Say you’re a producer in the movie business and you’re looking for the perfect location. Wherever you go, streets will have to be closed, security will have to be provided, and cars will have to be cleared off the streets. Still, states eager to attract big projects are not only willing to disrupt their cities to gain your business, they are willing to pay you to be there. That’s right — pay you, through tax credits which you can then sell on the open market to another company, often through a third-party broker.
It works like this: States and cities frequently offer tax credits to lure new business in a number of industries. But some companies can’t use the credits because they don’t ultimately pay taxes in that state. “Unless you have an indigenous industry to start with, you’re not going to have many companies that would have a tax liability,” says Sherri McConnell, director of entertainment industry development for Louisiana, where companies receive tradable credits for film productions. Tradable credits can be sold openly and legally by one company to another — in any industry — usually in the range of 80 to 95 cents on the dollar.
It’s sort of like buying concert tickets from a scalper the day of a show that never sold out: The owners are willing to unload the useless credits for less than their face value, and the buyer is happy to be getting a deal. Tradable tax credit programs have developed piecemeal — with no standard across industries or amongst state governments. There’s no credible estimate of the size of the entire market and no consensus as to whether states are profiting from the plan or getting a raw deal. However, there are examples of how the credits are used across the country.
Film Industry Credits: Transferable tax credits have proven particularly popular in the film industry — 15 states currently offer them according to Bruce Deichl, founder and president of Tax Credits LLC and the Tax Transfer Corporation in New Jersey. Louisiana was the first state to implement such a program in 2002 — film studios receive a 30 percent credit toward their tax bill on in-state production expenditures.
Historic Preservation Credits: At least 13 states offer transferable tax credits for the preservation and/or rehabilitation of historic buildings. Missouri, for example, offers a 25 percent credit for the eligible costs of rehabilitating historic structures. The program has proven hugely popular. In fiscal 2009, the state authorized almost $212 million in such credits. Starting last year, the state imposed an annual cap of $140 million in its larger effort to better control its budget.
R&D Credits: New Jersey and Pennsylvania allow tech and biotech firms operating at a loss to sell their tax credits. In New Jersey, the R&D credits have to be sold for at least 80 percent of their value, and there is a lifetime maximum of $15 million in credits for each company (the application fee for the program is $2,500). Startup firms in this industry — and especially in biotech — often post losses for many years as they develop a product, so corporate income tax credits are useless. Selling tax credits is a way to help tide them over until the revenue rolls in.
Land Conservation Credits: Colorado is one of three states offering landowners a credit for creating conservation easements on their properties of at least 80 acres (fewer acres in some cases) — the landowner prohibits development in return for a tax break. In this case, the state offers a maximum $375,000 credit, or 50 percent of the value of the property. The program was created in 2001, and the credits have been transferable since 2003. Some states also have tradable “brownfield” credits, which encourage the redevelopment of contaminated industrial sites.
Energy Tax Credits: Oregon is one of several states in which companies that invest in renewable energy resources (including equipment manufacturing) or energy conservation receive a tax credit, in this case ranging from 35 percent to 50 percent of eligible costs, depending on the type of project. Oregon’s tax credit has been in place since 1979, but has been transferable only since 2001.
The Middle Men
As with most markets where there’s a profit to be made, there are intermediaries who may help a buyer find a seller and take a commission. Sometimes they buy tax credits and distribute them to client companies, collecting a fee in the process.
“There is definitely a boutique industry of tax credit brokers,” says McConnell. In Connecticut, for example, of 80 film productions that have received a tax credit, 71 have sold them through a third party, according to an investigation by the Stamford Advocate. Deichl says the market for tradable film tax credits alone is now over $500 million per year.
It’s not always just a matter of matching a seller with a buyer. “The intermediaries get very creative,” says Robert Tannenwald, senior fellow at the Center on Budget and Policy Priorities’ State Fiscal Project. He explains that investors often buy the tax credits, package and/or securitize them, and then pitch the product as an investment. “A lot of intermediaries make a lot of money on these deals, just like they did with mortgage products,” he says.
Sometimes, brokers act as lenders. “Many of them will actually front-end finance a film based on what they’re going to get in tax credits on the back end. It’s a way to collateralize those credits,” says McConnell.Other times, the state itself becomes the buyer. In Louisiana, the state now offers to buy back its own tax credits at 85 cents on the dollar, and Massachusetts has a similar program. “We’re saving 15 cents on every dollar, whereas if you sell it on the open market, ultimately that credit is going to come back and be redeemed for the full 100 cents,” says McConnell.
Worth it for the States?
McConnell says the credits are a no-brainer. “We think it has a huge economic impact for the state. We had well over $1 billion of economic activity in 2010 alone [from the entertainment/film industry],” she says. Before the tax credit program was created, that number was under $10 million.
Tannenwald of CBPP disagrees. “The states lose big time because these tax credits do not generate enough economic activity to enable the tax credits to pay for themselves,” he says. In a report he authored last year for CBPP, Tannenwald calls them a “wasteful, ineffective and unfair instrument of economic development.”
A 2009 study of Pennsylvania’s film credit program shows a nominal benefit. It found that film tax credits resulted in a $4.5 million net gain in state revenue ($58.2 million in tax credits versus $62.7 million in state revenues generated) for 2008 — hardly a windfall. A New Jersey Institute of Technology review last year found that New Jersey’s R&D credit for tech companies was effective in fostering the growth of biotech companies in the state, but ineffective for the technology industry at large.
In the case of tax credits that encourage conservation of land or historic buildings, or development of alternative energies, the ultimate goal is not necessarily to make the state money. Success is partly measured in land preserved, or energy systems created. As of 2010, Colorado had protected roughly 1.7 million acres from development through easements. Colorado’s estimated return was $6 for every $1 of easement tax credit, based on the additional economic activity in the state, according to a study from the Trust for Public Land. But the program has generated a number of lawsuits from landowners claiming that the state owes them tax credits, creating a cloud of uncertainty.
Thus far, there’s no consensus on the viability of tradable tax credits. The clear winners are the tax credit sellers, the buyers and the middle men. State governments may be taking a leap of faith.