This is the accessible text file for GAO report number GAO-07-296 
entitled 'Tax Policy: New Markets Tax Credit Appears to Increase 
Investment by Investors in Low-Income Communities, but Opportunities 
Exist to Better Monitor Compliance' which was released on January 31, 
2007. 

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Report to Congressional Committees: 

United States Government Accountability Office: 

GAO: 

January 2007: 

Tax Policy: 

New Markets Tax Credit Appears to Increase Investment by Investors in 
Low-Income Communities, but Opportunities Exist to Better Monitor 
Compliance: 

GAO-07-296: 

GAO Highlights: 

Highlights of GAO-07-296, a report to congressional committees 

Why GAO Did This Study: 

The Community Renewal Tax Relief Act of 2000 authorized up to $15 
billion of allocation authority under the New Markets Tax Credit (NMTC) 
to stimulate investment in low-income communities. The act mandated 
that GAO report on the program to Congress by January 31, 2004, 2007, 
and 2010. Two subsequent laws authorized an additional $1 billion in 
NMTC authority for certain qualified investments and extended the 
program for 1 year with an additional $3.5 billion of authority. 

This report (1) describes the status of the NMTC program, (2) profiles 
NMTC program participants, (3) assesses the credit’s effectiveness in 
attracting investment by participating investors, and (4) assesses IRS 
and the Community Development Financial Institutions (CDFI) Fund 
compliance monitoring efforts. To conduct the analysis, GAO surveyed 
NMTC investors, conducted statistical analysis, and interviewed IRS and 
CDFI Fund officials. 

What GAO Found: 

As of January 2007, the CDFI Fund had awarded $12.1 billion of NMTC 
authority to 179 Community Development Entities (CDE). CDEs that 
received allocations began making NMTC investments in 2003, and the 
program has continued to grow since then. Investors use two main 
investment structures to make NMTC investments: direct investments to 
CDEs and tiered investments, which include equity investments and 
leveraged investments, where a portion of the investment amount 
originates from debt and a portion from equity. 

Banks and individuals constitute the largest proportion of NMTC 
investors, though banks and other corporations have made the largest 
share of NMTC investment. CDEs that received allocations applied for 
allocations in a competitive selection process and, through fiscal year 
2005, most investment from CDEs to low-income communities had been used 
for either commercial real estate rehabilitation or new commercial real 
estate construction. 

Figure: NMTC Loans and Investment by Type of Activity for Fiscal Years 
2003 through 2005: 

[See PDF for Image] 

Source: GAO analysis of CDFI Fund data. 

[End of Figure] 

The results of GAO’s survey and statistical analysis indicate that the 
NMTC may be increasing investment in low-income communities by 
participating investors. Investors indicated that they have increased 
their investment budgets in low-income communities as a result of the 
credit, and GAO’s analysis indicates that businesses may be shifting 
investment funds from other types of assets to invest in the NMTC, 
while individual investors may be using at least some new funds to 
invest in the NMTC. 

The CDFI Fund and IRS developed processes to monitor CDEs’ compliance 
with their allocation agreements and the tax code. However, IRS’s study 
of CDE compliance does not cover the full range of NMTC transactions, 
focusing instead on transactions that were readily available, and may 
not support the best decisions about enforcement in the future. 
Moreover, IRS and the CDFI Fund are not collecting data that would 
allow IRS to identify credit claimants and amounts to be claimed. 

What GAO Recommends: 

To ensure that it is reviewing the full range of NMTC transactions, IRS 
should develop information for selecting which CDEs to audit as part of 
its compliance study. In addition, IRS should work with the CDFI Fund 
to further explore options for cost effectively monitoring investor 
compliance. 

IRS and the CDFI Fund agreed with our recommendations. 

[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-07-296]. 

To view the full product, including the scope and methodology, click on 
the link above. For more information, contact Michael Brostek at (202) 
512-9110 or brostekm@gao.gov. 

[End of Section] 

Contents: 

Letter: 

Results in Brief: 

Background: 

CDEs Are Using NMTC Allocations to Invest in Low-Income Communities, 
and the CDFI Fund Is Tracking Program Implementation: 

Financial Institutions and Individuals Are the Primary NMTC Investors, 
and CDEs Most Often Use NMTC Investments to Make Loans to Qualified 
Businesses: 

NMTC Investors Report That the NMTC Increases Investment in Low-Income 
Communities and Statistical Analysis Indicates That These Investments 
May Be Financed by Shifting Assets from Other Uses and Some New 
Investment: 

IRS and the CDFI Fund Monitor NMTC Compliance, but Additional 
Opportunities Exist to Better Measure Noncompliance and Identify NMTC 
Investors: 

Conclusions: 

Recommendations for Executive Action: 

Agency Comments: 

Appendix I: Objectives, Scope, and Methodology: 

Appendix II: Description of Data and Methodology for Statistical 
Analysis of the Effect of NMTC Participation on Investment: 

Appendix III: NMTC Investment Data by State, Fiscal Years 2003 through 
2005: 

Appendix IV: Comments from the Community Development Financial 
Institutions Fund: 

Appendix V: Comments from the Internal Revenue Service: 

Appendix VI: GAO Contact and Staff Acknowledgments: 

Tables: 

Table 1: NMTC Allocation Rounds: 

Table 2: NMTC Claimant Types: 

Table 3: Reasons NMTC Investors Invested in the NMTC Program (in 
Percentages): 

Table 4: Investor Knowledge of CDE Operations (in Percentages): 

Table 5: NMTC Allocations Awarded by Round: 

Table 6: CDEs That Applied for NMTC and Received Allocations by Round: 

Table 7: Top 10 States by NMTC Dollars through Fiscal Year 2005: 

Table 8: Effects of NMTC Individual Investor Participation on Wealth: 

