Provide New Tax Incentives for Regional Growth
Extend and modify the New Markets Tax Credit
The New Markets Tax Credit (NMTC) was designed to stimulate the flow of capital into low-income and economically distressed areas by giving investors a tax incentive to invest in qualified Community Development Entities (CDEs). The CDEs, in turn, provide capital directly to low-income areas by investing in projects or organizations located or operating in qualified census tracts. Investors receive a tax credit equal to 5 percent of the investment amount in each of the first three years following their initial investment, and a credit equal to 6 percent of the investment amount in each of the following four years. In total, investors receive a credit equal to 39 percent of the initial investment amount. Investors are required to maintain their investment in the CDE for the entire seven-year period. If the investment isn’t maintained, investors can no longer claim the credit, and income tax liabilities on the project will increase to recapture the credits previously received plus interest resulting from the underpayment of tax liability.
CDEs are certified by a branch of the Treasury, the Community Development Financial Institutions Fund (CDFI Fund), and participate in a competitive process for the right to receive tax-preferred financing. A qualified CDE is a corporation, partnership, or other entity that is engaged in the development of a low-income area, defined as a census tract with a poverty rate in excess of 20 percent, or with a median family income below the greater of the median income for metropolitan areas or statewide median income (only the latter criterion is used for non-metro areas). Qualifying CDEs must invest at least 85 percent of their tax-preferred financing in the development of a low-income community. CDEs may be community development banks, venture funds, or for-profit subsidiaries of community development corporations, among others. Through August 2011, the CDFI Fund had authorized $29.5 billion in NMTC allocation authority.
The American Recovery and Reinvestment Act (ARRA) increased the annual limit on allowable tax-preferred investment from $3.5 billion to $5 billion in 2008 and 2009 and allowed investors to claim the tax credits against the AMT in 2009.* The NMTC expired on December 31, 2011.
The president proposes extending the NMTC for two more years through 2013. The extension would allow for the higher allocation amounts implemented under ARRA—$5 billion per year—and would allow the NMTC to be creditable against the AMT. The administration estimates that the provision would cost $3.4 billion through 2022.
Government Accountability Office, New Markets Tax Credit: The Credit Helps Fund a Variety of Projects in Low-Income Communities, but Could Be Simplified.
Reform and Expand the Low-Income Housing Tax Credit
The Low-Income Housing Tax Credit (LIHTC) is the primary federal program to encourage the production of affordable rental housing for low-income households. The credit was originally enacted in the Tax Reform Act of 1986 to replace accelerated depreciation for low-income housing and made permanent in 1993. The administration projects that it will cost $39.3 billion between fiscal years 2013 and 2017.
The credit subsidizes the acquisition, construction, and rehabilitation of rental property by private developers. Developers may claim credits over 10 years equal to 70 percent of the qualified costs of a development project. The credit rate is reduced to 30 percent for projects receiving other federal subsidies or acquiring existing housing. To be eligible for credits, a project must satisfy various tests based on income of the residents and limitations on rent. State housing authorities administer the program and allocate the credits among eligible projects, subject to caps on the amounts of credit they may allocate.
The LIHTC serves a public policy goal of helping to increase the availability of affordable housing to low-income people, but some analysts have criticized it as being both complex and inefficient. Nonetheless, the credit has been popular over the years and has had bipartisan support.
The budget proposes a number of reforms and expansions the LIHTC, including: 1) encouraging mixed occupancy by allowing LIHTC-supported projects to elect a criterion employing a restriction on average income, 2) making the LIHTC beneficial to Real Estate Investment Trusts (REITs), 3) providing a 30-percent basis “boost” to properties that receive and allocation of tax-exempt bond volume cap and consume that allocation, and 4) requiring LIHTC-support housing to provide appropriate protection to victims of domestic violence. As a group, the proposals would cost $1 million in fiscal year 2012 and an additional $903 million over the subsequent decade.
The proposals have various rationalizations. The goal of the first proposal is to expand the income criteria to encourage more mixed-income housing, which is believed to help revitalize low-income communities. The second proposal seeks to expand the demand for the credit by enabling REIT shareholders to benefit from them. The third proposal seeks to increase incentives to invest in preservation projects, which now receive only a 30 percent credit. The fourth proposal seeks to ensure that buildings receiving federal subsidy through the LIHTC provide reasonable protections for victims of domestic abuse.
Designate Growth Zones
The Internal Revenue Code contains various targeted incentives to encourage the development of particular geographic regions, including empowerment zones and the Gulf Opportunity (GO) Zone. There are currently 40 empowerment zones—30 in urban areas and 10 in rural areas—that have been designated through a competitive application process in 1994, 1998, and 2002. State and local governments nominated distressed geographic areas, which were selected on the strength of their strategic plans for economic and social revitalization. The Secretary of Housing and Urban Development designated the urban areas while the Secretary of Agriculture designated the rural areas. In addition, the District of Columbia Enterprise Zone (DC Zone) was established in 1998, and the GO Zone was established in 2005 in the aftermath of Hurricane Katrina. Empowerment zone designations were retroactively renewed from December 31, 2009, to December 31, 2011, in the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. They have not yet been extended beyond December 31, 2011.
