would only rise above $51 if all the willingness to sell at $51 were exhausted; and similarly, the price wouldn’t fall below $50 unless all the buyers willing to pay as much as $50 were satisfied. Sellers needing or wanting to sell more would have to lower their offer price. Put another way, it’s the persistence of excess supply or excess demand that forces prices to continue to move in one direction or another.

When we move away from financial markets, it gets a little trickier. Consider housing.  The fact that housing units are idiosyncratic and aren’t transportable creates the first complication. The market for housing in NYC is wholly distinct from the market for housing, say, in a rural community in Nebraska.  Beyond that, in the market for housing, the concepts of stocks and flows are critical. The stock of housing is the count of existing housing units at any point in time; the flow of housing is the amount of new construction that gets added to the housing stock over some interval of time – i.e., during the month or quarter – less any existing housing that gets destroyed. 

When we think how the price of housing is determined, we don’t have anywhere near the immediacy of intention and transactions that we have in financial markets.  Supply still reflects the number of units that sellers are willing to deliver to buyers over a range of prices, but within a time frame of, say, a couple of months. These housing units may be existing structures or new construction – i.e., some mix of the existing stock and flows of new housing.  Similarly, demand reflects the number of units desired for purchase within the next couple of months; and generally, these demands may be largely indifferent between units from the existing stock or from those that are newly constructed.

Another feature of the housing market is that many market participants function on both the supply side and the demand side of the market. That is, they want to sell their current house, while at the same time seeking to buy a different house.  This duality offers no real information about how housing prices are likely to move in the future.  In retrospect, however, the fact that home prices have appreciated as dramatically as they have in recent years in many markets strongly suggests that we’ve been experiencing an extended period characterized by excess demand.  Since the end of the great recession (July 2009), the average price of home sales in the US. rose 83 percent through July of 2024, while consumer prices rose by about 46 percent.

It appears that the affordability crisis has been due in large part to a sharp reduction in new construction over the last decade and a half, relative to what we were building before the great recession. By way of comparison, between 2000 and 2007, the average annual pace of housing starts was about 1.7 million single- and multi-family units, combined.  We’ve yet to get back to volumes even close to that. Since 2008, we’ve averaged fewer than 1.1 million units per year.  The reduction for construction of single-family units has been even more severe. Between 2000 and 2007, single-family starts averaged 1.4 units per year. Since then, they’ve averaged about half of that pace.   

In theory, the way to stimulate new home construction is to lower the barriers to entry for prospective builders. The market solution is to make the activity of building more profitable. One way of achieving this objective is through subsidies and tax preferences, but those involve a wealth transfer from the broad base of taxpayers to builders. The other approach requires a structural change that benefits builders by reducing building restrictions and regulations, ideally, without compromising concerns about safety.  This approach could only be expected to work, however, if those cost savings could be kept by the builders rather than being passed along to the buyers.  Unfortunately, I see both approaches as heavy lifts with significant resistance to implementation, suggesting that the problem of affordability isn’t likely to be solved any time soon.

The more I think about this problem, the more I come back to taxes.  I’m not in favor of granting subsidies to workers or owners in particular industries, whereby two people of comparable incomes end up paying different amounts of income taxes because one happens to operate in a favored industry and the other doesn’t. I think we can solve this problem by raising the level of the threshold of income at which taxes would be applied across the board. Obviously, such a change would reduce tax revenues, but that could be made up for by increasing the progressivity of our income tax structure at the upper end.  I would expect the prospect of substantially reduced taxes for lower- and middle-class households to unleash considerable entrepreneurial energy, where housing and myriad other industries would benefit.

Critically, this suggestion is a far cry from trickle-down economics, where the biggest tax breaks go to the wealthiest. Whatever entrepreneurial instincts those higher income households may have, they’re largely already in effect, such that the marginal effects of additional tax cuts directed toward that population would likely be minimal. Beyond unleashing this entrepreneurial energy by reducing the tax burden on lower- and middle-class households, lower taxes for this population will also enable more households to build wealth and escape the trap of living paycheck to paycheck – worthy objectives in their own right.  Remedying the dearth of affordable housing won’t happen quickly, but I’d expect that the kind of changes in the tax structure I’m suggesting would mitigate the problem over time, all the while making our tax system fairer in the process.