Table 9: Growth in Net Assets Using Fixed Effects Regression and 
Comparisons Based on Nearest Neighbor Propensity Score Matching: 

Table 10: Baseline Analysis: Instrumental Variables Fixed Effects 
Regressions on the Full Sample: 

Table 11: Growth in Assets: Comparisons Based on Nearest Neighbor 
Propensity Score Matching: 

Figures: 

Figure 1: NMTC Process for Using Allocated Tax Credits to Make 
Qualified Low-Income Community Investments: 

Figure 2: NMTC Eligible Areas: 

Figure 3: Number of CDE Allocations by Round (Calendar Year): 

Figure 4: Qualified Equity Investment by Calendar Year: 

Figure 5: Comparison of NMTC Investment Structures: 

Figure 6: Interaction of CDFI Fund NMTC Data Collection Systems: 

Figure 7: NMTC Loans and Investment by Type of Activity for Fiscal 
Years 2003 through 2005: 

Figure 8: NMTC Dollars Used in Loans with Better Rates and Terms: 

Figure 9: NMTC Investors Packaging the NMTC with Other Government 
Incentives: 

Figure 10: Activities Investor Survey Respondents Undertake to Monitor 
CDE Compliance: 

Abbreviations: 

AAS: Allocation Agreement System: 

ATS: Allocation Tracking System: 

BRTF: Business Returns Transaction File: 

CDE: Community Development Entity: 

CDFI: Community Development Financial Institutions: 

CIIS: Community Investment Impact System: 

CPI: Consumer Price Index: 

CRA: Community Reinvestment Act: 

FCOS: Financial Counseling and Other Services: 

FEMA: Federal Emergency Management Agency: 

GO Zone: Gulf Opportunity Zone: 

HUB Zone: Historically Underutilized Business Zone: 

ILR: Institution Level Report: 

IRS: Internal Revenue Service: 

IRTF: Individual Returns Transaction File: 

MOU: memorandum of understanding: 

NCMS: New Markets Compliance Monitoring System: 

NMTC: New Markets Tax Credit: 

SBA: Small Business Administration: 

SCF: Survey of Consumer Finances: 

TIN: Taxpayer Identification Number: 

TLR: Transaction Level Report: 

QALICB: qualified active low-income community business: 

QEI: qualified equity investment: 

QLICI: qualified low-income community investment: 

United States Government Accountability Office: 
Washington, DC 20548: 

January 31, 2007: 

Congressional Committees: 

Congress established the New Markets Tax Credit (NMTC) program in the 
Community Renewal Tax Relief Act of 2000[Footnote 1] as part of an 
ongoing effort to address one of our nation's most persistent 
challenges--the revitalization of impoverished, low-income communities. 
Conventional access to credit and investment capital for developing 
small businesses, retaining jobs, and revitalizing neighborhoods is 
often limited in economically distressed communities or in communities 
with large low-income populations. The NMTC provides investors 
(individuals, financial institutions, other corporations, etc.) with a 
tax credit for investing in communities that are economically 
distressed or consist of low-income populations. 

Currently, the Community Development Financial Institutions (CDFI) Fund 
in the Department of the Treasury is authorized to allocate up to $19.5 
billion[Footnote 2] in tax credit authority to Community Development 
Entities (CDE) that manage NMTC investments in low-income community 
development projects. CDEs are domestic corporations or partnerships 
with a primary mission of serving or providing investment capital for 
low-income communities or low-income persons. Tax credit authority is 
the amount of investment for which investors can claim a tax credit at 
rates that total, over the 7 years they can claim the credit, 39 
percent of their investment. In return for the tax credit, investors 
supply capital to the CDEs, which, in turn, make investments in 
qualified low-income communities. 

The Community Renewal Tax Relief Act of 2000 mandated that we report to 
Congress on the NMTC program by January 31, 2004, 2007, and 2010. In 
our report issued January 30, 2004,[Footnote 3] we described the status 
of the NMTC program, profiled CDEs that received first round 
allocations (there have now been four rounds of NMTC allocations), and 
evaluated whether the systems were in place or planned in order to 
ensure NMTC compliance. We concluded progress was being made in 
implementing the NMTC program, but we also recommended that Internal 
Revenue Service (IRS) and the CDFI Fund work together to develop plans 
for designing and implementing compliance monitoring processes. IRS and 
the CDFI Fund agreed with our recommendation and have taken steps to 
design and implement compliance monitoring processes. 

Based on consultations with staff at cognizant congressional 
committees, this report (1) describes the status of the NMTC program; 
(2) profiles the characteristics of NMTC investors, the CDEs that 
receive NMTC allocations, and the businesses and communities that 
receive NMTC investments; (3) assesses how effective the NMTC has been 
in bringing new investment to low-income communities by the investors 
that have participated in the program; and (4) assesses the steps that 
IRS and the CDFI Fund are taking to ensure CDEs and investors are 
complying with the NMTC and evaluates how effective these steps have 
been. 

To accomplish these reporting objectives, we met with officials from 
the CDFI Fund and IRS. We collected documents on the program's status 
and efforts to monitor NMTC compliance. We also analyzed data from the 
CDFI Fund on the CDEs and their investment in low-income communities 
and tax return data from tax years 1997 through 2004 for investors in 
the NMTC program. We used these data to report summary statistics that 
profile the participants in the program and to conduct statistical 
analysis that measures the effect of the NMTC on investment by 
participating investors. In our statistical analysis, we compared a 
stratified random sample of taxpayers that did not make NMTC 
investments with investors that did make NMTC investments using fixed- 
effects regressions and comparisons based on other statistical methods 
to measure the effect of the NMTC on corporate investors' growth in net 
assets and individual investors' growth in wealth. We also surveyed 
investors in the NMTC program in order to provide additional 
information on the effect of the credit and characteristics of the 
investors. Our overall response rate was 51 percent. We weighted our 
survey responses using information on investor type and investor size 
to reduce possible nonresponse bias that is associated with investor 
type and size. Results from our statistical analysis and the survey are 
limited to the effects of NMTC investments on the investment choices of 
participating investors and do not assess the effect of this investment 
on the investments by non-NMTC participants in low-income communities. 
Our scope and methodology section (app. I) provides additional details 
on how we did our work. 

