Tax credits: what they are, and why they could be the key to England building enough affordable housing

Government figures show that in 2023-24, councils spent £2.8bn on temporary accommodation. According to the report, if this money was instead spent on servicing interest on government-issued bonds at the current rate of 1.75%, it could raise £160bn in cheap borrowing. A total subsidy of £27.2bn (assuming a £209,000 spend per home) would deliver 130,000 social rent homes and wipe out the temporary accommodation bill.

It might sound like a convoluted route, but in essence it is about using money that does nothing but pay for temporary accommodation in order to borrow to build permanent homes and reduce future expenditure.

As Mike Keaveney, director of land and development at Grainger, puts it: “It is far, far more efficient to invest capital into building new homes than it is subsidising hotel operators through temporary accommodation and housing benefit.”

The problem, he adds, is that even with subsidy, there need to be investors and developers willing to pay for and build these homes. “The income stream from social rent is nowhere near enough to cover the cost of capital,” he accepts.

The question is not whether social rent needs support. It is how that support is delivered.

The report offers a potential solution: the use of housing tax credits, an idea based loosely on the US Low-Income Housing Tax Credit (LIHTC), created under the Tax Reform Act of 1986.

In the US model, federal tax credits are allocated to states, which award them to qualifying affordable housing projects. Developers then sell those credits – typically at around 85 to 90 cents on the dollar – to corporate investors. In return, investors receive a reduction in their federal tax liability over 10 years. The equity raised reduces the debt burden on the project, making lower rents viable.

“Tax credits are one of the most bipartisan policies in America because they align incentives – good for banks, good for business, good for communities”

Ayrianne Parks, senior director of policy advocacy at Enterprise Community Partners and co-chair of the ACTION Campaign, a US-wide LIHTC coalition, describes LIHTC as “our number one tool for financing the creation and preservation of affordable rental housing”.

Since 1986, more than four million homes have been financed through the programme, serving an estimated 9.3 million households. Investors do not receive their tax credits until homes are built, placed in service and occupied by income-eligible tenants. “They have a lot of incentive to make sure everything is going right,” Ms Parks says. “The onus is on the private sector.”

Crucially, the programme has proved politically durable. Recent federal legislation expanded it further, with supporters estimating an additional 1.2 million homes over the next decade.

For Mr Allnutt, that durability is instructive. “The US embedded affordable housing into its financial system,” he says. “Tax credits are one of the most bipartisan policies in America because they align incentives – good for banks, good for business, good for communities.”

It should be stressed that a cut-and-paste replica of the US system would not work in the UK, given the different economic and regulatory landscapes for low-cost housing. But the sector is starting to warm to the principle.

Paul Hackett, chief executive of Southern Housing, stresses that the attraction here is primarily fiscal. “From what I understand, it would have a more beneficial PSBR [public sector borrowing requirement] impact than raising tax or selling government bonds,” he says. “That presents some really interesting opportunities.”

Under the variant proposed in the report, the government would offer future corporation tax reductions to investors. The capital raised would then flow to Homes England or the Greater London Authority and be distributed in traditional form – grant or low-interest loans – to registered providers.

“The beauty of this model,” Mr Hackett adds, “is that it separates the revenue-raising from the housing delivery. From a housing association perspective, it would just be another funding stream.”

Mr Keaveney is clear that the proposal would not make tax credits the most financially viable model, but rather that they would become another option for borrowing.

“Of course it would be cheaper for government to issue bonds,” he says. “The only reason you would do it this way is if you’re tapped out of the bond market, or if borrowing at that scale isn’t politically or fiscally feasible.”

In short, tax credits are a way to unlock private capital without increasing the government’s headline borrowing.

Those with long memories might equate promises to keep spending “off the books” for the government with the catastrophic Private Finance Initiative (PFI), the Blair-era procurement policy that encouraged contracting private firms for public project, incurring billions of pounds of debt in the process.

Mr Hackett acknowledges the perception risk. “When you hear ‘off-balance-sheet’, you immediately think of PFI,” he says.

But he agrees the comparison is superficial. PFI involved long-term operational contracts and significant risk transfer priced into deals. A tax credit structure, he says, would raise revenue in a different way and then deploy it through existing grant systems.

