A Comment on Reports by GAO and Senator Coburn
On August 11, 2014, two reports were released on the New Markets Tax Credit (NMTC), one by the Government Accountability Office (GAO) and another by Senator Tom Coburn (R-OK), respectively “Better Controls and Data are Needed to Ensure Effectiveness” and “Banking on the Poor.” Taken together, these two reports present an inaccurate and misleading picture of the NMTC.
GAO’s report reflects a limited understanding of the obstacles and challenges to investing in economically distressed communities. The report is less a thorough analysis of the NMTC than a series of suppositions and theories that are, in many cases, not supported by the data. While GAO arrives at recommendations that are not objectionable, the report itself provides little new or accurate information on the NMTC and the positive impacts NMTC investments have had in communities across the country.
The GAO report includes a number of recommendations, some of which Treasury is already implementing. Others are under consideration. Their overall aim is to improve efficiency and transparency in NMTC investments. The New Markets Tax Credit Coalition shares these goals and stands ready to work with Congress and the Treasury Department to ensure the NMTC continues to meet its goal of revitalizing the many urban neighborhoods and rural communities left out of the economic mainstream, and to do so in a cost-effective manner. Senator Coburn’s report simply rehashed his long-standing criticism of the NMTC, claiming that businesses that receive NMTC financing are examples of the federal government choosing favorites. At base, Senator Coburn objects to tax incentives to promote private sector investing in low income community revitalization efforts. However, that is the point of NMTC and there is ample evidence that this approach has been very successful and effective.
The NMTC is a tool that is available to economically distressed communities to promote revitalization through private sector investment by providing a modest incentive against federal income taxes. The projects financed by the NMTC were not selected by Washington bureaucrats, but by communities and investors with knowledge of local markets and a commitment to improving local economies.
Both the GAO report and Senator Coburn’s report ignore the impact of NMTC investments nationwide. Neither report reflects an understanding of what is necessary to rebuild our low income communities nor addresses the challenges of investing in economically distressed areas where the private market provides insufficient capital. The reports fail to describe the significant and tangible impacts that NMTC investments have made in terms of job creation and retention, access to affordable and healthy food, improved health care facilities, as well as jumpstarting the manufacturing sector.
One of the most glaring omissions is the failure to describe the role of the NMTC as the federal government’s single largest and most effective tool for community revitalization. The NMTC was enacted in 2000 as part of the Community Renewal Tax Relief Act. Since its inception, the NMTC has delivered more than $60 billion in capital to business and revitalization projects, and this financing has created over 744,000 jobs in some of the poorest rural and urban communities in America.
Finally, in its report, GAO misinterprets the manner in which this Credit attracts private capital. This results in an inaccurate analysis of the NMTC, which was further sensationalized in the Coburn report.
The following is an analysis of the claims made in the reports.
Coburn report: NMTC is duplicative of other federal programs.
FACT: The New Markets Tax Credit is unique in its targeting and purpose. The NMTC is designed to stimulate investment and economic growth in low income communities that are often overlooked by conventional capital markets. The NMTC is the only federal incentive that is primarily intended to drive capital to credit-starved businesses in economically distressed urban and rural communities. The Recovery Zone Bonds and Tribal Economic Development Bonds serve a similar purpose, but they both expired at the end of 2010 and had a narrow list of targeted communities. The increased Section 179 deduction for businesses within Empowerment Zones (EZs) allows businesses located in one of less than 100 low income communities to claim a larger deduction for certain assets (accelerated depreciation for capital expenditures), but the Section 179 deduction does not directly incentivize outside financing like the NMTC. The only other incentive that drives capital to businesses in low income communities is the Brownfields redevelopment program, but this incentive is narrowly targeted to areas needing environmental remediation.
According to the Community Development Financial Institutions (CDFI) Fund, which administers the Credit, more than 72 percent of NMTC businesses and projects are located in the poorest communities in the country. These ‘severely distressed’ communities have poverty rates of more than 30 percent, median incomes not exceeding 60 percent of the area median, or unemployment rates exceeding 1.5 times the national average. Developing and financing businesses and projects in those high distress communities is challenging in terms of infrastructure, the availability of other sources of private sector financing, and uncertain markets.
Recent cuts in federal community development spending – at HUD, USDA, Commerce, and Interior – have diminished the availability of federal subsidy in low income communities. Over the last 30 years, as measured as a share of GDP, federal community development spending has been reduced by 75 percent. For many communities, NMTC is one of the few sources of capital for revitalization.
GAO report and Coburn report: ‘Twinning’- the practice of combining federal tax credits to finance a project – allows investors to claim credits based on a value much higher than the amount of their own money invested in the project.