Our work was conducted from July 2006 through December 2006 in 
accordance with generally accepted government auditing standards. In 
December 2006, we requested written comments on a draft of this report 
from the Director of the Community Development Financial Institutions 
Fund and the Commissioner of the Internal Revenue Service; 
their comments are reprinted in appendices IV and V. 

Results in Brief: 

Since the CDFI Fund made its first allocations in 2003, the NMTC 
program has grown in terms of the amount of tax credit authority 
allocated to CDEs, the complexity of NMTC investments, and the amount 
of money invested in low-income communities. As of January 2007, the 
CDFI Fund had made 233 NMTC allocation awards totaling $12.1 billion in 
allocation authority to 179 CDEs--some CDEs have received multiple 
allocations--which the CDEs have used to attract nearly $5.3 billion in 
NMTC investment. These CDEs with allocation awards are required to 
attract investment sufficient to use the remaining $6.8 billion of 
allocation authority in the coming years. The total amount per year 
invested by these CDEs in low-income communities grew from about $140 
million in 2003 to $2.2 billion in 2005. As the NMTC program has grown, 
more investors have participated in more complicated NMTC investment 
structures, such as tiered investments, which include both equity 
investments and leveraged investments. The CDFI Fund has developed data 
systems that track allocation agreements (which set forth conditions 
such as approved uses of the allocations and approved service areas), 
allocated credits, and collected data about investors, the CDEs, and 
their investments in low-income communities. The CDFI Fund combines 
data from these systems to monitor compliance with allocation 
agreements and to help IRS determine whether laws and regulations are 
being observed. All of these systems were operational in time to meet 
the CDFI Fund's needs. 

Banks and individuals constitute the majority of NMTC claimants, 
accounting for 70 percent of NMTC claimants through 2006, though banks 
and other corporations account for the largest share of NMTC 
investment. Banks and other corporations that invested in the credit 
had relatively large net assets, and individuals who invested in the 
NMTC had, on average, higher incomes than other taxpayers. Most 
investors made only one investment in a CDE: 55 percent of investors 
made a single investment while 12 percent made five or more 
investments. The CDEs applied for far more allocation dollars than were 
available. They received only about 11 percent of $107 billion in 
allocation authority for which they applied. Data reported through 
fiscal year 2005 indicate that businesses in low-income communities 
received investments from CDEs to fund over 580 NMTC projects, totaling 
over $3 billion of investment. The projects were funded primarily by 
loans from the CDEs and were used chiefly to finance commercial real 
estate construction and rehabilitation. The communities where the 
investment projects were located were dispersed across states and about 
90 percent were located in areas designated as "areas of high distress" 
because of factors such as low median incomes or high unemployment 
rates. 

The results of our survey and statistical analysis are consistent with 
the NMTC program increasing investment in eligible low-income 
communities by the investors that participate in the program and with 
this investment coming primarily from funds shifted from other uses. 
Such a shift would be one indicator that the NMTC program is effective 
because the NMTC sought to increase investment in eligible low-income 
communities. An estimated 64 percent of the NMTC investors reported 
that they increased the share of their investment budget for low-income 
communities because of the credit. One limitation of our survey is that 
the population of NMTC investors we surveyed benefit from claiming the 
credit and have an interest in ensuring that the NMTC program continues 
in the future. However, in many cases the survey also indicated that 
the credit alone may not have been sufficient to justify the investment 
and meeting other government regulations may be an important incentive 
for making NMTC investments. Any increased investment in low-income 
communities because of the credit can occur when NMTC investors make 
new investment by increasing their total funds available for investment 
or when they shift funds from other uses in higher income communities. 
Our statistical analysis suggests that in general corporate NMTC 
investors are not increasing their overall level of investment to 
participate in the NMTC program. Taking this information together with 
information from our survey of investors, we infer 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. Our statistical 
analysis indicates that unlike corporate investors, participating 
individual investors as a group appear to be making at least some new 
investment to participate in the NMTC program. This finding that 
corporate and individual NMTC investors appear to be increasing 
investment in low-income communities is not, in and of itself, 
sufficient to determine that the credit is effective. For example, it 
was beyond the scope of our analysis to determine whether investment by 
NMTC investors reduced such investments by non-NMTC investors. A 
complete evaluation of the program's effectiveness also requires 
determining the costs of the program, including any behavioral changes 
by taxpayers that may be introduced by shifted investment funds. In 
addition, such an evaluation requires an assessment of the program's 
economic and social benefits. For example, to the extent a community 
experiences a reduction in poverty and increases in employment 
opportunities as a result of the program, possible "spillover" benefits 
to the community may include reductions in crime and improvements in 
the health status of community residents. The CDFI Fund is working with 
a contractor to develop plans for a comprehensive evaluation of the 
NMTC, which may include evaluating the program's effectiveness. 

