Regulation: A Monumental Burden #cre


DEBATES over the effect of regulation on the economy typically focus on national rules when quite often it is the local restrictions that end up having the greatest costs. One ongoing regulatory discussion in the city of Washington helps make the point. Back in 1899, the construction of a new, 164-foot building in a residential neighbourhood of Washington prompted the passage of the city’s Height Act (by the federal Congress, thanks to the District’s unfortunate and constitutional lack of political autonomy). As it stands now, the city’s height limit restricts building heights in various ways and essentially maintains a hard cap at 160 feet. While in much of the city it is local zoning rules rather than the limit that constrain building heights, the height limit does bind in the busiest office and residential areas, including the city’s central business district.

The inconveniences generated by this policy have prompted periodic debate over whether and how it ought to change. A bipartisan effort currently underway, led by Democratic DC delegate Eleanor Holmes Norton (a non-voting member of the House of Representatives) and Republican California representative Darrell Issa, appears to be the most promising attempt in decades to alter the city’s rules.

And so the debate is on. Writing at the Washington urbanist blog Greater Greater Washington, David Alpert assembles the arguments made for and against a change in the limit. There’s much to dislike about the current policy. It’s arbitrary. Taller buildings have gone up just across the Potomac River from downtown Washington in Virginia neighbourhoods like Rosslyn and Pentagon City, without destroying the fabric of local society. And it’s costly. Mr Alpert notes that downtown Washington has among the lowest vacancy rates and highest rents in the country. Economists Christian Hilber and Frederic Robert-Nicoud have estimated the effective regulatory “shadow tax” imposed by land-use rules and land scarcity. As of 1998, Washington’s shadow-tax rate was fifth highest in the country at 22%. One suspects the tax rate has soared since that time; there was a lot more underdeveloped land available in Washington then, at the tail end of the city’s era of high crime and depopulation, than there is now, after a decade of booming economic and population growth and plummeting crime rates.

Even simply taking the 22% figure, we’re left to conclude that the policy is extraordinarily costly. It represents a sigificant transfer of income from renters to homeowners. It represents a rise in the cost of business for all those operating in the area (which translates into more expensive government, as the impact of high housing costs on real wages forces the government to pay higher nominal salaries to attract qualified workers). And it captures the stultifying economic effect of crowding out in the Washington-area economy, as relatively location-sensitive activities (effectively, those not conducting business with the government) are driven out of the District into the suburbs or other metropolitan areas.

What benefits are set against these enormous costs? The arguments Mr Alpert lists fall into two categories: economic and aesthetic. The economic case is that the limit encourages infill development in central areas, eliminating unsightly empty lots, and then pushes growth to other neighbourhoods, effectively acting as a development programme. There are several big problems with these sorts of arguments. One is that they typically lack empirical backing, leading to a confused reading of the nature of causation. One paragraph in Mr Alpert’s post is illustrative:

Go to a lot of midsize US cities and the downtowns have a few big towers with lots of empty space for parking in between. Those empty spaces create walking dead zones. The District has almost no empty lots downtown, and even space on top of freeways like the Center Leg I-395, or the Union Station railyards, will be covered over. That’s because land is so valuable (thanks to the height limit) that it’s economical to build decks for buildings.

Some cities feature towers alongside parking lots but many others do not. To take this argument seriously, we’d really want to know whether there is a systematic relationship between freer development and empty lots, and even then we’d have to be cautious in assigning causality. But no such systematic evidence is provided.

There is a much simpler reading of the limited information presented above: defenders of the height limit are ignoring demand. In markets where demand and supply are close to finely balanced, construction of a single large project can reduce market rents below construction costs, making it unprofitable to build more in the neighbourhood. Indeed, a builder with market power may be able to deter competitors from entering the market through the threat of glut, a threat that will be more credible when big projects are subject to local government incentives and subsidies, as they often are. But in deep office markets with lots of excess demand, like that in Washington, individual builders will find it difficult to wield market power. Moreover, a developer would have to add an awful lot of new square footage to bring rents down below construction costs. The fact that the shadow regulatory tax in Washington was already 22% back in 1998 suggest that the city would have enjoyed substantial infill development even with a much more liberal development environment.

Meanwhile, the argument that the restrictions push development outward actually undermines the case for the height limit. Outward diversion comes at the cost of reduced benefits from local spillovers—one of the major returns to clustering. The economic advantages to invididual neighborhoods of increased local demand are at least party offset by reduced metropolitan demand, thanks to the constraint on scale economies imposed by height limits.

Then there are the aesthetic arguments: that the District would be less attractive thanks to the oppressive effect of boring office towers and reduced sunlight, and that the monumental views now on offer would be harmed. These are less clear cut than many height-limit supporters reckon. A city full of low, boxy buildings may be aesthetically unappealing to many residents and tourists (especially when high real-estate costs have crowded out economic diversity, leaving the building full of lawyers and other suits). I don’t think we can be confident that aesthetics are on net a positive for the height limit. But let’s be very generous and assume that they are. Indeed, let’s assume that aesthetics are worth $1 billion in benefits a year. That’s like saying that after cancelling out all those who dislike short cities with those that love them, we’re left with a net of 1m individuals willing to pay $1000 each, every year, to keep the heights like they are. That seems wildly implausible to me, but let’s keep it as an assumption.

Downtown Washington, which is a small part of the city’s total area and which excludes portions of the central business district, has an estimated 66m square feet of office space. The average commercial rent in downtown Washington is $94 per square foot. Using the 1998 shadow-tax figure, we can guess that perhaps $21 of that rental cost is attributable to regulatory restrictions, which means that the total annual regulatory cost in downtown alone is around $1.4 billion: well above even implausibly high guesstimates of the aesthetic benefits of the height limit.

There is a more practical case for limiting development, namely, that as Washington becomes more dense there will be negative spillovers accompanying the positive ones: more traffic, for instance, and more noise. Such costs aren’t negligible and often help explain NIMBY attitudes. Yet these shouldn’t dissuade Washington from making it easier to build. The net benefits of easier building should be large enough to help compensate losers and invest in projects to ameliorate negative effects. Just a quarter of that $400m annual gap between imagined aesthetic benefits and rent savings could be collected in the form of a tax and used to upgrade streets, transit, and other infrastructure, for instance.

There are opportunities like this across America. The metropolitan cluster of the San Francisco Bay Area isn’t subject to a region-wide height tax, but land-use restrictions are large enough to leave San Francisco, San Jose, and Oakland with shadow tax rates above that in Washington. That dynamic comes with the added cost, that the clustering effects being constrained are occuring in the nation’s most innovative tech hub, where the costs to future growth may well be greatest. These sorts of issues don’t get the sort of national attention that attaches to debates over financial regulations. Yet the aggregate economic effect seems sure to be very large indeed.

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