There is a peculiar logic at work in American affordable housing policy. The federal government's largest affordable housing program — the Low-Income Housing Tax Credit (LIHTC), created under the Tax Reform Act of 1986 — now costs taxpayers approximately $13.5 billion annually in forgone federal revenue. Since its inception, it has subsidized the construction of roughly 3.65 million housing units. It accounts for an estimated 90 percent of all newly created affordable rental housing in the United States. And yet, in California — the state with perhaps the most acute housing affordability crisis in the nation — the average inflation-adjusted cost to build a single LIHTC unit rose from $411,000 in 2008 to $480,000 by 2019, with per-square-foot costs climbing 55 percent to $700 over that same period. These are not market-rate luxury apartments. These are the units the government is subsidizing to house low-income families.
The numbers deserve to be read slowly, because they collapse the central promise of the program. Milton Friedman observed that the first lesson of economics is the recognition of trade-offs — that every benefit has a cost, and every dollar spent on one thing is a dollar not spent on another. LIHTC does not lower the cost of housing. It reallocates who bears that cost — and in doing so, generates extraordinary waste at every stage of the transaction.
How LIHTC Works: A Chain of Intermediaries
The mechanics of LIHTC are byzantine by design. The Internal Revenue Service allocates tax credits to state Housing Finance Agencies, which then award them competitively to private developers. Developers, however, rarely use these credits themselves — they have no tax liability large enough to absorb them. Instead, as the Cato Institute's 2025 congressional testimony on LIHTC describes, developers sell the credits to syndicators — specialist intermediary firms that pool the credits and market them to large corporate investors (banks, insurance companies) who can use the credits to reduce their federal tax bills. Each link in this chain extracts a fee. Each party must be compensated for its participation. By the time a tax credit is converted into actual construction dollars, a substantial portion of its face value has been absorbed in transaction costs and intermediary profits.
The Congressional Budget Office identified this structural problem directly: overhead and administrative costs are substantially greater for a housing unit subsidized with tax credits than for one subsidized with a direct rental voucher. The subsidy mechanism that Congress chose for LIHTC was not selected for efficiency — it was selected because it routes benefits through the private sector in a form that appears less like government spending, even though the fiscal cost is identical to an outright appropriation.
The Cost Problem: Building "Affordable" Units at a Premium
LIHTC's cost problem is not incidental — it is structural. Research cited by the Tax Foundation found that LIHTC developers produce housing units that are an estimated 20 percent more expensive per square foot than average industry estimates for comparable construction. In a market transaction, cost discipline is enforced by the buyer's ability to walk away. In the LIHTC model, the "buyer" is a regulatory agency applying compliance checklists, and the developer's actual revenue comes not from efficiently producing housing but from navigating the allocation process successfully.
The National Low Income Housing Coalition's summary of Terner Center research puts the California numbers in stark relief: between 2008 and 2019, the average inflation-adjusted per-unit cost of 9% LIHTC new construction increased from $411,000 to $480,000 — a 17% real increase at a time when private-market multifamily construction had begun incorporating significant efficiency improvements. The cost per square foot rose 55%, from $451 to $700. These are not figures from a competitive market. They are the output of a heavily regulated, compliance-driven financing system in which no party faces a direct incentive to minimize cost.
Prevailing Wages: Government Mandates Compounding Government Costs
Layered atop LIHTC's inherent structural inefficiency is the Davis-Bacon prevailing wage requirement, which applies to most federally assisted construction. A 2024 study by the UC Berkeley Terner Center quantified the impact specifically for LIHTC projects in California. Prevailing wages in California are approximately 1.5 times market-rate wages in Los Angeles and San Diego, and 2.2 times market wages in San Francisco. For a program ostensibly designed to make housing cheaper, these mandates function as an anti-efficiency tax — applied not to luxury developments, but specifically to the subsidized housing stock that is supposed to reach the lowest-income households.
Thomas Sowell's framework is directly applicable here. The question is not whether construction workers deserve fair wages — they do, and competitive markets deliver them. The question is whether mandating above-market wages on subsidized projects serves the interests of the low-income families the program was designed to house, or whether it serves a different constituency entirely. When the added labor cost reduces the number of units that can be built within a fixed subsidy budget, the answer is unambiguous: the mandate taxes the program's intended beneficiaries to subsidize a different group.
Layered Financing: Complexity as a Cost Driver
Because the LIHTC subsidy alone is often insufficient to make projects financially feasible — especially in high-cost states — developers must stack multiple public funding sources on top of the federal credit. Research from the UC Berkeley Terner Center's 2025 analysis of California LIHTC projects found that each additional public funding source adds, on average, four months to the construction timeline and approximately $20,460 in per-unit total development costs. A California project drawing on six or seven funding sources — a common scenario in high-cost markets — may spend two to three additional years in pre-development before breaking ground, while accumulating six-figure overhead costs that the final tenant never sees but always pays for in the form of restricted supply.
Friedrich Hayek's insight about the knowledge problem is precisely applicable to this layered financing architecture. No central planner can coordinate the incentives, timelines, and requirements of six overlapping government agencies without generating friction, delay, and waste. The market alternative — competitive private development responding to price signals — does not require a funding stack at all. It requires only that the regulatory barriers to building be removed.
Who Actually Captures the Subsidy?
The most damning critique of LIHTC is not that it is expensive. It is that the tenants it purports to serve capture only a fraction of the subsidy. Research reviewed in the Cato Institute's congressional testimony found that occupants of tax credit projects capture a small fraction of the subsidies provided to developers — with developers, syndicators, and investors absorbing a disproportionate share. A study by Gregory Burge found that housing vouchers create more benefits to renters at a lower budget cost than the LIHTC. The Congressional Budget Office independently reached the same conclusion. The President's Economic Recovery Advisory Board, in a 2010 assessment, noted that "some experts believe that vouchers would more cost-effectively help low-income households" than tax credits.
This is not a minor efficiency quibble. It goes to the heart of whether LIHTC is, as it claims, a housing program — or whether it is more accurately described as a developer and investor subsidy that incidentally produces some below-market-rate units as a side effect.
The Market Alternative
The strongest argument against LIHTC is not that we should do nothing about housing affordability. It is that we are doing the wrong things with large sums of money, and that a different approach — one grounded in supply deregulation rather than subsidy engineering — would produce better outcomes at lower cost.
As the Cato Institute's analysis concludes: the way forward should be deregulation, innovation, and lower costs — not more subsidies, higher costs, and central planning through tax-credit programs. The evidence is by now substantial that exclusionary zoning, regulatory compliance burdens, and government-imposed construction cost mandates are the primary drivers of housing unaffordability. A federal government serious about housing affordability would attack those constraints directly, rather than spending $13.5 billion annually to partially offset the costs its own regulations impose.
Friedman understood this dynamic clearly: a government that creates a problem and then subsidizes partial solutions to that problem is not solving anything. It is building a constituency for its own interventions. The LIHTC program has now been operational for four decades. The National Low Income Housing Coalition's 2024 Gap Report documents a shortage of 7.3 million affordable rental homes for the nation's lowest-income renters — a deficit that has grown, not shrunk, since the program launched. The honest accounting begins there.