IRS and the CDFI Fund have taken steps to monitor compliance with the 
requirements of the NMTC program, but additional opportunities exist to 
better measure noncompliance and identify NMTC investors. IRS is 
conducting a compliance study focusing on whether CDEs comply with the 
"substantially all" test imposed by the Internal Revenue Code, which 
requires that CDEs invest at least 85 percent of a qualified equity 
investment (QEI) in a low-income community within 1 year of receiving 
the investment. However, because CDEs did not file initial returns as 
soon as IRS expected, IRS was not able to select CDEs to audit in a way 
likely to produce findings that are representative of the full range of 
CDE activity. However, as the program expands and more CDEs make NMTC 
investments, IRS should have more CDEs to choose from when selecting 
CDEs to audit for its compliance study, and IRS could use CDFI Fund 
data to aid in developing criteria for selecting which CDEs to audit. 
The CDFI Fund is focusing on ensuring that CDEs fulfill their 
allocation agreement requirements. The CDFI Fund monitors CDE 
compliance primarily through its data systems and, to a lesser extent, 
by making site visits. The data systems are designed to enable the CDFI 
Fund to identify when a CDE falls out of compliance with its allocation 
agreement. However, neither IRS nor the CDFI Fund currently have 
sufficient information to enable the IRS to identify NMTC investors and 
the amount of credit that the investors are entitled to claim, 
particularly when the original investments are sold to others. CDEs may 
be a useful source of information because they need to know who their 
investors are, even when investments are sold, in order to submit 
appropriate reports to those investors. If IRS or the CDFI Fund 
developed ways to identify investors and the amounts they invested, 
even when NMTC investors sell their equity share in a CDE after the 
original investment is made, the IRS would be better able to ensure 
that credits are claimed correctly. 

To ensure that IRS is reviewing the full range of NMTC transactions and 
that the conclusions of its compliance study are more representative of 
all CDEs with NMTC allocations, we recommend that IRS use CDFI Fund 
data and the results of its current NMTC compliance study to develop 
criteria for selecting which CDEs to audit as part of its future 
compliance monitoring efforts. Additionally, to ensure that eligible 
taxpayers claim the correct amount of NMTC on their tax returns and IRS 
is able to identify all tax credit claimants in the event of a CDE 
falling out of compliance with NMTC regulations, we recommend that IRS 
work with the CDFI Fund to further explore options for cost effectively 
monitoring investor compliance and developing a way to identify NMTC 
claimants, even in instances where the original investor sells its 
equity share in a CDE, and the amount of NMTC investment that investors 
made. In commenting on this report, both the Acting Director of the 
CDFI Fund and the Commissioner of Internal Revenue agreed with our 
recommendations (their responses are reprinted in appendices IV and V). 

Background: 

As we noted in a past report, the NMTC was created in an effort to 
increase the amount of capital available to low-income 
communities,[Footnote 4] facilitate economic development in these 
communities, and encourage investment in high-risk areas.[Footnote 5] 
In order to achieve these goals, the program allows investors that 
provide eligible capital to low-income communities and businesses to 
reduce their tax liability by 39 percent of the amount of the 
investment over a 7-year period. 

The NMTC Investment Process: 

The process of making an NMTC investment involves several steps and a 
number of stakeholders. Before applying for an NMTC allocation, the 
applicant must apply for and be certified as a CDE, which is an entity 
that manages investments for community development.[Footnote 6] Once an 
organization has been certified as a CDE by the CDFI Fund, it is then 
eligible to apply for an NMTC allocation. 

Both for-profit and nonprofit CDEs may apply for and receive NMTC 
allocations (once a CDE is awarded with an allocation, it is often 
referred to as an allocatee). However, only a for-profit CDE can offer 
NMTCs to investors. Therefore, when a nonprofit CDE receives an NMTC 
allocation, it must transfer the allocation to one or more for-profit 
subsidiary CDEs (referred to as suballocatees). NMTC applicants submit 
standardized application packages in which they respond to a series of 
questions about their track records, the amounts of NMTC allocation 
authority being requested, and their plans for using the tax credit 
authority. 

The CDFI Fund staff and a group of external reviewers who have 
experience in business, real estate, and community development finance 
then review the applications and score them based on the following four 
areas: (1) community impact, (2) business strategy, (3) capitalization 
strategy, and (4) management capacity. The applicants can receive a 
score of up to 25 points in each of the areas, and CDEs can obtain up 
to 10 additional "priority points" for demonstrating that they have 
track records of successfully investing in low-income communities and/ 
or that they intend to invest in unrelated entities. After being 
reviewed and scored by three different reviewers (and, in some cases, a 
fourth reviewer if a scoring anomaly exists), the applicants are ranked 
and NMTC allocation awards are made in descending order of the highest 
aggregate scores to applicants that met minimum thresholds in each of 
the four areas.[Footnote 7] The CDFI Fund makes award determinations in 
this order until the allocation authority is exhausted. The CDFI Fund 
also provides a written debriefing to each CDE that does not receive an 
allocation in order to provide them with reasons their application did 
not receive an NMTC award and to provide the CDE with suggestions on 
how to be more competitive for NMTC awards when applying in future 
rounds. 

As figure 1 shows, after the allocations are made to the CDEs, 
investors make equity investments, by acquiring stock or a capital 
interest, in the CDEs to receive the right to claim tax credits on a 
portion of their investment.[Footnote 8] In turn, the CDE must invest 
"substantially all"[Footnote 9] of the proceeds into qualified low- 
income community investments (QLICI). Eligible investments include, but 
are not limited to, loans to or investments in businesses to be used 
for developing residential, commercial, industrial, and retail real 
estate projects; and purchasing loans from other CDEs. 

Figure 1: NMTC Process for Using Allocated Tax Credits to Make 
Qualified Low-Income Community Investments: 

[See PDF for image] 

Source: GAO. 

[A] Only a for-profit CDE can receive qualified equity investment from 
NMTC investors. These CDEs can then make investments in other CDEs that 
could be for-profit CDEs or nonprofit CDEs or they can directly invest 
the NMTC funds in low-income communities. However, both for-profit and 
nonprofit CDEs can receive allocations from the CDFI Fund. If a 
nonprofit CDE receives a NMTC allocation from the CDFI Fund, it must 
transfer the allocation authority to a for-profit CDE before NMTC 
investments can be made. 

