Tax Incentives for Economic Development: What tax incentives promote the economic development of low-income communities?
Several tax incentives encourage businesses to participate in the economic development of low-income communities. Employers may claim tax credits for hiring underemployed workers and tax subsidies for investing in low-income communities. The Joint Committee on Taxation estimates that these provisions, in total, will cost nearly 14 billion dollars from fiscal years 2008 to 2012.
- The Work Opportunity Tax Credit (WOTC) gives businesses a tax credit equal to 40 percent of the first $6,000 paid to each first-year employee in a targeted group, which originally included welfare, food stamp, and Supplemental Security Income recipients, poor and disabled veterans, youth from disadvantaged areas, and ex-felons. The recent stimulus bill expanded that list to include unemployed veterans and disconnected youth.
- The Welfare-to-Work Tax Credit, lets firms claim a tax credit for wages paid to a first- or second-year employee hired within two years of receiving Temporary Assistance for Needy Families payments for at least 18 months. The credit equals 40 percent (50 percent in the second year) of up to $10,000 in annual wages paid to qualifying workers. In 2006, this credit was combined with the WOTC, though firms can still claim the larger amount for the subset of workers who qualify.
- Firms and investors in Empowerment Zones (EZs) and Renewal Communities (RCs)—impoverished communities designated by the Department of Housing and Urban Development—qualify for various tax benefits. There are currently 30 urban EZs and 40 urban and rural RCs.
- EZ and RC Tax Credits subsidize the hiring of employees who live and work in the designated area. Businesses operating in Empowerment Zones receive a credit equal to 20 percent of the first $15,000 in wages paid to a qualified employee, while the credit for Renewal Community businesses is equal to 15 percent of the first $10,000 of wages.
- Both EZ and RC businesses may claim an additional section 179 deduction of up to $35,000 on new investment in qualifying areas. Businesses in RCs may also use an accelerated method of recovering the cost of new or substantially rehabilitated buildings in the area. Businesses in both types of areas also qualify for tax-exempt bond financing.
- Investors in EZ businesses may roll over gains from the sale of EZ assets, and non-corporate taxpayers can exclude from taxable income 60 percent of the gain from the sale of stock in an EZ business that was held for more than 5 years. Gains from the sale of stock in a RC business that was held for more than five years are completely tax-exempt.
- The stimulus bill allocated $25 billion for Recovery Zone bonds that state and local governments may issue in 2009 and 2010. The tax-preferred bonds must support economic development within Empowerment Zones or areas with high rates of poverty, unemployment, or home foreclosures. Lending authority is allocated among the states based on 2008 employment losses.
- The New Markets Tax Credit allows investors to reduce their taxes by up to 39 percent of their equity investment in community development entities (CDEs), private funds that invest in low-income community businesses. The Treasury Department allocates credits to CDEs through a competitive process. The recent stimulus bill increased the equity limitation to a total of $5 billion for 2008 and 2009.
- Recent studies have questioned the efficiency of these incentives. Evidence suggests that employer-based tax credits subsidize behavior that would have occurred in their absence. Tax credits have low rates of participation and have not increased the employment rates of disadvantaged workers, though the few workers whose employers have participated in the program have had modest earnings increases. At the same time, the subsidies may induce investors to pursue opportunities in low-income communities rather than in other locations.
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Joint Committee on Taxation, "Estimated Budget Effects of the Revenue Provisions Contained in the Conference Agreement for H.R. 1, The 'American Recovery and Reinvestment Tax Act of 2009'' (JCX-19-09, February 12, 2009).
Joint Committee on Taxation, "Estimates of Federal Tax Expenditures for Fiscal Years 2008-2012" (JCS-2-08, October 31, 2008).
Altshuler, Rosanne, Leonard E. Burman, Howard Gleckman, Dan Halperin, Ben Harris, Elaine Maag, Kim Rueben, Eric Toder, and Roberton Williams, "Tax Stimulus Report Card: Conference Bill" (Tax Policy Center, February 13, 2009).
Government Accountability Office, "New Markets Tax Credits Appear to Increase Investment by Investors in Low-Income Communities, but Opportunities Exist for Better Compliance" (GAO-07-296, January 2007).
Hamersma, Sarah, "The Work Opportunity and Welfare-to-Work Tax Credits" (Tax Policy Center: Tax Policy Issues and Options No. 15, October 2005).
Internal Revenue Service, "Tax Incentives for Distressed Communities" (Publication 954, January 2004).
Authors: Paul Duncan, Carol Rosenberg, and Kim Rueben
Last Updated: April 28, 2009