By Benjamin Powell and Edward Stringham
Categories: Economic Regulation Government Policy The Economics of Special Markets The Marketplace
By Benjamin Powell and Edward Stringham,
he average U.S. consumer now enjoys a larger and higher-quality home than ever before. In 2001, the average home was 1,693 square feet, while in 1960 it was less than 1,200 square feet. In 2001, 58 percent of homes had three or more bedrooms, and 57 percent had 1.5 or more bathrooms. Compare that with 1970, when fewer than half of homes had three or more bedrooms and only 30 percent had 1.5 or more bathrooms. Housing amenities have also improved. In 2001, 76 percent of homes had a washing machine, 73 percent had a dryer, 56 percent had a dishwasher, and 44 percent had a kitchen sink garbage disposal; 58 percent of homes had a garage, and 80 percent had an outdoor deck or patio. In 2001, 82 percent of homes had some form of air-conditioning and 55 percent had central air; in 1970, only 36 percent of homes had airconditioning and 11 percent had central air. Housing has improved almost across the board. Now, 98.7 percent of homes have complete plumbing that includes sinks, hot water, and flush toilets compared with 93.5 percent thirty years ago. The improvement has been especially dramatic for low-income households. University of California at Berkeley professors Quigley and Raphael (2003) report that the percentage of homes occupied by the poorest onefifth of income earners that have incomplete plumbing declined from 40 percent in 1963 to essentially zero today.
While the size and quality of homes have increased, so have prices. Between 1970 and 2001, the median price of owner-occupied housing rose from $78,051 to $123,887 (in 2001 dollars), leading a number of groups to declare a national affordability crisis. But despite noticeable price increases, housing is not necessarily unaffordable. The U.S. Census’s 2001 American Housing Survey estimates the cost of owning the median home at $725 per month. If 30 percent of income is spent on housing, any household earning $29,000 per year can purchase the median home. Median household income in the United States is much higher, at $41,994, and so spending $8,700 per year on the median home is well within reach. Although a nationwide affordability crisis does not exist, the numbers in certain regions are less rosy. In many areas of California and the Northeast, for example, housing is much more expensive than in the rest of the United States.
Most commentators attribute the elevated prices to high demand for scarce land. A number of economists, however, point to another explanation. High prices may not be due to intrinsically valuable land but, instead, to housing regulations such as restrictions on density, height, and design; building fees; slow approval processes; restrictions on growth; and preservation laws. One way of measuring whether high prices are due to regulations or high demand for land is to look at how much increased lot size increases the value of a home. If land scarcity drives housing prices, doubling the lot size would increase the difference between construction costs and home value by 100 percent. But Edward Glaser and Joseph Gyourko (2002) found that consumers in most cities value homes on twenty-thousand-square-foot lots by only ten to twenty thousand dollars more than they do equivalent homes on ten-thousand-square-foot lots.
This indicates that intrinsically valuable land is not the main cause of high prices. Economists who have studied the issue conclude that the scarcest input for housing is government permission to build. Econometric estimates indicate that only 10 percent of the gap between construction costs and home prices is caused by intrinsically high land prices; the other 90 percent is caused by zoning and land-use regulations. Glaser and Gyourko conclude that “land-use regulation is responsible for high housing costs where they exist” (p. 30). Another study reached the same conclusion using a different methodology. Stephen Malpezzi (1996) constructed an index of seven different land-use regulatory variables and ranked fifty-six different metropolitan areas according to how strictly land use was regulated. Regulatory variables included measures such as changes in length of approval time, time required to get land rezoned, amount of acreage zoned for residential development, and percentage of zoning changes approved. Malpezzi found that a change from a lightly regulated environment to a heavily regulated one increased home values by 51 percent and decreased the number of permits to build by 42 percent. Home ownership rates also declined by about ten percentage points. Regardless of methodology, evidence shows that areas with high levels of regulation have higher housing prices, higher rents, and lower home ownership rates.
Although no national affordable housing crisis exists, prices are quite high in some high-regulation jurisdictions. In Santa Clara County, California, for example, the median price of a newly constructed home in 2003 was more than $638,000. Assuming a family can spend 30 percent of its income on a mortgage, even with low 5 percent interest rates a family must earn more than $135,000 per year to afford the median-priced new home. If the above estimates are correct, regulations such as urban growth boundaries, moratoriums on building permits, environmental regulations, and other restrictions raise home prices as much as $300,000 in this county. Put another way, the portion of purchase price paid by residents of Santa Clara County due to regulation is almost enough to buy three complete homes of median value elsewhere in the United States.