[End of figure] 

Once a qualifying investment has been made in a CDE and the CDE has 
invested the funds in an eligible low-income community, the investor 
can claim the tax credit over the course of 7 years. In addition, 
equity investors may receive returns on their investments in the form 
of dividends or other income that they receive from the CDE during the 
period in which they are eligible to claim the credit. The NMTC 
investor is still usually allowed to claim the NMTC for the full 7-year 
period even if the business that the CDE provides investment to 
defaults on its loans or files for bankruptcy. However, in the case of 
a business that receives NMTC funds going bankrupt, the ability of the 
investor to recover its initial equity investment in a CDE would depend 
on the assets and financial condition of the CDE as well as the 
original agreement that the CDE entered into with the investor. 

The NMTC is a nonrefundable tax credit, meaning that taxpayers do not 
receive payments for tax credits that exceed their total tax liability. 
In addition, taxpayers that are eligible to claim the tax credit may 
sell their investment, along with the right to claim any remaining tax 
credits, to another investor after the initial NMTC investment. For 
example, an investor may make an equity investment in a CDE that would 
allow it to claim the credit and then sell its equity share in the CDE 
to another investor, thereby transferring the right to claim the 
remaining credits to this investor. The original investor may choose to 
sell its equity share in a CDE, and consequently its right to claim the 
credit, because it does not have a tax liability for that year or other 
reasons, such as the timing of the original investment.[Footnote 10] 

Once investors begin claiming the credit on their tax returns, three 
things can trigger a recapture event (meaning that the investor will no 
longer be able to claim the credit because the investment no longer 
qualifies for NMTCs). The NMTCs can be subject to a recapture if the 
CDE (1) ceases to be certified as a CDE, (2) does not satisfy the 
"substantially all" requirement, or (3) redeems the investment. In 
general, a recapture event means that the investors that originally 
purchased the equity investment and subsequent holders of the 
investment are required to increase their income tax liability by the 
credits previously claimed plus interest for each resulting 
underpayment of tax. 

Legislative Changes Created Targeted Populations: 

Two recent legislative changes have increased the number of areas where 
NMTC investments can be made. First, the American Jobs Creation Act of 
2004[Footnote 11] added "targeted populations" to the eligibility 
criteria for NMTC investments. Second, Congress also expanded the NMTC 
program in 2005,[Footnote 12] providing an additional $1 billion of 
allocation authority to be made available to CDEs with a significant 
mission of recovery and redevelopment of low-income communities in the 
Gulf Opportunity Zone (GO Zone), which are specified areas in 
Louisiana, Mississippi, and Alabama that were affected by Hurricane 
Katrina during 2005. 

In general, targeted populations were introduced to give CDEs 
flexibility in making investments serving individuals and groups that 
reside or work in communities that might not otherwise fall under the 
NMTC program's geographically based definition of a low-income 
community. Currently, regulations defining targeted populations have 
not been finalized. However, the CDFI Fund and IRS have provided 
guidance for what qualifies as a targeted population.[Footnote 13] 
These guidelines specify that the targeted populations, which are 
individuals or an identifiable group of individuals, must meet tests to 
qualify as low-income communities and the businesses or entities 
receiving the investments must also meet certain criteria.[Footnote 14] 

In IRS's recently provided guidance, the definition of GO Zone targeted 
populations is similar to the definition for low-income targeted 
populations with some differences. In cases where a business is located 
within the GO Zone, it does not mean that it automatically qualifies 
for NMTC investment dollars. First, the GO Zone targeted population 
need not qualify as low-income individuals as defined above, but rather 
the population must consist of individuals who lack access to loans or 
equity investments because they were displaced from their principal 
residence or lost their principal source of employment because of 
Hurricane Katrina. Second, the NMTC investment must serve targeted 
populations in census tracts within the GO Zone that meet certain 
requirements, including that they contain one or more areas designated 
by the Federal Emergency Management Agency (FEMA) as flooded or having 
sustained extensive or catastrophic damage as a result of Hurricane 
Katrina. 

Figure 2 illustrates the effect that recent legislative changes have 
had on the census tracts that are eligible to receive NMTC investments. 
As the figure shows, geographically, a large portion of the country 
qualifies for NMTC investment, and there are eligible areas in every 
state. The figure also shows the area of the GO Zone where NMTC 
investments can be made in both eligible low-income communities and 
specified targeted populations as a result of additional allocation 
authority made available for areas affected by Hurricane Katrina. 

Figure 2: NMTC Eligible Areas: 

[See PDF for image] 

Source: CDFI Fund. 

Note: All unshaded areas identified as "Not NMTC eligible" could 
receive NMTC investment funds if CDEs serve targeted populations in 
those areas under the American Jobs Creation Act of 2004 (Pub. L. No. 
108-357). In addition, targeted populations in areas shaded in black in 
the GO Zone may receive NMTC investment because they meet the 
definition of a GO Zone targeted population. 

[End of figure] 

Authorized Allocation Rounds End in 2008: 

Congress initially provided a schedule for allocating annual NMTC 
authority to CDEs for calendar years 2001 through 2007.[Footnote 15] 
However, as we also reported in 2004, the CDFI Fund did not make any 
NMTC allocations to CDEs until 2003 because it needed to complete 
various start-up tasks for the new program, such as establishing the 
rules for using allocations. Because the initial allocations were not 
made until 2003, the CDFI Fund combined the allocation amounts 
available for 2001 and 2002 and awarded those NMTC allocations in 2003. 
The allocation amounts designated for 2003 and 2004 were then combined 
and awarded in 2004. Table 1 shows the current schedule for allocation 
rounds. Since 2004, allocation awards have been made to CDEs annually. 

Table 1: NMTC Allocation Rounds: 

Dollars in billions. 

Round: Round 1; 
Allocation year: 2003; 
Original allocation years: 2001-2002; 
Amount allocated: $2.5. 

Round: Round 2; 
Allocation year: 2004; 
Original allocation years: 2003-2004; 
Amount allocated: 3.5. 

