Opinion: Carolina Journal Opinions

New Market Tax Credit Provision Would Enable Crony Capitalism

Section of Senate Bill 826 would reverse progress in making taxes fairer and less equitable

Like a recovering addict on the verge of a major binge, some North Carolina lawmakers are on the brink of falling back into the black hole of tax credits. Rather than serving as a national model for tax and regulatory reform, North Carolina risks becoming, again, a national leader in crony capitalism.

Triggering this addictive craving for a tax-credit high is Senate Bill 826. It would create a new state-level credit mirroring the federal New Markets Tax Credit. The state version would give insurance companies and affiliates a credit to filter money to private entities making investments in distressed communities.

Established in 2000, the goal of the NMTC was to spur revitalization of low-income and impoverished communities by providing capital to support and grow businesses, create jobs, and build healthy economies. But the federal government has questioned whether to continue NMTC. The program was set to expire in December 2011, but was renewed until January 2014. In 2015, it was renewed for another five years.  As of 2014, 14 states have adopted state NMTC programs. Texas, Georgia, and North Carolina have introduced legislation to adopt a NCMT program.

But what we know about these targeted incentives is they never live up to the promises, they benefit a few at the expense of many, and they are not a good investment of taxpayer money. When credits, grants and carve-outs are layered over and over and over, success for “investors” comes almost entirely at the expense of taxpayers. North Carolina’s reforms since 2011 — transforming our tax code, reducing regulations, building a strong infrastructure, and providing a well-skilled work force — have worked. Targeted incentives have not. North Carolina decision makers need to stay the course with fair and equitable treatment for all rather than backtracking and creating a new tax carve-out.

In short, here’s what’s proposed with a North Carolina New Market Tax Credit (NC-NMTC). A new complex, convoluted tax credit program in North Carolina would offer a 25 percent credit for private investments over seven years, requiring that 75 percent of the investment be made in the most economically disadvantaged Tier 1 and Tier 2 counties. This is on top of a complex, nontransparent, convoluted federal program that offers a 39 percent tax credit over seven years for investments in low-income, distressed communities. With both credits, an investor receives 64 percent equity (aka cash) in exchange for tax credits toward an investment with certain strings attached.

How would this NC-NMTC work? A qualified community development entity applies to the U.S. Treasury for authorization for a qualified equity investment eligible for the new market tax credit. The total credit amount from the NC-NMTC is limited to $100 million per year and $5 million per project. First come, first served.

The approved applicant transfers all or a portion of its certified qualified equity investment authority to its controlling entity and notifies the N.C. Department of Commerce for acknowledgement and certification. Within 30 days, the qualified community development entity issues the qualified equity investment, receives the cash, and designates that amount as a federal qualified equity investment with the Community Development Financial Institutions Funds and notifies the Department of Commerce again. They make the investment in their project.

Where does the money come from? It comes from individuals buying insurance in North Carolina. A credit issued to insurers – hospital, medical, dental services, health maintenance organizations, and self-insurers — on their state gross premium tax.

The insurers are issued the credit – 12.5 percent upon acceptance of the project and 12.5 percent in the first year of the project for a total of 25 percent credit off the gross premium tax they pay to the state. The insurance company then turns the cash over to the investor. In other words, the insurance company is the pass-through to get the money from the taxpayer to the private investor.

For example, with a seven-year, $100 million project, a private investor would get $12.5 million in NC-NMTC upon acceptance of the project, $12.5 million in NC-NMTC in the first year. In addition, he would get $5 million each year for the first three years of the project and $6 million per year for the final four years in federal NMTC. For the $100 million project, $64 million comes from taxpayers, $36 million from the private investor.

There are tight deadlines. If they’re not met, the money is reclaimed and redistributed to other applicants. The Department of Commerce can recapture and revoke the tax credit if the qualified community development entity doesn’t comply with deadlines, doesn’t use the money the way it’s intended, or is noncompliant with federal rules. The Department of Commerce is authorized to make rules and issue advisory letters. If the tax credit exceeds the tax liability, the entity can carry forward that “extra” tax credit for five years.

Prior to making the low-income community investment, the development entity must provide a revenue impact assessment using “a nationally recognized third-party independent economic forecasting method that projects State and local tax revenue to be generated by the project.” There are numerous reports claiming large increases in state revenues, economic outputs, and jobs. The problem is the reports use a flawed economic analysis model called IMPLAN or REMI, all thoroughly debunked by well-respected economists That economic model ignores opportunity costs and frequently conflates business costs with societal benefits.

A July 2014 U.S. Government Accountability Office report on NMTC found better controls on data are needed to ensure effectiveness, calling the program complex, less transparent, and unnecessarily duplicative. The GAO found “they (NMTC) also increase the complexity of the financial structures by adding more parties and more transactions which in turn reduces transparency and may increase the cost in terms of fees and other transactional costs,” “the data on equity remaining in businesses after the credit period were unreliable,” and “data on NMTC project failure rates were unavailable.”

But it’s not just the NMTC that’s available to a select few. At the federal level, about 16 additional tax credits, breaks, and carve-outs are used in conjunction with the NMTC. Duplication and layering of tax credits is likely in North Carolina as well. In addition to the federal NMTC and NC-NMTC, historic restoration credits, solar and renewable energy credits, Job Development Investment Grants, OneNC Fund grants, and local incentive packages are just a few of the tax credits and grants for which an investor might also be eligible.

Any entity making an investment in low-income counties could use the credit to build and invest in all kinds of facilities and businesses. The only item prohibited from the North Carolina credit is real-estate projects. Although the stated intent is to generate economic activity in Tier 1 and Tier 2 counties, of the 95 NMTC projects currently underway in North Carolina, 60 are located in Charlotte, Durham, Greensboro, Raleigh, and Winston-Salem. There are hundreds of projects in North Carolina already identified as eligible for the NMTC. Most are clustered around the same areas.

Long-term evidence and academic research tells us that investment credits don’t work. Special treatments like NMTC benefit a few at the risk and expense of taxpayers. Such credits create a drag on the economy and are a bad deal for taxpayers.

North Carolina lawmakers have fought hard to roll back special tax carve-outs and set the state on the right road to economic prosperity. To turn in the opposite direction, adopt a new NC-NMTC, and set the state back is foolish, irresponsible, and ill-advised.

North Carolina has become a national model in tax reform, focusing on low rates and fair tax treatment rather than picking winners and losers through targeted incentives. Stick with the plan that’s working — eliminating special breaks and carve-outs and staying with lower taxes, fewer regulations, and a fair and equitable system. We’ve come too far to return to bad habits, poor choices, and destructive decisions.

Becki Gray is vice president for outreach at the John Locke Foundation.