States legalized more housing by 2025, but sticky tax policies still hurt builders and buyers

Since the COVID-19 pandemic boom, the conversation about housing reform has been dominated by one big idea: legalizing more housing.

In response, cities and states have passed roughly 225 pro-housing bills since 2023, according to research by the Mercatus Centerrewriting zoning codes, relaxing density rules and trying to clear red tape that is slowing construction.

The idea was simple: if you allow more homes, supply will automatically follow.

But that promise has hit a wall. New construction in October reached its slowest pace since 2020, underscoring that while legality was the first hurdle to building new homes, it was certainly not the last. What remains is the complicated calculation that determines which projects are financially feasible.

That is the missing link in today’s pro-housing scenario. Zoning laws can open the door, but tax policy decides whether someone walks through it. And until tax systems stop penalizing housing production, many of the country’s greatest land use successes are at risk of remaining on paper.

How tax policy shapes what gets built: ‘Legal’ is not the same as ‘feasible’

While cities and states have scrutinized their zoning laws, fewer have examined whether their tax systems support or sabotage the construction of new housing.

This disconnect looms as a specter over the future of sustainable housing.

“I tend to think that land use is about determining what is legal, and then tax policy determines what is feasible,” he explains. Solomon Greeneexecutive director of land and communities at Lincoln Institute for Land Policy.

“Tax policy always goes hand in hand with zoning and land use when it comes to shaping housing supply,” Greene explains. “How much tax is collected and when it is collected on land, and its improvements, really determines what gets built and whether deals can be made.”

That calculus influences every stage of development. If taxes have to be paid early in the process – before construction even begins – capital is tied up longer, increasing risk. That risk is not evenly distributed. Some tax structures shift more of the uncertainty to the developer; others make long-term projects more viable. Ultimately, the system influences which projects move forward, what types of homes are built, and who is willing to finance them.

Greene puts it plainly: “I would argue that while we have seen a lot of momentum around loosening land use regulations and streamlining permitting processes to build more housing, we have seen less attention to the sound tax policy reforms and evidence-based tax policy reforms that will allow these deals to be designed.”

These forces don’t just shape the decisions of major developers; they also flow to small landlords and homeowners. Whether you’re trying to build, renovate, or simply stay in your home, the rules of what’s taxed and when can make all the difference.

The tax policy that most shapes housing

To understand these ripple effects, it’s helpful to first understand the key tax levers that federal, state, and local governments can use to make construction calculations more forgiving.

At the federal level, Greene points to the Low-Income Housing Tax Credit (LIHTC) as the most effective tool for producing new affordable housing. The program allocates roughly $10.5 billion in annual tax benefits to support the purchase, renovation or construction of rental housing for lower-income households.

It is a clear example of how tax policy makes housing viable by reducing long-term tax liability and improving the return profile for investors. Today, LIHTC finances approximately 90% of all new limited-income rental housing built in the United States.

But other federal stimulus measures are much less targeted.

The mortgage interest deduction – which allows mortgage holders to deduct interest from their taxable income – is the biggest benefit on housing tax, but is not beneficial for households or tenants with a low income. And while it lowers the cost of homeownership for those who qualify, it does little to increase the supply of housing.

At the state level, many offer their own LIHTC programs or support affordable housing through trust funds. But the real power lies in how they regulate local governments, especially in the area of ​​property taxes.

High property taxes create a whole host of complications in the housing market. Most acutely, sudden spikes in assessed values ​​can make homeownership unaffordable, especially for people on fixed incomes. They can also discourage homeowners from making improvements, as upgrades often trigger reassessments at higher rates.

And while state-level reforms, such as caps on assessments or limits on annual tax growth, are intended to help residents stay put, they can inadvertently distort the broader tax base, undermining both fairness and local revenues over time.

When aid harms supply

To understand how these good intentions can go wrong, look no further than two states that tried to protect homeowners by setting low property taxes — only to inadvertently discourage better land use.

California’s Proposition 13 is the clearest example. Passed in 1978, it caps property tax bills and limits how much they can rise each year. While it succeeded in stabilizing tax bills for longtime owners, it also discouraged them from selling.

Over time, the supply froze.

“Prop 13 really shows what happens when land is undertaxed,” Greene explains. “The housing supply is freezing, while demand is exploding.”

And today, California is paying the price: The state scored an F on its affordability report card Realtor.com®both because of high house prices and the lack of new construction.

Florida’s Save Our Homes law follows a similar logic, limiting annual assessment increases to protect homeowners in the long term. But there’s a major catch: A major remodel (which housing advocates typically consider a win) can lead to a complete revaluation of the home at its current market value, as if it were a brand new construction.

That’s what happened to a Florida couple whose property taxes jumped from $15,000 to more than $91,000 after renovating their home. In fact, they were punished for improving their land use.

However, there is another way. Some cities have tried to reverse the equation by focusing the tax burden on the land itself, rather than the homes built on it.

Pittsburgh is a shining example. From 1913 to 2001, the city instituted a split rate system, under which land was taxed at a higher rate than improvements. It encouraged landowners to develop the land rather than speculate on it, leading to fewer vacant lots and more infill development.

And today, the Steel City ranks as America’s most affordable city—a sign that tax policies at the local level, if designed well, can support rather than stifle housing growth.

A New Way Forward: Tax Reforms That End Disadvantaging Manufacturing

If cities and states want to turn pro-housing rhetoric into real results, they can’t stop at zoning reform. They also need to fix the tax systems that are quietly blocking new construction.

But instead of putting incentives on an already broken system, the solution could be as simple as removing the barriers that already exist.

“There is no tax incentive that can overcome things like exclusionary zoning or slow approvals,” Greene explains. That’s why he and other housing experts emphasize the need to coordinate tax policy with permitting and land use reform.

Too often, cities claim to support new housing while taxing it as a problem. From bringing forward infrastructure costs to abusing reductions, local policies often punish the very things they are trying to encourage. But instead of adding carrots, just remove the stick.

“I don’t think they need more incentives,” Greene said. “They need tax systems that stop penalizing housing production.”