FACT: This contention is at odds with the facts. The NMTC is risk-based capital. Market rates for such capital are 6.5 to 13 percent or more annually. However, the NMTC, which is employed in communities that are economically distressed and lack many of the attributes of conventional markets, typically provides a rate of return at the low end of that range: 6 to 7 percent.
The GAO cites a case study profiled in the 2013 Urban Institute report that misinterpreted the details of the project’s financing, incorrectly stating that the pricing on the NMTC came to $0.45 per dollar of investment.
This error resulted in the GAO’s contention that one project ‘apparently’ provided investors with a 24 percent annual rate of return and that 83 percent of the qualified equity investment was provided by other state and federal tax credit programs. Due to confidentiality agreements, the GAO was not able to identify the project sponsor nor the investor, so there is not any data available to support this claim.
After making this assertion on the first page of their report, the GAO Report later concedes (page 13) that it lacks the evidence to make this claim, stating:
“…it is possible that the investor’s overall rate of return may have been lower and more in-line with market return.”
Here are the facts, according to the Urban Institute Report:
A large national bank invested $3,025,000 and, in exchange, the bank anticipated receiving $2.5 million in federal and state historic tax credits (HTC), and about $1.2 million in new markets tax credits. The combined equity pricing based on the credits – both NMTC and HTC – was about 82 cents per tax credit dollar.
It appears that the Urban Institute and the GAO assumed that the pricing of the historic tax credits was $1 per credit dollar, and assumed that the NMTC investment amount was 45 cents per credit dollar. This is not industry practice. When investors invest in a transaction with several differing tax benefits, they generally combine the benefits to determine the overall equity pricing of the transaction. At about 82 cents per tax credit the annual rate of return is likely closer to 5 percent, nowhere near the 24 percent rate claimed in the GAO report.
GAO report and Coburn report: A majority of NMTC projects (62 percent) involve the combining of the NMTC and other public funds.
FACT: Public funds represent a very small portion of total project financing flowing into NMTC projects.
Many NMTC projects combine several sources of private and public capital, however, this finding exaggerates the limited role played by public subsidies as a share of total NMTC project financing. In fact, according to the GAO’s own survey data, federal subsidies only accounted for a small share (17 percent) of total NMTC project financing in 2011 and 2012.
There is little evidence that the blending of NMTC with public subsidies increases the return to investors. However, it is clearly the case, as GAO concedes, that public investment is necessary to attract the private sector capital required to finance a project. Without the blending of public subsidies with the NMTC, the benefits of the Credit would not reach the poorest communities where the investment is most needed.
Coburn report: Singles out projects that are not representative of the NMTC program overall.
FACT: According to the NMTC Coalition’s most recent survey in 2013, the largest single use of NMTC was for financing manufacturing facilities, making up a quarter of the businesses financed. The report focuses a great deal of attention on hotels, but that asset class totals only 5 percent of total NMTC financing, and only 2.5 percent in 2013. Museums, another favorite target of the report, comprised less than 4 percent of the activity in 2013.
As noted previously, these projects were not selected by Washington, but by local communities and businesses. The 19 businesses and projects profiled in the Coburn report are in communities with high poverty and unemployment rates. NMTC financing delivered over $770 million to these communities. This financing also created more 7,500 jobs in cities and towns with an average unemployment rate of 11.7 percent and a poverty rate of 32.5 percent. While one may quarrel with individual projects, there is no question that these projects are located in communities of great need.
GAO Report and Coburn Report: Complex financial structures may mask whether the NMTC is truly needed in order to complete a project.
FACT: NMTC projects are located in some of the most severely distressed communities in the nation, where conventional financing is extremely difficult to secure. Without NMTC financing, these projects would not proceed. Moreover, as the GAO concedes in its report, investments in economically distressed communities by their nature require more complex financial structures.
- Using inconclusive data from an Urban Institute Study of NMTC projects financed during the first four years of the program (2003-2007), the GAO suggests that some NMTC projects may not require the subsidy for completion. The reality is that since 2007, as the NMTC program has matured, financing has shifted toward communities with higher levels of distress where conventional financing is much more difficult to secure. For example, in the timeframe analyzed by the Urban Institute report (2003-2007), 48.2 percent of NMTC projects were in communities with unemployment rates more than 1.5 times the national average. Between 2008 and 2011, the proportion of projects in these communities increased to 54.1 percent.
- In fact, the 2013 Urban Institute report cited by the GAO acknowledged that as the NMTC program matured, CDEs have applied a stringent “but-for” test and the percentage of projects receiving, but not specifically requiring NMTC financing to proceed, fell by 50 percent between 2003 and 2007. This trend was brought about by stricter program requirements placed upon CDEs by the Treasury Department, as well as an evolution in the application with an emphasis on providing non-traditional financing, targeting investments to severely distressed communities, and demonstrating the direct benefits to community residents.
