Federal tax revenue losses for the New Markets Tax Credit (NMTC) were over $700 million for 2010 according to the Department of the Treasury. Congress enacted the NMTC in 2000 as part of an ongoing effort to revitalize impoverished, low-income communities. The Treasury Department's Community Development Financial Institutions (CDFI) Fund awards tax credits to Community Development Entities (CDE), who sell the credits to investors to raise funds. Investors can claim a tax credit over 7 years totaling 39 percent of their investment in a CDE. Through fiscal year 2008, CDE reported investing about $12 billion in 2,111 projects located in all 50 states, the District of Columbia, and Puerto Rico. In December 2010, Congress extended the NMTC for tax year 2010 and 2011. However, the complexity of NMTC transaction structures appears to make it difficult to complete smaller projects and often results in less equity ending up in low-income community businessesthe beneficiaries of NMTC financingthan would be the case if the program were simplified.
An alternative to the NMTC could be the use of a grant program, recognizing that Congress has turned to grant programs in similar cases. Such grants would eliminate the program's dependence on the market for tax credits and could reduce transaction costs.
Replacing the tax credit with a grant likely would increase the equity that could be placed in low-income businesses and make the federal subsidy more cost-effective. When CDE sell credits to investors to raise additional funds, the price investors pay for the credits reflects market conditions and the investors' attitudes toward risk. According to CDE representatives GAO interviewed in 2009, when the demand for NMTCs was highest, before the housing market collapse and 2008 credit crisis, the tax credits sold for $0.75 to $0.80 per dollar. Therefore, the federal subsidy intended to assist low-income businesses was reduced by 20 percent to 25 percent before any funds were made available to CDE. Representatives from CDE GAO interviewed also noted that with low demand for the tax credits, as was the case when GAO conducted its work during 2009, the credits generally sold for about $0.65 to $0.70 and have sold for as little as $0.50 or less. After accounting for CDE and other third-party fees, such as asset management and legal fees, about 50 percent to 65 percent of the federal subsidy generally reaches low-income businesses.
In a grant program, these up-front reductions in the federal subsidy could be largely avoided. If the grant program is well designed and at least as effective as the credit in attracting private investment, it could save a significant portion of the estimated $3.8 billion five-year revenue cost of the current program.
Congress has turned to grant programs in other cases where tax credits had formerly been used. For example, to fill funding gaps in Low-Income Housing Tax Credit projects, under the American Recovery and Reinvestment Act of 2009, Congress offered the option of allowing state housing finance agencies to exchange Low-Income Housing Tax Credits for federal grants to subsidize low-income rental housing.
However, CDFI officials were concerned that a grant may not channel a greater portion of the federal subsidy to intended recipients than the tax credit and a grant program could have administrative costs or other effects that would reduce its desirability.
As stated in its January 2010 report, GAO continues to believe that Congress should consider offering grants in lieu of credits to CDE if it extends the program again. Doing so would help ensure that the maximum amount of capital ends up in low-income community businesses. If it does so, Congress should require Treasury to gather appropriate data to assess whether and to what extent the grant program increases the amount of federal subsidy provided to low-income community businesses compared to the NMTC; how costs for administering the program incurred by the CDFI Fund, CDE, and investors would change; and whether the grant program otherwise affects the success of efforts to assist low-income communities. One option would be for Congress to set aside a portion of funds to be used as grants and a portion to be used as tax credit allocation authority under the current structure of the program to facilitate comparison of the two program structures. Such a study could help resolve uncertainties about the relative effectiveness of grants and the tax credit in promoting economic development. Although eliminating the tax credit would increase federal revenues, replacing the NMTC with a grant would introduce outlay costs. However, given that the federal subsidy to low-income community businesses was reduced by 20 percent to 25 percent up front even when the price paid by investors to claim NMTC was at its highest and transaction costs due to the credit's structure can be substantial, the grant could result in a similar amount of investment in low-income communities at a lower overall cost to the federal government.
The information contained in this analysis is based on the related GAO product listed under the "Related GAO Products" tab.
For additional information about this area, contact James R. White at (202) 512-9110 or firstname.lastname@example.org.
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