In recent years, housing prices and rents have increased dramatically in the cities of the Northeast corridor and the West Coast. Leading Democratic presidential candidates have proposed plans to address this issue and, fortunately, most of these proposals recognize that public policy (i.e., local zoning and land use regulations) has limited the construction of new housing. As Edward Glaeser and Joseph Gyourko observed in a 2002 Regulation article, local and state laws have restrained housing supply from keeping pace with demand. While the willingness of Democrats to admit the importance of constraints on private supply is an important step away from an exclusive focus on public provision of housing or subsidies, a more direct and local option would be to establish a framework for developers to pay localities to alter their zoning constraints.

A recent New York Times editorial outlines Senator Cory Booker’s, Julian Castro’s, and Senator Elizabeth Warren’s plans to incentivize local governments to relax land-use laws and allow more housing development. Booker and Castro would require local governments to institute land-use reforms before they can obtain existing federal infrastructure subsidies while Warren would attach the land-use reform requirement to a new $10 billion spending program for governments that comply. Booker and Castro have additionally proposed increasing subsidies to tenants through tax credits or expanded housing vouchers. (Senator Kamala Harris also has proposed increasing tenant subsidies but without a parallel incentive to increase the housing supply.)

For the most part, Booker’s, Castro’s, and Warren’s plans eschew traditional, deleterious alternatives such as rent regulations and subsidies for developers. Last month I discussed how New York State’s recently tightened rent control regulations will decrease housing supply and harm both current and future renters. And, while not ideal, tenant-based assistance is more efficient and equitable than project-based assistance, such as housing tax credits.

It is encouraging that the proposals have managed to avoid those types of interventions and identified the harmful effects of zoning laws, but the proposals’ downside is that they tie land-use reform to federal subsidies for infrastructure. As a recent Regulation article argued, “although there are some reasons for higher-level governments to provide some local infrastructure projects … it is preferable for users to pay whenever that is feasible.”

In the current issue of Regulation, law professor Christopher Elmendorf proposes an alternative. Instead of incentivizing jurisdictions to relax zoning laws with federal money, state and local governments can independently create systems for developers to pay incumbent homeowners for the right to build more and denser housing. Fundamental to Elmendorf’s proposal is the recognition that zoning rules have become de facto property rights. Currently, local governments hold these rights and capture value from them by imposing impact fees, mandating that developers offer communities in-kind benefits (such as affordable housing requirements), or, most commonly, by zoning for less development than needed and extracting benefits including money, land for parks, and affordable housing from developers on a project-by-project basis (Roderick Hills and David Schleicher describe the negative consequences of this ad hoc exaction in their Fall 2015 Regulation article). The negotiations between developers and politicians are often behind the scenes and the benefits extracted do not always clearly go to incumbent homeowners.

Elmendorf’s alternative is for localities to transparently and directly sell developers the right to upzone. As he explains,

Development rights would be auctioned in the form of tradeable “development allowances” roughly analogous to the emissions allowances that are now bought and sold under cap-and-trade regimes for greenhouse gas emissions. Each allowance would permit its owner to build, say, 100 square feet of housing in excess of the baseline, up to a maximum defined by the new zoning map. To illustrate, imagine a parcel of 5,000 square feet that had been zoned for a floor-to-area ratio of 2:1, i.e., 2 square feet of housing for every square foot of lot size. After upzoning, the maximum floor-to-area ratio is 8:1. This means that the owner of the parcel, who previously could build no more than 10,000 square feet, may now construct as many as 40,000 square feet. But to obtain a permit to build 40,000 square feet, she would have to acquire and redeem 300 development allowances ([40,000 – 10,000] ÷ 100 = 300).

The local governments would be able to take the proceeds they receive and put them towards building new parks, infrastructure projects, tax reductions, or direct compensation of incumbent residents.

I have made similar proposals to resolve conflicts over Airbnb and conventional air pollution, which are rooted in economic theory developed by Nobel Laureate Ronald Coase. Allowing those with initial property rights to negotiate with entities who wish to purchase those property rights leads to trade and conflict resolution as long as transaction costs are low. In regard to the aforementioned examples and zoning rights, those who wish to offer their homes up for short-term rental, emit air pollutants, or develop new housing can purchase the right to do so and thus reimburse the initial property rights holders for any costs imposed.

Though the theory supporting Elmendorf’s idea is sound, there are pragmatic concerns. In a comment on Elmendorf’s article, economist William Fischel, one of the originators of the concept of exchanging zoning rights, notes that there will still be significant interests opposed to new development. The same incumbent homeowners that currently fight each building project and the unions and other interest groups that attempt to capture some of the producers’ surplus from development, will still attempt to influence the local politicians who will retain control of the zoning rights auctions. In fact, Fischel contends that because a zoning rights auction confers an abstract right to increase a plot’s floor-to-area ratio, as opposed to a tangible building plan that interests groups can directly address in zoning hearings, Elmendorf’s proposal actually may increase homeowners’ perceived risk of land-use change. 

But if the compensation for change is high enough and directed specifically to incumbent homeowners, change occurs. For example, Northern Virginia was once dominated by single-family homes. Between the late 1980s and early 2000s, developers bought up neighborhoods for redevelopment, often paying homeowners more than double the listed price of their houses. The Ballston corridor now has 22-story apartment buildings.

Allowing local governments to convert the current in-kind, opaque, underground market for zoning change into an explicit legal exchange of cash for density would facilitate the development of housing and address affordable housing shortages.

Written with research assistance from David Kemp.