Constructing Better Property Taxes

To spur affordable housing, Mayor Bloomberg wants to reform the city's tax break for new residential buildings. But the mayor's proposed fixes would only further distort New York's already distorted property market, without lowering housing costs for average New Yorkers. The mayor would do better to push the state Legislature and the City Council to scrap the convoluted tax break altogether. The savings could then be used to cut taxes across the board on owners of apartment buildings, condos, and co-ops.

At issue is a tax-abatement law known as 421-a. The city and state designed 421-a more than three decades ago to address a complaint voiced by developers: As soon as they built on their lots, they faced massive tax increases due to the increased value of their property, even if it would take them years to recoup their investments.

So the city offered developers of rental buildings, co-ops, and condos a good deal: Build under certain rules, and you won't have to pay the higher taxes right away, as the city would phase them in gradually, over at least a decade. Co-op and condo builders could sell apartments built with the tax break at any price, but rental builders had to put their units into the city's rent-stabilization system over the life of the tax breaks.

More than a decade later, the city and state tinkered with the program in response to complaints that developers were using the tax break to erect mostly "luxury" housing in the city's most popular neighborhoods. The pols designed an "exclusionary zone," ending the tax break in mid-Manhattan (between 14th and 96th streets) unless developers there made up to one-fifth of their apartments "affordable" — that is, rented them at below-market rates. They could do so directly in their buildings or by subsidizing such development elsewhere in the city via payments to affordable housing developers.

More recently, Mayor Bloomberg has added areas of the Brooklyn waterfront to this "exclusionary zone." (The mayor also defines "affordability" so broadly that under his "New Housing Marketplace" plan, 92% of New York families are theoretically eligible for officially affordable housing.)

But since Gotham's real-estate market began to take off over the past decade and a half, housing activists have branded the 421-a program a failure. The evidence? Builders have received hundreds of millions of dollars in tax breaks without building much below-market housing. In fact, the program, which costs the city $400 million annually in forgone taxes, has awarded breaks to more than 100,000 housing units. But only 8% are "affordable," according to a 2003 study by the city's Independent Budget Office.

So the mayor convened a task force to propose some fixes, which the group unveiled recently. Among the fixes is a plan to expand the "exclusionary zone" to fast-growing neighborhoods like Harlem and Lower Manhattan as well as to Brooklyn's DUMBO, forcing developers there to build some affordable housing to get the break.

The mayor also would award the longest exemptions only to developers that provide affordable housing, force developers to build much of their below-market housing in their new buildings rather than subsidize such development elsewhere, and cap a market-rate building's exemption at $100,000 per unit unless the developer provides affordable housing.

But these fixes miss the mark. Why? They're designed to encourage a comparatively few more units of officially affordable housing, instead of addressing the real problem: Without tax breaks like 421-a, people who own or live in apartment buildings must pay higher taxes than those who live in stand-alone homes (mostly in the boroughs).

Consider: although the tax rates on apartment buildings and private homes don't differ much — 15.7% for the former vs. 12.4% for the latter — taxes on large buildings are distorted because the tax rate applies to a full 45% of a building's value, while it only applies to 6% of the value of a single-, two-, or three-family home.

The taxes on a market-rate condo can be up to six times higher than on a private home of the same value. In condos, co-ops, and market-rate rental units without special tax breaks, residents must bear these costs. In regulated units, landlords bear them (although New York's rentregulation system depresses the taxable value of many apartment buildings, anyway).

Further, the mayor's fixes would push up costs for market-rate renters and buyers even further by forcing them to subsidize more affordable housing for owners' tax breaks. But even if tying tax breaks more tightly to such housing encourages 10 times more subsidized housing than it's encouraged in the past, 97% of New Yorkers would never be lucky enough to land such an apartment, because the demand for subsidized apartments is so high. This is the definition of an inefficient tax break: higher costs for more people to fund lower costs for a select few.

The mayor should just work with the Legislature and the City Council to end these kinds of complicated special tax breaks altogether, and replace them with an across-the-board tax cut for apartment buildings, with tax bills on brandnew construction phasing in gradually after a building is completed so as not to discourage new construction.

Lower, simpler taxes would encourage developers to add more supply, including in less sexy areas of outer boroughs — and more supply would encourage more rational prices for everyone.

Ms. Gelinas is a Chartered Financial Analyst and a senior fellow at the Manhattan Institute.