Revelations last fall about the mismanagement of Iowa's film-tax-credit program came at a convenient time for the governor and the state legislature, as they provide an opportunity to evaluate tax credits at a time when the state budget is tight.
Governor Chet Culver has included two major cost-cutting features in the budget proposal he released last week: reorganizing state government (saving $341 million) and making changes to the state's more-than-two-dozen tax-credit programs (saving $52.5 million). The governor's budget proposal reads: "In Fiscal Year 2011, state tax credits are expected to cost the state $525 million if no legislative changes are made. ... [T]he Culver-Judge Administration believes that state tax expenditures must ... be scaled back in light of declining state revenues."
Culver did not specify how he wanted the legislature to achieve cost savings by $52.5 million, only referring to seven recommendations of his Tax Credit Review Panel, which released its report on January 8.
The legislature has one easy option to achieve the governor's cost-saving target. The review panel estimated that following its recommendations would result in first-year savings of $55.2 million and second-year savings of $106.3 million. Basically, lawmakers could rubber-stamp the report.
But this is also an opportunity for the state to re-think the way it does economic development through tax credits. If it's so inclined, the General Assembly could do a more-comprehensive overhaul of tax credits, making them better tools.
Easy Buttons
The review panel's budget-affecting recommendations are modest, including eliminating the transferability of the eight tax credits that presently allow it; capping seven currently uncapped tax credits; eliminating eight credits that are "not being fully utilized, are no longer necessary because of changing economic conditions or the availability of federal funds, have been improperly managed, or the resources for the credit have been exhausted"; and eliminating the refundability provision of the Research Activities Tax Credit.
The two film-related tax credits are among those recommended for elimination. The program, enacted in 2007, was meant to spur the state's film industry, and tax credits for $32 million were issued for 22 projects. In addition, the state remains on-the-hook for tax credits for projects that were under contract or approved before new applications were cut off in September; those could cost the state additional tens of millions of dollars.
A report issued in October faulted the film-tax-credit program for "incomplete or inadequate records," "inconsistencies with ... contracts," and several different types of non-qualified expenditures being used for tax-credit calculations, including out-of-state purchases, tax-credit-broker fees, deferred payments, and the salaries of directors, producers, and principal talent.
Whether plagued by lax management or corruption, it's a decent bet that the film tax credits are dead.
Senator Herman Quirmbach (D-Ames), an associate professor of economics at Iowa State University, said the legislature is likely to reduce the state's tax-credit expenditures in some fashion this session. "If we don't make the savings there, then we have to cut the budget someplace else," he said. "I think one or more bills will pass this year."
He added that any legislator who supported the film tax credits -- Quirmbach voted against them -- "is going to have to defend that vote. That's not a very comfortable position to be in. ... I think I would want to have it on my record that at least after the thing blew up I had the good sense to end it."
mp3 Audio interview with Senator Herman Quirmbach
Furthermore, he said, the film tax credit doesn't create permanent jobs in Iowa, and "that's what our taxpayers deserve."
Beyond the film tax credit, though, in a legislative session that's expected to be abbreviated, the legislature could easily avoid the larger questions of tax credits.
As David Roederer, executive director of the Iowa Chamber Alliance, said, "It appears to be more economic-driven than it is philosophical at this point."
Roederer said his organization is concerned that the state will eliminate or limit some tax credits without understanding the consequences. With "a tax credit, by definition, the money doesn't go back until there's an investment," he said. "I don't think the state gains anything by doing that [eliminating tax credits]. ... By saving some expense, you're losing a lot of income in the process."
In some ways, the review panel has already confirmed that answering the big questions about tax credits is impossible at this point. One of its seven major recommendations is to "develop an appropriate Return on Investment calculation for each tax credit." That's an admission that we don't know right now whether specific tax credits are good public policy, and how effective they are relative to each other.
In a survey of legislators representing Scott County (see sidebar), most Quad Cities lawmakers who responded wanted to wait before committing to dramatic changes. Several were even hesitant to give a concrete response to the review panel's relatively straightforward recommendations.
Tax credits are popular for a few reasons. First, they require that an investment be made before the benefit is collected. Second, they are often used to target certain industries or economic activities. So the state can use tax credits to try to lure advanced manufacturing, for instance.
