Government and the Cost of Living: Income-Based vs. Cost-Based Approaches to Alleviating Poverty

by Ryan Bourne, CATO Institute, September 4, 2018 (excerpt)

…The single largest expenditure for most families is shelter (rent or the cost of owner-occupied housing). It makes up 25.2 percent of total spending for the average household in the poorest quintile, and 21.8 percent for the average single-parent household. Since the poorest quintile includes many older and poorer households with low incomes, spending as a proportion of income is higher still. The Pew Foundation estimates households in the bottom third of the income distribution spent 40 percent of their income on housing in 2014, while renters spent nearly half.25

The United States has relatively cheaper housing overall than other major developed English-speaking countries. But prices and rents are extraordinarily high in certain metropolitan areas. Demographia’s median multiple index (median house price divided by median income) is over 9 in Los Angeles and San Francisco, and just below 6 for Seattle and New York (see Table 2).26 Thirty overall housing markets and 13 major metropolitan markets are defined as “severely unaffordable,” meaning they have median multiples of 5.1 or over. But even these are quite broad markets, including suburban areas on the outskirts of cities. The online housing marketplace Zumper estimates that the median one-bedroom rental price in March 2018 was $3,400 per month in San Francisco; $2,900 in New York; $2,450 in San Jose; $2,300 in Boston; and $2,220 in Washington, D.C.27

Table 2: Severely unaffordable housing markets

Source: Demographia.com, 14th Annual Demographia International Housing Affordability Survey, 2018, January 22, 2018.
Note: The median multiple is the result of dividing median house price by median household income.

High housing costs have major consequences for the poor, both in direct financial terms and, indirectly, in terms of labor mobility and job match. They encourage families to live in smaller apartments and condominiums, to commute greater distances to jobs, and can even act as a prohibitive financial barrier to taking up employment opportunities in certain cities.

Regulatory restraints at the local-government level have a significant effect on housing affordability. Land-use planning and zoning laws — including urban growth boundaries, minimum lot sizes, density and height restrictions, and design requirements — raise the costs associated with providing new housing, restricting the potential supply and making it less responsive to changes in demand. The result of the latter is structurally higher prices as incomes rise and the population grows.

Because of the vast, complex, and differentiated nature of regulations across the country, it is difficult to measure and compare the permissiveness toward development across regions, but economists have used two techniques to measure the effects of regulations.

Some estimate an implied “regulatory tax” as the deviation between new house prices and marginal building costs. Using this method, Ed Glaeser, Joseph Gyourko, and Raven Saks estimated that Manhattan condominium prices were 50 percent higher in the early 2000s than under a free development regime.28 For single-family homes across the country, their estimates show regulatory costs much higher in some areas than others — being indistinguishable from zero in cities such as Baltimore and Houston, but as high as 53 percent in the San Francisco Bay Area, 34 percent in Los Angeles, 22 percent in Washington, D.C., and 19 percent in Boston. Work by the Cato Institute’s Vanessa Brown Calder has subsequently found that regulatory burdens have intensified in many areas since the Glaeser et al. article appeared. We would therefore expect these implied regulatory taxes to be higher in many cities today.29

Other economists estimate the effect of land-use regulations on prices and rents econometrically. Results from these studies, again, consistently suggest that tighter regulatory constraints drive higher housing costs. A 1996 paper by Stephen Malpezzi examining metropolitan markets found that increasing regulation by one standard deviation from average lowered construction by 11 percent and raised house prices by 22 percent.30 A more recent assessment found that a similar one-standard-deviation increase reduced construction by a larger 17 percent, with twice the upward effect — 34 percent — on housing prices.31 A study of cities in Florida also found that restricting growth through farm preservation and open-space zoning made housing more expensive, with the most pronounced effects on the price of smaller houses.32

Anti-development regulations have regressive effects. Poorer households are more likely to rent (61 percent of households in the bottom quintile and 66 percent of single-parent households rent, compared with just 38 percent for the population as a whole). An increase in housing costs has unambiguously negative consequences for renters. Poor households also tend to spend relatively more on housing, are more likely to value lower housing costs over improved amenities, and are more susceptible to being locked out of rich, productive cities and the economic opportunities they bring. This can have a big macroeconomic impact. Chang-Tai Hsieh and Enrico Moretti estimate that lowering the level of housing regulation to the median level across all U.S. cities for New York, San Francisco, and San Jose alone would raise long-term U.S. GDP by nearly 9 percent.33

The negative consequences of land-use and zoning laws can also result in policies that exacerbate these regressive effects further. Local rent control laws, for example, are notionally justified as attempts to keep rents affordable, but binding controls deter investment in the rentable stock and encourage existing landlords to convert units to noncontrolled tenure types or to be more discerning about tenants. A recent study on the expansion of rent control in San Francisco in 1994 shows how this hurts the poor.34Landlords converted some properties to owner-occupied apartments and condos better suited to higher-income families. The overall supply of new housing fell too, increasing market rents by over 5 percent. Rent control both increased the cost of rental accommodation and intensified gentrification.

Federal taxpayers foot the bill for these mistakes, with relatively more housing aid flowing to states with restrictive zoning and land-use rules.35 Treating the symptoms in this way helps entrench unnecessarily restrictive regulations. Subsidies ease the pressure on local governments to address the cause of high housing costs.

How much do existing regulations raise house prices or rents for households in the poorest 20 percent of the income distribution? It depends on where they live. Residents in many rural areas face no real housing cost increases. But estimates of regulatory taxes for major metropolitan areas by Glaeser et al. imply that average annual housing costs in New York are $2,060 more than in a competitive housing market; $3,200 in Boston; $5,230 in Los Angeles; $3,939 in D.C.; and a whopping $11,500 in San Francisco.36

Some degree of regulatory tax in major cities might be appropriate given the externalities associated with new building, not least congestion. In cities such as San Francisco, the income distribution is very different from the national average too, meaning that there are fewer poor people residing in the city who would benefit directly from liberalization (though this is partly the result of high housing costs).37 On the flip side, the Glaeser et al. estimates apply to the housing markets of nearly 20 years ago; since then the regulatory burden has intensified. New York as a whole has an income distribution similar to the overall U.S. population. Even using Glaeser’s older regulatory tax estimate implies that the poorest 20 percent there currently pay $1,044 per year more for shelter than they would under a permissive development regime.38 These calculations would be much higher still for several cities in California.

Calculating an average effect for poor households across the country is difficult. Salim Furth has estimated that the average household’s annual housing costs increase by $1,700 as a result of land-use regulation. This implies housing costs for the poorest fifth are about $1,000 higher than they need be annually, given relative differences in spending on shelter. A similar result arises using Calder’s alternative measure of land-use regulation. Making the assumption that those states with above-average regulatory burdens were able to reduce these to the average of the rest of the country implies annual savings of $1,075 per year for poor households. But given that poorer households are more likely to live in rural areas, those figures may somewhat overestimate the effect.

Nevertheless, the direct cost of land-use planning and zoning regulations on low-income households could reasonably be anywhere between $0 and around $2,000 per year in the long term, depending on location. The broader economic costs are much greater still, given the secondary effect of poorer families finding it more difficult to move to areas with high-paying jobs. For single-parent households the range would be even wider, with regulatory costs up to around $3,500 or more for wealthier single-parent households in California’s most restrictive cities. Land-use and zoning liberalization could, in the long term, reduce housing costs significantly and greatly increase economic opportunities….

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