In addition to land-use restrictions, governments drive up housing prices for lower-income families by dictating improvements in housing quality that the families might not otherwise choose. Governments do this by, for example, setting minimum lot sizes. Also, the federal government’s urban renewal program between 1949 and the early 1970s destroyed more than 600,000 low-income dwellings, replacing them with 250,000 homes that were mostly for middle- and upper-income buyers (O’Sullivan 1996). Martha Burt’s 1992 study found that urban renewal’s destruction of low-quality, low-cost residential hotel rooms in U.S. central cities contributed to the rise of homelessness.
Real federal outlays for housing have steadily increased since the early 1960s to reach their current level of approximately thirty billion dollars per year. Today, approximately 6 million renter households receive federal housing subsidies, and 1.5 million households live in public housing. But the public sector lacks a profit incentive, and government programs are highly inefficient. One study estimated that for every hundred dollars of government spending on housing production, housing worth only forty-three dollars to the residents is produced (Mayo 1986). Because residents of public housing do not own it—and, indeed, no one owns it—public housing usually deteriorates rapidly through poor upkeep, in many cases becoming uninhabitable within twenty years. Some of the worst effects of public housing have been on the very residents the housing was created to help. Public housing projects are often plagued by high crime, and are thus considered undesirable places to live. In contrast, private developers and landlords have an incentive to make sure customers are satisfied: they lose business otherwise.
Recognizing that government is not a particularly good landlord, many policymakers are looking for other “affordable” housing solutions. At the local level, inclusionary zoning is becoming increasingly popular. The word “inclusionary” actually refers to price controls on a percentage of new homes. Builders and subsequent owners are forced to price the homes so they are “affordable” to people at specific income levels. In Tiburon, California, for example, where the median price of existing homes exceeds $1 million, builders are required to sell 10 percent of new homes for $109,825 or less. Inclusionary zoning is most popular in California, Maryland, and New Jersey. A nationwide 1991 survey found that 9 percent of cities larger than 100,000 had inclusionary zoning, and the number is increasing rapidly. In 1990, roughly thirty jurisdictions in California had inclusionary zoning; the number had increased to more than one hundred by 2004.
Inclusionary zoning produces negative effects similar to those caused by other price controls. Price controls restrict the supply of new homes and actually make housing less affordable. Because builders are forced to sell a portion of a development at a loss, inclusionary zoning functions as a tax on new construction. Estimates of the level of the tax in California cities such as Portola Valley are above $200,000 per market-rate home. To maintain normal profit margins, builders end up passing the tax on to landowners and other home buyers. Elasticities of supply and demand determine exactly how the burden is split, but the result is almost certainly higher home prices.
Inclusionary zoning also leads to less construction. In the forty-five San Francisco Bay Area cities for which data are available, new construction fell by 31 percent in the year following the adoption of inclusionary zoning (Powell and Stringham 2004). In some cases, inclusionary zoning halts development completely. The experience of Watsonville, California, illustrates this effect. In 1990, Watsonville’s inclusionary zoning ordinance imposed price controls on 25 percent of new homes. Between 1990 and 1999, with the exception of a few small nonprofit developments, almost no new construction occurred. The law was finally revised in 1999 because, in the words of Watsonville Mayor Judy Doering-Nielsen, “There was an incredible pent-up demand. Our inclusionary housing ordinance was so onerous that developers wouldn’t come in.” Jan Davison, director of the city’s Redevelopment and Housing Department, commented that the inclusionary zoning law “was so stringent, and land costs were so high, that few units were produced,” but “[it] was completely redone in 2000, and we got more units produced” (Morgan 2003). Watsonville reduced the number of units under price controls from 25 percent of all developments to 15 percent on smaller developments and 20 percent on developments of fifty units or more. In the three years after easing requirements, the city’s housing stock increased by 12 percent.
In addition to restricting supply, inclusionary zoning produces a number of other undesirable effects. Price controls exacerbate shortages, decrease mobility, and are a poor way of helping those most in need. Because inclusionary zoning comes with restrictions on resale, it prevents equity appreciation and leads families to live in the homes longer than they would otherwise. This takes homes off the market and does not help other low-income families who are seeking to buy homes. Even if a family’s income has considerably increased, owners of price-controlled homes are less able to move because price controls prevent their homes from appreciating at market rates. These residents are stuck with an asset that they cannot fully cash out and cannot even pass on to their children unless those children also meet low-income guidelines. This creates an incentive for owners to evade the law and resell or sublet their units at market rates. Governments then must spend resources supervising the price controls.