But Ed Failor Jr., president of Iowans for Tax Relief, said tax credits prove that the state's tax structure discourages business investment. "It's an acknowledgment that our income-tax system is broken, a problem, and not the right way for government to get revenues and do business," he said. "We make it so that businesses in Iowa can't be competitive. So what we have to do is provide some income-tax credits."
Quirmbach agreed that tax credits are theoretically a bad idea: "In an ideal world, the government would just keep its hands off and let the market do what it will. ...
"[But] the ideal world isn't the way the real world works. [With] a state that took the pristine position of saying, 'We're not going to get involved in tax credits or grants or whatever,' every other state would stand up and applaud and then turn around and eat your lunch. ... If you're not willing to play that game ... then you're probably going to lose out."
So the question becomes: What tax credits should the state offer, and how are they best structured?
It's critical to keep in mind that while all tax credits might be worthy, they need to be considered in relation to each other. The state has a limited pool of economic-development incentives, and "the dollars that go into the film tax credit are dollars that don't go into other forms of economic development ... ," Quirmbach said.
So the "return on investment" information will be critical in the evaluation of what tax credits should be kept and which should be discarded. And in that way, legislators are right to take a wait-and-see attitude.
The business community will be against any major changes. Roederer claimed that the Iowa Chamber Alliance looked at six and a half years of tax-credit records from the Iowa Department of Economic Development, and "if you eliminate those which either didn't continue on or the companies went out of business," $667 million in tax credits were given for investment of more than $12 billion. "The proof is in the numbers," he said. "The bigger question is: Why aren't we doing more of this?"
mp3 Audio interview with Iowa Chamber Alliance Executive Director David Roederer
Beyond that muddying caveat ("those which either didn't continue on or the companies went out of business"), what Roederer can't say is whether the tax credits paid for themselves in terms of tax revenue. "I don't know anybody who has that number," he said.
And would that investment have happened without the tax credits? "Nobody knows for sure," he said.
Still, Roederer said that the Iowa Chamber Alliance opposes the legislative recommendations of the Tax Credit Review Panel, from eliminating transferability to putting a five-year sunset on credits to capping credits to eliminating the refundability of one credit to killing eight tax credits, including for film production.
Any of those changes, he said, would make the state less attractive to business.
A Course of Action
Given a shortened session, the complexity of tax issues, and business opposition, there are still reasonable reforms that could be made for tax credits beyond what has already been recommended, or instead of what has been recommended.
Quirmbach has several worthy ideas.
First, he said, treat refundable tax credits -- those in which the state could be writing checks -- more like the grants they are.
"A refundable tax credit isn't really a tax credit at all," he said. "It's a grant. A $100,000 refundable credit is worth $100,000 whether you owe a lot of tax or a little tax or no tax at all. ... That's not to say it's necessarily bad."
In grant programs, recipients have to apply, and there's follow-up to make sure recipients did what they were supposed to do.
What he's really talking about is effectively turning refundable tax credits into grant programs, with more oversight.
As Senator Shawn Hamerlinck (R-Davenport) said, "There are no provisions [safeguards] on the grant when you do it as a tax credit."
Second, Quirmbach said, the state should turn all transferable tax credits into refundable credits or grants.
"A transferable credit is a refundable credit that's refundable to somebody else," Quirmbach said. "I think that's clearly inferior. You could clearly make an improvement by taking every transferable credit and at minimum making it a refundable credit. ... All the money goes to people you're trying to create an incentive for."
The trouble with a transferable credit -- such as the historic tax credit that many surveyed legislators defended -- is bang for the buck. The recipient sells the tax credit for less than its full value, and often there's an intermediary further draining its value to the recipient. If it's a refundable credit, the full value goes to the recipient. Transferable credits are also difficult to claw back if there's a problem similar to those in the film-tax-credit program, while a refundable credit would make that slightly easier.
On the recommendation to eliminate the refundability of the research-activities tax credit, Quirmbach and Hamerlinck had different ideas.
Hamerlinck said that he would support eliminating the refundability but would like to allow companies to roll over the tax credit to the next tax year, so that they can still reap the benefit but without the state writing a check.
