Why Zoning Reform Alone Won't Solve the Housing Crisis — and What Will

A Crisis Decades in the Making

Much of the Western world is facing a persistent housing crisis marked by historically high housing cost inflation. The portion of income the median American puts towards rent has risen rapidly in tandem with soaring home ownership costs. This has quelled the old dream of property ownership for the younger generations. However, the housing crisis is unsurprising given the slow growth of the country's housing stock.

Since 2000, housing demand in the United States has grown 26% versus a 19% increase in housing stock (U.S. Treasury). The situation is even more pressing in cities. For example, New York's housing stock grew nearly half as quickly as population over the past decade. Housing takes time to build. Every year this shortfall persists means that the crisis will be harder, and slower, to rectify, spurring long-term pressure on rents. In all then, this persistently slow housing supply growth is a major contributor to the housing crisis.

Zoning Reform Is Necessary — But Not Sufficient

Nonetheless, policymakers have been slow to implement pro-housing policies. While the fight for zoning reform is a powerful step, it remains a solution focused on issues most prominent in the United States and Canada. In contrast, many European cities typically permit greater baseline density than most American cities and yet they are still enthralled by housing shortages.

The movement for zoning reform seeks to raise the cap on how many units of housing developers can build. In doing so, it focuses primarily on legal permissions to build. We should complement this approach by understanding developers' incentives. Their decisions on whether and how much to build are economic ones shaped by a multitude of factors feeding into the question—"what must I build to maximize profits?"

Zoning limitations put a hard upper bound on any proposed answer to this question. Developers may want to answer with a medium-density housing development but may instead be forced to build a single-family property. However, zoning constraints are not uniformly binding, and we cannot say that their absence alone would spur the volume of development necessary for broad affordability. Some developers already operate below existing zoning limitations, meaning their construction decisions would not necessarily be affected by looser zoning. As such, zoning reform should be seen as a powerful policy tool, but not as the be-all and end-all. Instead, zoning reform should be complemented by reasonable policies which push developers to more fully utilize the new opportunities that it unlocks.

Land Value Tax: The Missing Piece of the Puzzle

Ensuring the efficient use of these new opportunities means ensuring efficient land use. Governments, whether consciously or not, broadly shape incentives via taxation. The current property tax regime is no exception. It dampens developers' incentives to build, inhibits density, and is partially passed on to renters, particularly in supply-constrained housing markets. However, an alternative taxation regime exists which avoids these issues. A Land Value Tax incentivizes developers to build more, and more efficiently. It is best to view in contrast with the current property tax regime.

Property taxes charge a percent of the property value to their owners every tax year. This has two main negative effects on housing affordability. One, it complicates developers' decisions to build larger properties. The more income an asset bears, the more it is worth and the higher its consequent tax liability. As such, their incentive to build is dampened at the margin, lowering the amount of housing provided. Two, despite their legal responsibility to pay property taxes, landlords can pass some of the tax onto renters in the form of higher rent. Indeed, a recent study from the Leibniz Center for European Economic Research found that the poorest households are affected the most by these effects. Land value taxes manage to avoid both issues. It only taxes the value of the land that a property rests upon. Since land cannot be created or destroyed, it taxes a completely inelastic good. Consequently, land taxes do not lower how much housing can be built in the way property taxes do, and their incidence is borne largely by landlords rather than renters, especially in supply constrained markets.

However, beyond unleashing incentives and lowering rents, land value taxes have further benefits on housing supply. Taxing the value of the land a property rests upon means that there is always a liability, even when derelict properties rest upon a plot, derived from how in demand that land is. This acts as a tax on vacancies, disincentivizing the abandoned and unproductive plots that often scar the centers of post-industrial cities, and promoting their revitalization. Furthermore, the tax places further unique incentives upon developers. By charging tax based on land's value (which must be paid irrespective of what they build), developers are pushed to intensify land use. They subsequently want to create as many commercial and rental units as possible to recover this fee quickly, since profits are only pocketed in excess of it. Thus, developers face strong incentives to intensely use scarce, high value urban land.

As outlined, a land value tax acts as a great complement to our broader effort towards zoning reform. Zoning reform seeks to raise the ceiling constraining development. Meanwhile, a land value tax seeks to raise the floor of development incentives. The full benefits of one cannot be felt without the other.

This distinction is vital for cities amidst a housing crisis. Zoning reform changes what is legally possible, and land value taxes change what is economically rational. Together, they permit municipalities to encourage development without micromanagement, while improving local finances.

Lessons from Pennsylvania: When Land Value Tax Actually Worked

We must look to the past to analyze what Land Value Taxes can and cannot achieve at the municipal level. Many cities in Pennsylvania adopted a kind of land value taxation (split-rate taxation) throughout much of the 20th century. A 2023 Federal Reserve review noted their effect. As the steel industry suddenly moved out of a collection of cities in western Pennsylvania, one of these cities, McKeesport, adopted a split-rate taxation system. McKeesport experienced a statistically significant 36% increase in building permits in contrast to comparable neighboring cities without a land value tax which experienced a 30% and 14% decrease in permitting. This was not just limited to housing, demonstrating a large increase in commercial permits as well. Further studies broadly agree with these results, finding that Land Value Taxes may increase density and units built yearly, and decrease urban sprawl (Banzhaf & Lavery, 2010).

The Challenges Are Administrative, Not Theoretical

Nonetheless, the cities of western Pennsylvania eventually abandoned this system. The Federal Reserve's analysis noted that this resulted from blowback on land revaluations as well as their general difficulty. However, these are not insurmountable issues. These failures reflected administrative challenges, not policy effectiveness. Denmark has sustained a Land Value Taxation regime for over 100 years, in doing so demonstrating that these administrative challenges and potential political setbacks are not insurmountable with quality design such as predictable revaluations and gradual phase-ins.

Raising the Ceiling and the Floor

The housing crisis is a complex issue with a plethora of underlying causes. It will not be reversed by a single reform. Zoning reform is rightly central to the current YIMBY movement, but it should not be isolated. Rather, it should be paired with reforms which push developers to fully use the opportunities endowed by zoning reforms.

Land value taxes are designed to do exactly that. As such, they are an ideal complement to zoning reform. They discourage vacancies, push valuable urban land to be used more efficiently, and create a sizable and stable source of revenue for municipalities in the process. In all, they align private incentives with public needs.

Cities cannot wait for the housing crisis to resolve itself. The issue of affordability is far too prescient for a hands-off approach. Zoning reform expands the options available to developers, and land value taxation changes their payoff structures. Together, these policies would allow cities to actively shape how scarce urban land is used. In doing so, they would both strengthen their finances and finally begin to tackle the housing crisis.