Will California Reform Its Broken Housing Policies?

When Democrats start rolling back regulations, especially environmental ones, it’s worth noticing. California, long known as the nation’s laboratory for environmental regulation, is finally beginning to unwind some of its most burdensome laws.

California has been leading the way for the nation, and at times the globe, in environmental regulation for decades. Starting with the passage of the 1970 California Environmental Quality Act (CEQA), under then-Governor Ronald Reagan, the state became a pioneer in climate-conscious policy. At the time, the law was hailed as a bold step toward protecting the state’s natural beauty. However, these environmental regulations came at a great cost, sharply limiting new home construction by saddling builders and developers with expensive environmental reviews. CEQA required time-consuming and expensive environmental studies for virtually every project with a “significant” impact, from freeways to housing. Over the years, it became one of the most powerful tools environmental activists and lawyers wielded to stop or delay development. The result has been fewer homes, higher costs, and a state spiraling into severe housing unaffordability.

California sits at the epicenter of America’s housing crisis. A recent study found that only 15% of Californians can afford to buy a home compared to the national average of 34% affordability. With a median price of $905,680, requiring an income of $232,400 just to qualify, homeownership is out of reach for nearly all California families. The gap between wages and housing costs has widened so dramatically that even middle-income earners are priced out. This affordability squeeze forces many residents to either rent indefinitely or leave the state altogether. Of the more than seven million affordable homes missing nationwide, over four million should be in California.

To further exacerbate their insufficient supply of housing, California issues a limited number of permits for new housing. Data released from the U.S. Census Bureau’s Building Permits Survey shows that, per million people, California permits many fewer housing units than other populous states. Infamously, in April 2024, the Dallas-Fort Worth Area, one-fifth the population of California, issued five times the number of permits that were issued by the entire state of California.

The urgency for housing became undeniable after the January 2025 wildfires in Los Angeles. The wildfires directly destroyed 16,251 homes, commercial properties, and other structures, along with thousands of automobiles and personal belongings. The devastation was both physical and symbolic; a state already in a housing crisis lost tens of thousands more units overnight. The fires brought national attention to California’s regulatory bottlenecks, amplifying calls for reform.

Governor Gavin Newsom, facing growing pressure to deregulate, signed bills AB 130 and SB 131 earlier this year. These bills bring significant reforms to CEQA to accelerate housing and infrastructure development. While the laws do not completely dismantle CEQA, they streamline project approvals and reduce the one-size-fits-all burdens that previously plagued developers.

One exciting side effect of these reforms, driven by economic forces, will be the building of a broader range of housing, particularly more affordable units. Before the reforms, CEQA regulations imposed nearly identical requirements on all projects, whether luxury high-rises or low-income apartments. That failure to differentiate made affordable housing disproportionately expensive.

Thus, this environmental law is a good example of the economic phenomenon called the Alchian-Allen effect, which explains how fixed costs distort markets by making higher-quality (or higher-priced) goods relatively more attractive. Applied to housing, the economic argument is such that when the same environmental review costs apply to all types of housing, the relative price to create the luxury housing decreases, making it more attractive to developers.

A simple example illustrates this effect. Let’s say it costs California developers $100 million to build an affordable housing structure and $200 million to develop a luxury housing structure. Therefore, it costs the developers twice as much to develop luxury housing as it does to develop affordable housing.

Now, if we add the same fixed environmental review cost to each project, let’s say it costs $10 million, then the cost to build affordable housing becomes $110 million, and the cost to develop luxury housing becomes $210 million. The cost to establish the luxury housing structure is less than twice the cost to develop the affordable housing. This means that, with the environmental review, the luxury housing becomes less expensive to develop relative to the affordable housing. So, the developers will, on the margin, opt to build more luxury housing.

The one-size-fits-all approach of the CEQA contributed to the state's shortage of affordable housing. As a result, luxury housing, especially with its higher potential returns, became more attractive to home builders than affordable housing. The lack of regulatory flexibility has thus exacerbated the affordability crisis.

By relaxing the environmental review requirements, these reforms lower the initial cost of development that all building asset classes are subject to. With the decrease in this fixed cost, higher-end homes will become more expensive relative to affordable developments. Thus, developers will, on the margin, start building more affordable units, and California will begin to see a more diverse mix of housing developments, particularly in the middle and lower-price segments.

Home builders will be better incentivized to build affordable housing on the margin, addressing the state’s pressing housing shortage. These reforms provide a much-needed opportunity to reorient the state’s burdensome regulations, ensuring that affordable housing is no longer sidelined.

For market advocates, this moment is instructive. California’s housing crisis is not an accident of geography or population growth. It is a product of policy, decades of decisions that treated every project as a threat rather than an opportunity. Deregulation does not have to be about cutting corners; it can allow markets to function, prices to adjust, and supply to meet demand. As other states consider adopting stricter environmental rules, California’s experiment offers a cautionary tale. Regulations imposed in the name of sustainability can backfire, creating scarcity and inequality. If the goal is a cleaner, more prosperous society, we must recognize that growth and stewardship are not mutually exclusive. A freer market, tempered by commonsense protections, will produce both.

The reforms to the California Environmental Quality Act are a key step in addressing the state’s housing supply and affordability crisis. By reducing regulatory burdens, these changes incentivize the construction of more affordable housing, particularly in the middle and lower price segments. This shift alleviates cost pressures and promotes a more diverse housing supply across the state, helping California make meaningful progress toward solving its housing and affordability challenges.

Julia R. Cartwright is Senior Research Fellow in Law & Economics at the American Institute for Economic Research.