Quirmbach said he could envision retaining the refundability of the tax credit for companies with a gross income of less than $20 million a year. "I think it's important to keep the focus on the small startups that don't have other good sources of funding and startup capital," he said.
He also suggested that the refundability could be tied to capital investment -- the fruits of the research activity. If, for example, eligible research activities lead to a company building a new facility or hiring new workers or upgrading equipment, then the tax credit would be refundable.
The key to tax credits, Quirmbach said, is to structure them intelligently, to ensure that you can a get a return on your investment, and to exploit the state's strengths.
Much of that can still be done this legislative session.
For documents related to the tax-credit issue and audio interviews with Senator Herman Quirmbach and Iowa Chamber Alliance Executive Director David Roederer, visit RiverCitiesReader.com.
Sidebar: Legislative Survey
The River Cities' Reader surveyed the nine state legislators representing Scott County. Legislators were sent two e-mail messages -- on January 12 and January 27 -- requesting a response on the five review-panel proposals relevant to the legislature:
1) Eliminate the transferability provision for all tax credits.
2) Establish a five-year sunset for all tax credits
3) Cap all currently uncapped tax credits
4) Eliminate certain tax credits:
A) Assistive Device Tax Credit
B) Disaster Recovery Housing Project Tax Credit
C) Early Childhood Development Tax Credit
D) Economic Development Region Revolving Fund Tax Credit
E) Film, Television, and Video Project Promotion Expenditures Tax Credit
F) Film Television, and Video Project Promotion Investment Tax Credit
G) Venture Capital Tax Credit -- Qualified Business or Community-Based Seed Capital Fund
H) Venture Capital Tax Credit -- Venture Capital Funds
5) Eliminate refundability provision of research activities tax credit
The following legislators had not responded by press time to the two e-mail messages, or a follow-up phone call on February 2:
Representative Cindy Winckler (D-Davenport)
Senator David Hartsuch (R-Bettendorf)
Representative Elesha Gayman (D-Davenport)
Representative Phyllis Thede (D-Bettendorf)
The responses of other legislators are included here. Some legislators responded in writing; others responded by phone.
Senator Shawn Hamerlinck (R-Davenport)
1) "I don't want to eliminate the transferability within the historical-tax-credit program. That's essentially how the cash is grown ... . If you eliminate historical tax credits and the transferability of them, you will not have investment into historical buildings within our downtowns ... ." On transferability in general, he said: "On construction projects, I'm okay with transferability; outside of that, I'm against it."
2) Supports a sunset for tax-credit programs, saying that legislators can be held accountable for renewing the credits: "Absolutely. You make me vote of them."
3) Wants the historic tax credit uncapped, but otherwise wants a cost-benefit analysis for each credit. "We need to do that for all tax credits," he said. "That's something we should have been tracking for 30 years."
4) Hamerlinck is willing to get rid of the film tax credits but otherwise wants to see a cost-benefit analysis for each credit. "I would support a new film tax credit only if actual jobs are created within the state of Iowa," he said.
5) Generally opposes refundability for research activities, but wants companies to be able to roll over those tax credits over consecutive years.
Senator Joe Seng (D-Davenport)
1) No.
2) Yes.
3) No.
4) "I don't want to eliminate any of them."
5) No.
Seng said that until a good way to evaluate tax credits is established, he's not in favor of changing existing programs. "The methodology of deciding whether they're worth adding refundability has not to me been established yet," he said in response to the fifth question. About tax-credit programs in general, he said: "We haven't come up with a good way of evaluating these."
Representative Jim Lykam (D-Davenport)
Lykam responded in writing but did not specifically address the questions.
"These are some of the recommendations and I will continue to study them as we look at this issue.
"State of Iowa Tax Credit Review Report:
"1. Savings: Enacting the entire report would save $55.2 million in FY 11, and $106.3 million in FY 12.
"2. Major Recommendations:
"• Provide greater transparency by requiring the Revenue Estimating Conference to list the types and amounts of tax credit claims it is including in its Tax Receipts calculation.
"• Develop a better return on investment calculation for each tax credit.
"• Eliminate transferability for all tax credits.
"• Establish a five-year sunset for all tax credits.
"• Cap all business-related tax credits.