Interestingly, even high-priced construction benefits all consumers. When a high-income household moves into a high-priced new home, it vacates its old home for someone else. That family, in turn, vacates its old residence, freeing it up for someone else. Economists call this process “filtering” because as new homes are built, the existing stock “filters down” to lower-income households. A classic study, New Homes and Poor People, looked at the chain of existing home sales in thirteen different cities and found that each new home generated an average of 3.5 moves. Even though new housing tends to be higher priced, low-income households make up to 14 percent of the moves generated by new housing. According to Malpezzi and Green (1996), “to the extent that a city makes it easy for any type of housing to be built, it will also enhance the available stock of low-cost housing” (p. 1811, italics added). When new construction is prevented or slowed, this process is stifled. Without new homes, high-income buyers bid up prices on existing homes, thus making all housing less affordable. A sure way to make housing more affordable is to reduce zoning regulations and other restrictions on new construction.
Despite the regulations, the U.S. housing market is quite resilient. Ninety-eight percent of Americans live in privately owned and constructed homes. The size and quality of these homes have increased substantially over the past few decades. Some cities, such as Houston, Texas, have gone without zoning, and some, such as Celebration, Florida, are almost entirely privately planned. Developments such as Santana Row in San Jose, California, now provide streets, parks, and even private security. A shift away from government planning to private planning is positive for renters and homebuyers (Beito et al. 2002).
About the Authors
Benjamin Powell is an assistant professor of economics at San Jose State University and the director of the Center for Entrepreneurial Innovation at the Independent Institute. Edward Stringham is an assistant professor of economics at San Jose State University.
Further Reading
Beito, David, Peter Gordon, and Alexander Tabarrok. The Voluntary City: Choice, Community, and Civil Society. Ann Arbor: University of Michigan Press, 2002.

Burt, Martha. Over the Edge: The Growth of Homelessness During the 1980s. New York: Russell Sage Foundation, 1992.
Glaeser, Edward, and Joseph Gyourko. “Zoning’s Steep Price.” Regulation (Fall 2002): 24-30.
Green, Richard, and Stephen Malpezzi. A Primer on U.S. Housing Markets and Housing Policy. Washington, D.C: Urban Institute Press, 2003.
Lansing, John, Charles Clifton, and James Morgan. New Homes and Poor People. Ann Arbor: Institute for Social Research, 1969.
Malpezzi, Stephen. “Housing Prices, Externalities, and Regulation in U.S. Metropolitan Areas.” Journal of Housing Research 7, no. 2 (1996): 209-241.
Malpezzi, Stephen, and Richard Green. “What Has Happened to the Bottom of the U.S. Housing Market?” Urban Studies 33, no. 10 (1996): 1807-1820.
Mayo, Stephen. “Sources of Inefficiency in Subsidized Housing Programs: A Comparison of U.S. and German Experience.” Journal of Urban Economics 20 (1986): 229-249.
Morgan, Terri. “Loosened Rules Lure Developers to Watsonville.” San Jose Mercury News, October 18, 2003.
O’Sullivan, Arthur. Urban Economics. Chicago: Irwin/McGraw-Hill, 1996.
Powell, Benjamin, and Edward Stringham. Housing Supply and Affordability: Do Affordable Housing Mandates Work? Policy Study no. 318. Reason Public Policy Institute, 2004.
Quigley, John, and Steven Raphael. “Is Housing Unaffordable? Why Isn’t It More Affordable?” Journal of Economic Perspectives 18, no. 1 (2004): 191-214.
U.S. Census Bureau. Annual Housing Survey, 1973: United States and Regions. Washington, D.C.: U.S. Census Bureau, 1975.
U.S. Census Bureau. American Housing Survey for the United States: 2001. Washington, D.C.: U.S. Census Bureau, 2002.
Epstein on Property Rights, Zoning and Kelo
Richard Epstein, of the University of Chicago and Stanford's Hoover Institution, makes the case that many current zoning restrictions are essentially "takings" and property owners should receive compensation for the lost value of their land. He also discusses the Kelo case and the political economy of the regulation of land.
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Epstein on Property Rights, Zoning and Kelo
Richard Epstein, of the University of Chicago and Stanford's Hoover Institution, makes the case that many current zoning restrictions are essentially "takings" and property owners should receive compensation for the lost value of their land. He also discusses the Kelo case and the political economy of the regulation of land.
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