Round: Round 3; 
Allocation year: 2005; 
Original allocation years: 2005; 
Amount allocated: 2.0. 

Round: Round 4; 
Allocation year: 2006; 
Original allocation years: 2006; 
Amount allocated: 4.1[A]. 

Round: Round 5; 
Allocation year: 2007; 
Original allocation years: 2007; 
Amount allocated: 3.9[A]. 

Round: Round 6; 
Allocation year: 2008; 
Original allocation years: 2008; 
Amount allocated: 3.5[B]. 

Round: Total; 
Allocation year: $19.5. 

Source: CDFI Fund. 

[A] The amounts available to be allocated in Round 4 and Round 5 were 
increased by $600 million and $400 million respectively because of 
increased NMTC allocation limits targeted toward the GO Zone. 

[B] Congress initially only authorized NMTC allocation authority 
through 2007. However, the Tax Relief and Health Care Act of 2006 (Pub. 
L. No. 109-432) extended NMTC allocation authority for 1 year (through 
2008) with an additional $3.5 billion of NMTC allocation authority. 

[End of table] 

As of January 2007, there have been four completed rounds of NMTC 
allocations, and the CDFI Fund is receiving applications for the 2007 
round of NMTC allocation awards, which will be announced in September 
2007. The 2007 allocation awards were originally scheduled to be the 
last authorized round of NMTC allocation awards. However, in December 
2006, Congress passed and the President signed the Tax Relief and 
Health Care Act of 2006,[Footnote 16] which extends the NMTC for an 
additional year (through the end of 2008) with an additional $3.5 
billion of NMTC allocation authority. Regulations are also required to 
be drafted to ensure that nonmetropolitan areas receive a proportional 
allocation of qualified equity investments. 

CDEs Are Using NMTC Allocations to Invest in Low-Income Communities, 
and the CDFI Fund Is Tracking Program Implementation: 

The CDFI Fund has completed four rounds of NMTC allocations, which CDEs 
are using to attract investment. The investment structures used to 
complete these deals have taken a variety of forms, including combining 
debt and equity in limited liability partnerships in order to invest in 
a CDE--called leveraging. In addition, the CDFI Fund has developed four 
main data collection systems to track efforts to implement and monitor 
the expanding NMTC program. 

NMTC Allocations and Investments in CDEs and Low-Income Communities 
Have Increased in Number and Amount: 

Beginning in 2003, the CDFI Fund awarded NMTC allocations of varying 
amounts to a number of CDEs. The CDFI Fund has awarded 233 NMTC 
allocations to 179 different CDEs totaling $12.1 billion over the 
course of the four completed NMTC allocation rounds. As figure 3 shows, 
the CDFI Fund made awards to the largest number of CDEs in 2003, when 
the fund awarded NMTC allocations to 66 CDEs, and it made awards to the 
smallest number of CDEs in 2005 when 41 CDEs received allocations. In 
its most recent allocation round in 2006, the CDFI Fund made 
allocations to 63 CDEs for a total of $4.1 billion of tax credit 
authority. The largest award to a single CDE in this allocation round 
was $143 million, while the median award was $60 million. 

Figure 3: Number of CDE Allocations by Round (Calendar Year): 

[See PDF for image] 

Source: GAO analysis of CDFI Fund data. 

[End of figure] 

The CDEs receiving allocations were able to attract an increasing 
number of QEIs. As of December 2006, investors had made nearly 1,400 
QEIs in CDEs, and as more allocation rounds have taken place, the 
number of QEIs has grown. Relatively few QEIs were made in 2003 when 
the program was in its early stages, but the number of QEIs increased 
significantly in both 2004 and 2005. This pattern of growth reflects 
increases in NMTC allocation authority and increased time for CDEs to 
establish business relationships with potential investors. In addition, 
more QEIs were made in CDEs that received allocations in 2003 and 2004 
than in CDEs that received NMTC allocations in 2005. As of December 
2006, 749 QEIs had been made in first round NMTC allocatees, 478 QEIs 
had been made in second round NMTC allocatees, and 154 QEIs had been 
made in third round allocatees.[Footnote 17] 

As figure 4 shows, the CDEs were generally able to attract increasing 
dollar amounts of qualified equity investment. QEI grew from about $140 
million of investment in 2003 to over $2.2 billion of investment in 
2005, and as of mid-December 2006, CDEs had recorded nearly $1.5 
billion in NMTC investment for the year--totaling $5.3 billion over the 
period. CDEs are required to invest the remaining $6.8 billion of 
allocation authority awarded to this point during the coming years. At 
the same time, the size of the QEIs varied considerably across CDEs. 
According to CDFI Fund data, the largest QEI made through December 2006 
was $113 million, while the median QEI during this period was about 
$1.8 million. 

Figure 4: Qualified Equity Investment by Calendar Year: 

[See PDF for image] 

Source: GAO analysis of CDFI Fund data. 

Note: Amount of QEI in 2006 is through mid-December. 

[End of figure] 

The CDEs used this QEI to make investments in 583 qualified NMTC 
projects totaling $3.1 billion through fiscal year 2005.[Footnote 18] 
Nearly all of these investments have been to qualified active low- 
income community businesses (QALICBs) in qualifying areas. However, 
according to CDFI Fund data, a small number (about 1 percent) of the 
investments were made to other CDEs, as permitted under NMTC 
regulations. As more NMTC allocation awards are made and more NMTC 
investment transactions are completed, additional information will be 
available about the size and type of NMTC investments. 

