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INCREASE IN NEW MARKETS TAX CREDIT

Key Points

• The New Markets Tax Credit provides a non-refundable tax credit to individuals and corporations who purchase equity in entities that invest in low-income communities. Investors receive a non-refundable credit equal to 5 percent of the investment amount in each of the first three years following the initial investment, and a credit equal to 6 percent in years four through seven.  Credits in 2009 may count against the AMT.
• The stimulus plan would raise the limit on investment funds that receive tax benefits from $3.5 billion to $5.0 billion in 2008 and 2009 ─ an increase of $3.0 billion in tax-advantaged investment. The total investment generated for low-income communities would likely be significantly higher.
• Delivery of the benefits would likely take several years, and might not result in significant new aggregate investment
• JCT estimates that this provision would cost $815 million over 10 years.

Current Law

The New Markets Tax Credit (NMTC) was designed to stimulate the flow of capital into low-income and economically-distressed areas by providing investors with a tax incentive for investing in qualified Community Development Entities (CDEs). The CDEs, in turn, directly provide capital 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 the 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.

CDEs are certified by a branch of the Treasury, the Community Development Financial Institutions Fund (CDFI), and participate in a competitive process for the right to receive tax-preferred financing. A qualified CDE is an 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 2008, CDFI has authorized $19.5 billion in NMTC financing. 

Stimulus Proposal:

The stimulus proposal would increase the amount of allowable tax-preferred investment to $5 billion in calendar years 2008 and 2009, an increase of $1.5 billion in each year. Tax credits for investment in 2009, made after the date of enactment, could be claimed against the AMT. JCT estimates the 10-year cost of the provision would be $815 million.   

Discussion:

The goal of the NMTC is to increase the after-tax attractiveness of investment in low-income communities. Available only to investors buying equity in enterprises devoted to investment in economically-distressed communities, the Credit is designed to be narrowly-targeted towards those Census tracts with high poverty rates and/or lower levels of median income. Under the stimulus proposal, an additional $3.0 billion in investment in low-income communities will be granted tax-preferred status.

There are several reasons to doubt the ability of the Credit to act as an effective stimulus tool. For one, on net, the NMTC appears to have drawn capital away from other investments, without generating much new investment activity. A recent GAO study found that “the most likely effect of the credit is that corporate investors, which make the majority of investments in CDEs, are shifting investment into low-income communities from higher income communities” (GAO 2007). The study also concluded that the primary use of the allocations was to provide loans for the development of commercial real estate, while investment in business and entrepreneurs was less prevalent. Furthermore, Armistad (2005) found that a large proportion of census tracts ─ approximately 40 percent ─ are eligible as potential destinations for qualified investment, raising questions about the ability of the credit to help truly distressed areas.

At the same time, there are several reasons to be optimistic about the credit’s potential. Bershadker et al. (2008) found that the NMTC is an effective stimulant for investment in low-income communities, estimating that each $1 in federal tax expenditure for the program resulted in $14 in investment in low-income communities. The Governmental Accountability Office (2007) concluded that despite the broad criteria for eligibility, as noted above, poorer areas are more likely to be targeted for investment. And Armistead (2005) found that the NMTC was an effective means of making borrowing more accessible to investors and developers, dropping the cost of borrowing by 250 to 500 basis points.

The program failed to meet our criteria for an optimal stimulus. First, and most important, it will likely be slower in stimulating new investment than other stimulus proposals. Qualified entities must first apply for tax-preferred status, attract investors in the various investment projects, and then allocate funds for investment. Berkshadker et al. (2008) found that for a recent round of allocations, only 51.7 percent of the allocated capital has been raised within 19 months after being declared eligible for the program.

Second, as noted above, preliminary evaluations indicate that the credit has created little new aggregate investment. As a result, the NMTC may actually hurt broad-based economic growth if it draws capital away from more productive investments.

On the other hand,, the program may have merit if it results in increased economic activity in the nation’s most economically-distressed areas; those likely to have high unemployment rates and other related economic challenges. Despite the program’s broad definition of a distressed area, initial evaluations indicate that the program is an effective means of transferring capital to some of the nation’s areas most in need of aid.

Grade:  C+

The provision would take a long tune to have any effect and even then the effect would likely be small. It would direct tax benefits to communities likely to be most burdened by the economic downturn and would reduce borrowing costs for developers active in low-income communities. 

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