- There can be no question that NMTC investments continue to go to the most economically distressed communities in America. According to the NMTC Coalition’s 2014 NMTC Progress Report, close to 80 percent of NMTC projects are located in severely distressed communities—those areas having high poverty rates, high unemployment rates, or very low median incomes.
GAO Report: NMTC projects that combine the NMTC and other public funds are over subsidized and could be completed with fewer subsidy dollars.
FACT: In making this claim, the Report fails to recognize three significant facts:
- The NMTC “but-for” test limits the amount of NMTC-generating financing necessary for financial feasibility. The NMTC typically provides “last-in” gap financing, meaning it is the last financing secured to make a project viable. CDEs and investors evaluate the sources and uses of available capital, the business plan of the enterprise in question, and its impact on the low income community in order to determine how much NMTC financing is needed to complete the project and maximize community impact.
- If additional subsidies are not needed, the project will not receive NMTC financing. The NMTC is a scarce resource, which CDEs deploy accordingly. CDEs have no incentive to provide more NMTC-backed financing than what is absolutely necessary to make a project viable. Only after all the financing from other sources is committed, and the impact is clear, does a CDE commit to provide NMTC financing.
- Intense competition and consideration of prior CDE performance incentivizes efficiency. In the most recent competition for Credits, the CDFI Fund received over $23 billion in applications for Credits, when only $3.5 billion was authorized for 2013. The allocation application includes questions related to prior performance of the applicant, including how past NMTC use has benefited low income businesses and distressed communities. The application requires applicants to quantify past loans and investments. If CDEs cannot demonstrate they have used NMTC financing wisely, they will not receive future allocations.
GAO Report and Coburn Report: NMTC fees and retentions are too high.
FACT: Under the law, CDEs are required to invest at least 85 percent of Qualified Equity Investments (QEIs) into projects. According to the GAO’s survey for 2011-2012, fees and retentions only totaled 7.1 percent of total NMTC Qualified Equity Investments (QEIs). The Urban Institute Report indicated that CDEs invested 97 percent of QEIs into businesses and projects. In other words, the two most recent reports on NMTC indicate that investment rates are well above the requirements established in law and regulation.
- GAO conclusions ignore the legitimate and necessary expenses CDEs incur. NMTC decision-making and most of the management duties associated with the NMTC are centered with CDEs. CDEs are responsible for a broad range of activities, including community education and outreach, working with investors, structuring and underwriting projects, establishing compliance monitoring systems, and meeting federal reporting requirements.
- In many cases, NMTC projects do not encounter a loan origination fee, which is unheard of in today’s market.
- Despite these challenges, the NMTC industry continues to work to reduce costs. There is evidence that transaction costs are dropping as the industry matures. For example, as the available capital to finance projects in low income areas has become increasingly scarce, CDEs are working together to jointly finance businesses and sharing documentation, resulting in lower legal and transaction-related fees.
- GAO acknowledges that the CDFI Fund has taken steps to improve the transparency of fees and retentions by requiring CDEs to provide businesses with a disclosure statement.
Coburn Report: “As a result of the definition of qualified low income communities, virtually all of the country’s census tracts are potentially eligible for the NMTC.”
FACT: Of the 74,134 census tracts in America, only 30,099 qualify (41 percent). Most NMTC projects are located in the poorest of those 30,099 census tracts. 29.5 percent of census tracts are designated as “severely distressed,” and according to the NMTC Coalition’s survey of 2013 NMTC projects, 80 percent of investments went to those severely distressed census tracts.
Coburn Report questioned the cost effectiveness of the NMTC.
FACT: The NMTC is not only good for communities, it pays for itself. In 2012, the New Markets Tax Credit Coalition prepared an analysis of actual NMTC transaction data from the inception of the program through 2010. The report, was the first of its kind and measured the aggregate impact of close to 3,000 NMTC-financed projects and businesses. The report also examined the extent to which federal tax revenue general by the individuals and businesses benefitting from NMTC investment offset the cost of the Credit to the federal government.
The report found that:
- These NMTC investments also generated over $5.3 billion in federal tax revenue and over $3 billion in state and local tax revenue between 2003 and 2010.
- The federal tax revenue generated by NMTC investments more than covers the cost of the program as measured in terms foregone federal tax revenue.
- Through 2010, NMTC investments directly generated over 124,000 operational (permanent) jobs. In 2010 alone, NMTC investments in operational activities generated almost $1.1 billion, easily offsetting the estimated $720 million cost of the program for the federal government and providing a 50 percent return on the federal investment.
Businesses may claim an increased deduction of up to the smaller of $35,000 or the cost of eligible property purchases (including equipment and machinery) for businesses in an EZ.