The Ability of Investors to Use Tiered Investment Structures May Have 
Contributed to the Growth of the NMTC Program: 

Certain NMTC investment structures may have been a factor in the growth 
of the program by making NMTC investments more attractive. NMTC 
investors have used two primary investment structures when making QEIs 
in CDEs: (1) direct NMTC investment and (2) tiered NMTC 
investments.[Footnote 19] As of December 2006, about 54 percent of the 
$5.3 billion in NMTC investments were made using tiered investment 
structures. In a direct NMTC investment, an investor makes a QEI in a 
CDE that reinvests the money in a low-income community. (See fig. 5 for 
a description of these NMTC investment structures). In tiered 
investment structures, which include both equity investments and 
leveraged NMTC investments, investors provide equity or loans to a pass-
through entity that combines funds from several sources, and the pass-
through entity makes the QEI in a CDE.[Footnote 20] In both direct and 
tiered investment structures, equity investors in a CDE are able to 
claim the NMTC on their tax returns and, after leaving the equity 
investment in the CDE for the 7 years during which they are eligible to 
claim the credit, they can redeem their original equity stake in the 
CDE. 

In a tiered equity investment structure, the dollars invested in the 
investment fund consist entirely of equity investments from multiple 
investors. These investment structures accounted for about 13 percent 
of NMTC investment as of December 2006. In a tiered leveraged 
investment structure,[Footnote 21] a portion of the money being 
invested in the investment fund comes from equity investors and a 
portion of the money originates from a debt investment (loan). As of 
December 2006, about 41 percent of all NMTC investment was made using 
the leveraged approach. 

Figure 5: Comparison of NMTC Investment Structures: 

[See PDF for image] 

Source: GAO. 

[A] Investors in a CDE cannot redeem any of the original QEI during the 
7-year period while they are allowed to claim the credit. However, 
equity investors can receive a return on their investment in a CDE, in 
the form of dividends or partnership income, for example. 

[End of figure] 

The leveraged investment structure may make NMTC investment more 
attractive to some investors because it allows investors to invest in 
the CDE who may not be able to claim tax credits but could still 
benefit from the economic returns. The investment structure can be used 
to separate the tax benefits of the investment from the economic 
benefits of the investment. For example, an investment fund partnership 
makes a $1 million leveraged qualified equity investment in a CDE where 
$400,000 of the money comes from the equity investors in the 
partnership and the other $600,000 comes from a bank as an interest- 
only loan to the investment partnership with a balloon payment after 7 
years. The CDE that receives the QEI reinvests the money by loaning 
"substantially all" of the $1 million to a QALICB. In this structure, 
the economic and tax benefits are separated: the bank receives interest 
payments on the loan to the CDE and, after 7 years, the bank will also 
be entitled to collect principle payments on the loan while the equity 
investors are entitled to claim the NMTC for 7 years, totaling 39 
percent of the total $1 million QEI--not just the $400,000 that was 
originally invested as equity. NMTC equity investors may also receive a 
return on their investment, in the form of dividends or partnership 
income, for example, during the 7-year period while they can claim the 
credit. However, neither the investment fund partnership nor the 
underlying investors can redeem any portion of the QEI during this 
period and still remain eligible to claim the credit. 

The leveraged investment structure may also offer a more attractive 
combination of risk and return than direct investment. From the bank's 
perspective in the example above, this investment structure may be 
attractive because the loan-to-value ratio[Footnote 22] is more 
favorable than it would have been if the debt was not being combined 
with the investors' equity. The more favorable ratio may compensate the 
bank for assuming a greater degree of risk, most notably if the 
business that receives the loan from the CDE defaults on its loan 
agreement. In that case, the bank's investment is only secured by the 
equity in the original investment partnership ($400,000 in the example 
above). From the equity investor's perspective, if the business 
defaults on its loan, they are still allowed to claim the full amount 
of the credit--as long as the business that receives the funds is a 
qualifying business in the year the loan is made. 

As the NMTC program has grown, investors have used more complicated 
investment structures, such as tiered investments. According to CDFI 
Fund data, 81 percent of investors making NMTC investments through 
December 2006 used tiered (including both equity and leveraged) NMTC 
investment structures, with investors in more recent years being more 
likely to use tiered structures. For example, 69.1 percent of investors 
making QEIs in 2003 and 2004 used tiered structures, while 87.5 percent 
of investors making QEIs in 2005 and 2006 used tiered structures. 

The CDFI Fund's Data Collection Systems Are Operational: 

The CDFI Fund uses four data collection systems to administer and 
monitor the NMTC program. All of these data collection systems were 
operational before they were needed to collect data and to help the 
CDFI Fund monitor NMTC compliance. These data collection systems 
include (1) the Allocation Agreement System (AAS), (2) the Allocation 
Tracking System (ATS), (3) the Community Investment Impact System 
(CIIS), and (4) the New Markets Compliance Monitoring System (NCMS). 
Figure 6 illustrates how the AAS, ATS, and CIIS, combine to populate 
the NCMS, which the CDFI Fund uses to monitor CDEs' compliance with 
their allocation agreements. 

Figure 6: Interaction of CDFI Fund NMTC Data Collection Systems: 

[See PDF for image] 

Source: The CDFI Fund and GAO. 

[End of figure] 

A brief description of these data collection systems follows. 

* The AAS contains information on the allocation agreements that CDEs 
enter into with the CDFI Fund. The AAS was operational as of August 
2003 and is primarily used by the CDFI Fund's legal staff to ensure 
that NMTC contracts are properly executed. 

* The ATS is the primary system that the CDFI Fund uses to monitor QEIs 
that have been made and track CDEs (allocatees), suballocatees, and 
investors in the CDEs. The ATS contains information reported by the 
CDEs on the type of QEI that is made in the CDE, the amount of the 
investment, the CDE that received the investment, whether the CDE that 
initially received the allocation transferred the allocation to a 
suballocatee, and how much of the allocation was transferred. In 
addition, the ATS contains data reported by CDEs on the equity 
investors in the NMTC program. The ATS was operational as of November 
2003. 

