Reports Question Effectiveness of New Markets Tax Credit

Both the Government Accountability Office (GAO) and Senator Tom Coburn's (R-OK) office have released new reports on a tax credit that rewards banks for investing in low-income communities. Both reports raise questions about whether the money is being used as effectively as it could be. The GAO report raises some concern with the credit's complexity and effectiveness, finding certain cases where investors are receiving many sources of federal money for the same project. Senator Coburn's report goes farther, identifying several places where the credit has been used for questionable purposes and calling for the credit's elimination. As his report explains:

The federal New Markets Tax Credit program was created to steer taxpayers dollars into banks that would in turn funnel financial assistance to businesses and developers in low-income communities to help create jobs. Yet, virtually every neighborhood, from Beverly Hills to the Hamptons, could qualify for the program. The New Markets Tax Credit (NMTC) has subsidized wealthy investors in nearly 4,000 projects, including car washes, bowling [alleys], parking lots and breweries. Many of these are wasteful and not a federal priority – such as an ice skating rink and a car museum - while others are corporations in little need of taxpayers’ handouts – such as chain restaurants like Subway and IHOP.

Since 2000, the New Markets Tax Credit (NMTC) has given investors, mostly large banks and financial institutions, a 39 percent credit for loaning money to businesses in low-income communities. Investors claim the credit over seven years.

GAO notes the financial arrangements used to claim the credit have become much more complex.

In a process known as "twinning," investors find other federal funds to cover the costs of projects; an estimated 62 percent of NMTC programs received some other federal, state, or local assistance, such as incentives for historic redevelopment. But investors can receive the tax credit based on the project's entire cost including the money provided by other government assistance. In one case study identified by the Urban Institute, a bank investor put in $525,000, which was then matched by $2.5 million of other state and federal tax credits. GAO notes that by claiming the credit on the entire $3 million, the investor was able to claim $1.2 million in tax credits, resulting in an apparent 24 percent return, well above market rates.

Finally, GAO notes there is little data available to judge the outcomes of these projects. It is difficult to know if the business receiving a loan failed or whether the investor maintains equity in the business (a sign of future success). The investor receives a return on their investment regardless whether the business succeeds.

Coburn's report "Banking on the Poor: How Corporate America Exploits Struggling Communities to Collect New Markets Tax Credits" is more critical, saying "the effort intended to enhance private sector business activity in struggling communities has largely become a cash cow for big banks and others in the financial industry." The report identifies specific instances where a project was funded through the NMTC program but may not be the best use of low-income development funds, including a new health clinic on a ritzy and booming Hawaiian island, luxury hotels and apartments, a yogurt plant, a corporate headquarters, and a vintage car museum. In 2010, about 65 percent of NMTC investments went toward commercial real estate projects, while only 22 percent went toward financing businesses in low-income communities.

The report also highlights a Congressional Research Service report finding that because of the varied definitions of low-income communities, "virtually all of the country’s census tracts are potentially eligible for the NMTC." Coburn concludes:

The New Markets Tax Credit is poorly designed, duplicative of more than 100 similar federal programs and tax credits, and has become a goodie bag for big banks and corporate America at the expense of the taxpayers. There is little evidence it has succeeded in its intended purpose of creating new markets in distressed areas to foster economic opportunities.

Even though the credit is expired right now, existing tax credits for investments already made will cost about $1 billion per year. The Senate Finance Committee would extend it, along with most of the other extenders, for two more years and allow investments made in 2014 and 2015 to qualify, costing an additional $1.8 billion over the next ten years. The House Ways & Means Committee has not considered legislation to extend it, and Chairman Dave Camp's (R-MI) tax reform discussion draft did not address the tax credit.

As one of the tax extenders, the NMTC expired at the end of 2013. Judging by past experience, Congress will likely extend the provisions as a package at the end of the year. Coburn, however, is calling on Congress to let it expire. On the other hand, the New Markets Tax Credits Coalition criticizes the reports and notes that over 50 House members have called for the credit to be extended.

Whether Congress renews the New Markets Tax Credit, changes it, or allows it to expire, the regular ritual of extending tax breaks should be seen as an opportunity. Instead of approving all 50-plus extenders in one package, Congress would be wise to evaluate the merits of each extender, make any necessary changes, and pay for the costs of extending them so as not to make the federal deficit even worse.

Read More:

• Senator Coburn's Banking on the Poor: How Corporate America Exploits Struggling Communities to Collect New Markets Tax Credits
• The GAO report: New Markets Tax Credit: Better Controls and Data Are Needed to Ensure Effectiveness
• Our Tax Break-Down, explaining the history and size of the tax extenders.