Steve Partridge, head of Savills’ Affordable Housing Consultancy, agrees that the distinction matters. “Treasury would be giving away a credit for tax that it hadn’t accounted for in the first place,” he says. “You’re not physically paying out cash in year one.”

But Mr Partridge also flags key structural questions. The US model typically requires at least 30 years of rent restrictions. Some proposals for the UK have floated 25-year time limits. “How compatible is that with regulated social housing, which is generally in perpetuity?” he asks. “If there’s a time bar, what happens at the end of it?”

“The idea of using tax credits to fund public good is a really good one. The challenges are in the implementation”

That issue has been a live debate in the US for some time. Ms Parks notes that an early “qualified contract” provision allowed some properties to exit affordability after 15 years. States have since tightened rules, but around 4,000 homes a year are still lost to the affordable stock as a result.

The lesson, Ms Parks suggests, is to be careful with how the legislation is framed. “It’s really difficult to change the law later,” she says.

Others with experience of the US system in operation are also cautious about how it has been implemented and whether the outcomes actually deliver the homes and facilities communities need.

“The idea of using tax credits to fund public good is a really good one,” says one experienced LIHTC investor, who spoke to Inside Housing on condition of anonymity. “The challenges are in the implementation.”

Each US state sets its own allocation rules and scoring criteria. Developers may commit to specific community facilities – preschools or specialist housing – to gain points (in a similar way to the UK’s Section 106 commitments), only to find local need has shifted.

“You end up with a whole class of professionals whose job is to maximise the application score,” the investor says, “not necessarily to do what’s best for the community.”

The rigidity is designed to prevent corruption, but it can also reduce flexibility. Sometimes, the net effect is that fewer homes are built and at higher cost than might otherwise be possible.

For the UK, the question is whether those pitfalls can be avoided. Mr Allnutt believes centralised policymaking could be an advantage. “You can design one programme that applies nationally,” he argues. “You don’t have 50 different state systems.”

Another live debate is about tenure. While the Grainger report focuses on social rent, Mr Allnutt sees potential to create a new “middle tier” between private rent and traditional social housing.

“It could be key worker housing, for people above social housing thresholds but still struggling,” he says. “[This could be] managed by a build-to-rent operator or a registered provider, but [could offer] security and lower rents.”

Mr Partridge is more cautious. “You might struggle to see it doing social rent in London,” he says, given the steep discount to market levels. He suggests that it could require a new sub-sector outside existing rent regulation – a politically sensitive move.

Not a panacea

Another question is whether there is investor appetite for tax credits.

In the US, around 70-80% of LIHTC investment is motivated by the Community Reinvestment Act, which scores banks on local investment. The UK has no direct equivalent. However, Ms Parks notes that several major institutions – JPMorganChase, U.S. Bank and others – have decades of experience with the model.

Savills has hosted US investors exploring UK affordable housing. “They talk about having come through the tax credit process in the States,” says Mr Partridge. “That has piqued interest here.”

The level of discount – how many pence in the pound investors would pay for credits – would be crucial. As Mr Keaveney notes, a higher required return would reduce the capital raised and therefore the number of homes delivered.

Ultimately, the decision as to whether this is just another idea or something that shifts the landscape rests with HM Treasury. Inside Housing asked the Treasury to comment for this story, but did not get a reply before publication.

Mr Keaveney argues that officials should model the full socio-economic return of investing in social rent: reduced housing benefit, lower temporary accommodation costs, higher employment and tax receipts. “Unless they run the numbers themselves, they won’t see what we see,” he says.

Mr Hackett believes the growth argument could be persuasive. “The multiplier effect from affordable housebuilding is well established,” he says. “If it helps increase supply during this parliament, it must be of interest.”

Tax credits alone are not a panacea for underinvestment in sub-market housing. They would not solve planning constraints, land shortages or construction inflation. And a poorly designed system could replicate some of the unintended consequences seen in the US.

But in a tight fiscal environment – and with Treasury ‘red lines’ cutting off direct investment at scale – the appeal of mobilising private capital without headline borrowing is obvious.

Whether that proves politically palatable – and operationally workable – will depend on the detail. As the US investor says: “The programme makes sense. The challenges are in how it is done.”

For a sector searching for scale and additionality, that may be both the promise and the warning.