Businesses that operate in these zones are eligible for various incentives including tax credits for qualifying wages, additional expensing for qualified zone property, tax-exempt financing for some facilities, deferral of capital gains on sales and reinvestment in zone assets, and exclusion of 60 percent (rather than 50 percent) of the gain on the sale of qualified small business stock held more than five years. Eligibility for these credits requires that employees primarily live and provide services within the zone and that most of the business’s gross income comes from the active conduct of business within the zone. Residents of empowerment zones age 18–39 qualify as a targeted group for the work opportunity tax credit (WOTC). The DC and GO Zones provide additional targeted incentives.
The designation of empowerment zones expired at the end of 2011; some empowerment zones have been in effect for 17 years, and the Administration’s proposal would reassess where resources should be targeted to provide the most benefit going forward. The budget proposes a national competition for growth zone status from which the administration would designate 20 growth zones (14 in urban areas and 6 in rural areas). The designation and tax incentives would be in effect for five years from 2014 through 2018. The Secretary of Commerce would select the zones in consultation with the secretaries of Housing and Urban Development and Agriculture. These designations will be based on the strength of the applicant’s “competitiveness plan” and its need to attract investment and jobs.
Two tax incentives would apply to growth zones. Businesses that employ zone residents could claim employment credits that would be similar to the enterprise zone credit. The credit would equal 20 percent of the first $15,000 of wages for zone residents hired to work within the zone and 10 percent for those working outside of the zone. Second, qualified property placed in service within the zone would be eligible for additional first-year depreciation of 100 percent of the adjusted basis of the property. To evaluate the effectiveness of the growth zone program, the Secretary of the Treasury would collect data from taxpayers on the use of such tax incentives in each zone, and the Secretary of Commerce may require the nominating local government to provide other data on the economic conditions in the zones before and after designation. The growth zone program is expected to cost $3.6 billion from 2013 through 2017 but then raise revenues in subsequent years due to the loss of depreciation on assets previously expensed, reducing the net cost to $3.2 billion over the 2013–22 period.
If the federal government is going to provide incentives to develop specific geographic areas, it should periodically reevaluate designated areas using up-to-date information. However, there is little evidence that the earlier creation of Empowerment Zones has led to economic revitalization. Data limitations, including the inability to accurately measure where funds were utilized, make evaluation difficult. A GAO report found that while improvements in poverty, unemployment, and economic growth had occurred in these zones, econometric analysis could not tie these changes to the additional incentives available through the program. Indeed, the requirements for better data collection and tracking is due to limitations of earlier studies and an increased emphasis on the need to evaluate these programs.
GAO Briefing for Congress, March 12, 2010, “Information on Empowerment Zone, Enterprise Community, and Renewal Community Programs.”
Restructure Assistance to New York City: Provide Tax Incentives for Transportation Infrastructure
The Job Creation and Worker Assistance Act of 2002 provided tax incentives for the area in New York City damaged or affected by the terrorist attacks on September 11, 2001. This legislation created the “New York Liberty Zone” and provided various tax incentives to help lower Manhattan recover, including the Work Opportunity Tax Credit that provided a 40-percent subsidy in 2002 and 2003 on the first $6000 of annual wages for Liberty Zone employees, The legislation also provided various long-term investment tax incentives: 1) a special depreciation allowance for qualified property; 2) a five-year recovery period for depreciation of qualified leasehold improvement property; 3) $8 billion of tax-exempt private activity bond financing for certain property; 4) $9 billion of additional tax-exempt, advanced refunding bonds; 5) increased section 179 expensing; and 6) an extension of the replacement period to avoid taxation of gains on involuntary conversions that were due to the terrorist attacks.
State and local officials have recommended modifying the current tax incentives for investment to enhance the recovery of lower Manhattan. The Administration’s Budget proposes restructuring the tax incentives to improve transportation infrastructure, which should have a greater impact on the area’s development. The proposal would provide tax credits to New York State and New York City for expenditures to construct or improve transportation in or connecting to the Liberty Zone. The designation and authorization of projects would be split evenly between the city and the state. The tax credit would be in effect from 2013–22 with an annual limit of $200 million, which if not used fully in one year could be carried into subsequent years and beyond the 10-year budget horizon. . The administration estimates the 10-year cost of the program would be $2 billion.
*The $1.5 billion in additional allowable investment in 2008 was directed toward rejected applicants or those recipients who did not receive their full requested allocation.