"3. Credit Specific Recommendations: In addition to these broad recommendations, the report made 37 recommendations regarding specific credits, including the Film Credit and the Assistive Device Credit; (b) Disaster Recovery Housing Credit; (c) Early Childhood Development Credit; (d) Economic Development Region Revolving Fund Credit; (e) Venture Capital Credit for a qualified business or community-based seed capital fund; and (f) Venture Capital Credit for venture capital funds.
"4. Research Activities Credit: This is one of the credits which has grown significantly in recent years. The report recommends eliminating the ability to get a refund for the credit amount exceeding tax liability, but then allow a five-year carry forward for corporations with more than $20 million in gross sales.
"Governors Budget:: The governor recommended reducing credits by 10% of their projected Fiscal Year 2011 costs -- which would be $52.5 million. He did not propose specific actions, but referred to the recommendations of the tax credit review.
"I do not yet have definite opinions on all the recommendations. I doubt that it will be possible to implement all recommendations -- as there will likely be a lack of support for some and others are so complex that it would be hard to make reforms this years. For example:
"• In general, it makes sensed to eliminate transferability of most credits -- but not all. In the case of the Historic Credit this may effectively eliminate them. Typically, a nonprofit entity applies for the Historic Credit and -- having no tax liability of its own -- sells the credit to finance the project.
"• Last session, the Legislature put a $185 million spending cap on certain credits awarded by the Department of Economic Development (DED). The report says put a cap on all credits -- but this may not work for credits that are not awarded by an agency but are available in the tax code to all eligible taxpayers. A cap would require waiting until all tax returns are filed so the cap can be prorated among all claims. For corporations which file on their own fiscal year with six month extensions allowed, it would be 18 months before early filers will find out how much of there claim will be honored.
"• The recommendations for community college job training programs include eliminating all bonding in favor of appropriations, limiting projects to certain targeted industries and applying wage and other criteria. This probably requires more than a few weeks to figure out. "
Representative Linda Miller (R-Bettendorf)
Miller responded in writing but did not address the questions specifically.
- "As tax credits and tax deductions are reviewed during the 2010 session, I think the beneficiaries of any 'savings' to the state treasury should be the taxpayers through broad based tax relief."
- "Iowans are dealing with job losses, employers are struggling to stay open and the last things they need are higher tax bills."
- "When a tax credit is capped or eliminated, someone's taxes are going up. The only entity that benefits from higher taxes is government. Raising taxes is not the answer to Iowa's budget problems."
"In mid-November, Governor Culver ordered a comprehensive review of Iowa's tax credit programs. Accordingly, on Friday, January 8, 2010, Governor Culver's hand picked seven-member tax credit review panel published their recommendations on how to reform Iowa's tax credit programs.
"The committee recommended that lawmakers make several changes to various tax credit programs as well as change how the agencies responsible for administering tax credits do so. If every recommendation the panel had made were implemented as is, the General Fund will grow by $55.2 million in FY11 and $106.3 million in FY12. Furthermore, Governor Culver in his Condition of the State address Tuesday appeared to endorse the panel's suggestions by urging lawmakers to adopt the recommendations this session.
"The panel recommendations and a summary of their rationale of why these changes are needed include :
"Provide Greater Transparency: The panel is recommending requiring the Revenue Estimating Conference to make available for public dissemination a list of the types and amounts of tax credit claims in its Tax Receipts calculation at each REC meeting. The panel proclaims that it is difficult to determine what is being spent on tax credits when the General Fund budget is printed.
"Develop a Return on Investment Calculation: The panel reports it is difficult to compare the costs and benefits of tax credit programs and that there is a lack of data available for many tax credit programs. As a result of this finding, the panel recommends that the State should determine whether the public investment produces greater business activity that the recipient engaged in and, if so, how much and for how long. According to the panel, this calculation should also take into consideration whether the tax credit produced a net increase in economic activity; and measure whether or not a tax credit achieved a particular behavior which it was intended to achieve when created.
"Eliminate the Transferability of Tax Credits: Currently, some tax credit programs allow entities that are awarded tax credits to sell (transfer) the tax credit, often at a discount; to a third party that then uses the full value of the credit when filing their Iowa taxes. The panel believes this practice is one factor that led to abuse in the film tax credit program and is proposing to eliminate it for all tax credits.
"Sunset Tax Credits Every Five Years: Currently, only a handful of tax credit programs have sunset provisions. The panel believes that requiring a sunset provision for every tax credit will allow lawmakers and the public to know which tax credits are accomplishing their intended goals and which ones are not.
"Cap Business Related Tax Credits: Last year the legislature placed a $185 million cap on five tax credit programs. Moreover, the panel recommends moving all business related tax credits to also be placed under this cap. The panel believes this is necessary for "predictability and stability" for the state budget.
"Eliminate Eight Tax Credit Programs: The panel suggests eliminating the following tax credit programs; Assistive Device Tax Credit, Disaster Recovery Housing Project Tax Credit, Early Childhood Development Tax Credit, Economic Development Region Revolving Fund Tax Credit, Film Television Promotion Expenditure and Investment Tax Credits, Venture Capital Qualified Business Tax Credit and Venture Capital -- Capital Funds Tax Credit. The panel believes these tax credits need to be terminated because either they are not working or they are not being utilized. However, legislative Democrats attempted to eliminate the Assistive Device Tax Credit last session, but the Governor disagreed and vetoed the proposal from the Standings Appropriations bill.
"Eliminate Refundability of Research Activities Tax Credit: The panel is proposing to eliminate the ability for a business that is eligible for the Research Activities Credit to claim an amount above their Iowa tax liability. When a tax credit is refundable, a recipient of that credit can claim the full amount of the credit regardless if their tax liability is below the amount of the tax credit. As a result, the recipient is eligible for a direct payment. The panel believes that the refund ability portion of the RAC is "not equitable" and makes the credit "more costly than comparable credits in surrounding states."
"In addition to the above recommendations, the panel recommended specific changes to many of the programs. You can access the complete report on the web by directing your web browser to the following address: http://www.dom.state.ia.us/tax_credit_review/files/TaxCreditStudyReviewReportFINAL1_8_2010.doc.
"It appears the legislature will act to make changes to Iowa's tax credit programs. During the first week of session, both the House and Senate Ways & Means committees spent a portion of their first meeting of the session receiving information on tax credits and discussing the panel's recommendations.
"While the panel made several recommendations, ultimately the legislature will review tax credit programs and make the changes they see fit. It is important for legislators to conduct an independent review of all tax credit programs to determine which one's are working and which one's are not. House Republicans believe that tax credit programs that are providing benefit to Iowa taxpayers should be maintained and those that are not should either be fixed or eliminated. Regardless of the result, House Republicans firmly believe that revenue generated by eliminating, capping or changing tax credits should not result in a windfall for the General Fund. Instead, it should be returned to the taxpayers thorough some type of tax relief.
Representative Steve Olson (R-DeWitt)
Olson did not respond to the questions specifically but gave a general response by phone.
He said tax credits should be reviewed individually to determine which are working: "Are there jobs being created from them?" he said.
He also said the transferability of tax credits needs to be reviewed.
Olson said he supported a five-year sunset for all tax credits.
"Transparency is key," he said.
Representative Cindy Winckler (D-Davenport)
"The tax-credit review process is one that I support. It is important that the legislature takes a periodic look at all tax credits and incentives. Our economy has changed since the mid-'90s when we started piecemeal tax-credit intitiatives. Tax credits are booked at about $500 million to $600 million each year. That is a lot of money to take out of our revenue stream without oversight. It is important that the legislature provide greater transparency and develop a process that assures that taxpayers receive a return on investment at least comparable to the potential loss of revenue."
1) "This needs to be determined on an individual basis. We need to determine if they are successful with transferability, and if their success would continue if they weren't transferable."
2) "This is a healthy idea in the beginning. Many tax credits are never reviewed after they are passed. Sunset might not be the right term, but there needs to be a consistent process to review tax credits."
3) "Credits are spending from revenue, instead of spending through the appropriations process. It is sound budgeting to know how much you are spending, and the impact on revenue."
4) "These tax-credit recommendation will be reviewed thoroughly in the Ways & Means committee. It is important that the user of these credits have an opportunity to weigh in. I will follow this process closely."
5) "The provision allows for a five-year carry-forward, which is a compromise. Giving carte blanche to corporations on their research activities is not transparency or accountability. We need to proceed carefully with this, but it is important to put some additional restrictions on this tax credit."