* The CIIS collects information about CDEs and the investments that 
they make in low-income communities. CIIS data is collected through two 
reports: the Institution Level Report (ILR) and the Transaction Level 
Report (TLR). The ILR provides information on the CDEs, as well as 
their loan purchases and Financial Counseling and Other Services (FCOS) 
activities, and the TLR provides information the CDEs' loans and 
investments in QALICBs and in other CDEs. The CIIS began receiving data 
in May 2004. 

* The NCMS combines data from the CIIS, ATS, AAS, and other CDFI Fund 
data collection systems and is used to monitor whether CDEs remain 
compliant with their allocation agreements. CDFI Fund officials said 
that the NCMS has been operational since April 2005 and that the system 
was in place in time to allow the CDFI Fund to monitor first round 
allocatees' compliance with their respective allocation agreements. 

Financial Institutions and Individuals Are the Primary NMTC Investors, 
and CDEs Most Often Use NMTC Investments to Make Loans to Qualified 
Businesses: 

Banks and individuals constitute the majority of NMTC claimants when 
qualified equity investments are originally made.[Footnote 23] Taken 
together, banks and individuals accounted for 70 percent of NMTC 
claimants through 2006. Banks and other corporations that invested in 
the credit had relatively large net assets. Individuals who invested in 
the NMTC had, on average, higher incomes than other taxpayers. The CDEs 
applied for far more allocation dollars than were available, receiving 
only about 11 percent of $107 billion in allocation authority for which 
they applied. The CDEs made investments in low-income communities, most 
often in the form of term loans to businesses.[Footnote 24] The 
businesses that received these loans used them for a variety of 
purposes but chiefly to finance new commercial real estate construction 
and rehabilitation. The communities where the investment projects were 
located were dispersed across states, and about 90 percent of projects 
were located in areas designated as "areas of high distress" because of 
factors such as low median incomes and high unemployment rates, 
including businesses in highly distressed areas, such as federally 
designated Empowerment Zones and Enterprise Communities. 

NMTC Investors Tend to Be Financial Institutions with Larger Net Assets 
and Individuals with Higher Incomes: 

Although the NMTC program has attracted a variety of types of 
investors, as table 2 indicates, banks and individuals make up the 
majority of investors, accounting for 70 percent of NMTC investors. 
Other corporate investors, such as real estate development firms and 
insurance companies, and still other types of investors, including 
estates and trusts, make up the remainder of investors in the CDEs. 
Banks and other regulated financial institutions also account for the 
majority of NMTC investment funds. 

Table 2: NMTC Claimant Types: 

Investor type: Bank or other regulated financial institution; 
Number of claimants: 155; 
Percent of claimants: 37.8. 

Investor type: Individual investor; 
Number of claimants: 132; 
Percent of claimants: 32.2. 

Investor type: Other corporate investor; 
Number of claimants: 76; 
Percent of claimants: 18.5. 

Investor type: Other; 
Number of claimants: 47; 
Percent of claimants: 11.5. 

Investor type: Total; 
Number of claimants: 410; 
Percent of claimants: 100.0. 

Source: GAO analysis of CDFI Fund data. 

[End of table] 

Corporations and individuals that claim the tax credit differ from 
other taxpayers in several key ways. Corporations investing in the NMTC 
tend, on average, to have larger total assets. For example, the average 
total assets for corporations that made NMTC investments was $98.3 
billion in tax year 2003, while the average total assets[Footnote 25] 
for all corporations was $9.9 million (the average total assets for 
banks, the most common type of corporate NMTC claimant, was close to 
$990 million in 2003).[Footnote 26] Similarly, individual NMTC 
investors had larger adjusted gross incomes than other individuals who 
filed tax returns in tax year 2003.[Footnote 27] The average adjusted 
gross income for individual NMTC investors was about $1.2 million, 
while the average income for all individual taxpayers was about 
$47,600. 

In response to our survey, NMTC investors indicated that they decided 
to participate in the NMTC program for a variety of reasons.[Footnote 
28] As table 3 shows, our investor survey revealed that the majority of 
NMTC investors indicated that the ability to claim the tax credit (over 
75 percent of investors) and obtain a return on their investment (82 
percent of investors) played at least a moderately important role in 
their decision to make an NMTC investment. Investors also indicated 
that improving conditions in low-income communities (90 percent) and 
creating and retaining jobs (78 percent) were at least moderately 
important motivations. About 40 percent of investors also noted that 
the credit played an important role in helping them remain compliant 
with other government regulations. 

Table 3: Reasons NMTC Investors Invested in the NMTC Program (in 
Percentages): 

Reason: Obtain the tax credit; 
Very great to moderate: 76.7 (67.9, 84.1); 
Little or no extent: 23.3 (15.9, 32.1). 

Reason: Obtain return on investment; 
Very great to moderate: 82.1 (73.8, 88.6); 
Little or no extent: 17.9 (11.4, 26.2). 

Reason: Improve conditions in low-income communities; 
Very great to moderate: 90.1 (82.7, 95.1); 
Little or no extent: 9.9 (4.9, 17.3). 

Reason: Comply with government regulations; 
Very great to moderate: 41.2 (33.4, 48.9); 
Little or no extent: 58.8 (51.1, 66.6). 

Reason: Create or retain jobs; 
Very great to moderate: 77.8 (69.1, 85.0); 
Little or no extent: 22.2 (15.0, 30.9). 

Reason: Expand lending relationships with special purpose borrowers; 
Very great to moderate: 52.0 (42.9, 61.0); 
Little or no extent: 48.0 (39.0, 57.1). 

Source: GAO survey of NMTC investors. 

Note: Numbers in parentheses indicate confidence intervals. 

[End of table] 

Over time the number of new investors in the CDEs that receive NMTC 
allocations has increased. For example, 19 percent of investors that 
made their first QEIs in 2003 were new investors. The CDFI Fund defines 
new investors as investors making their first investment in a 
particular CDE. The percentage of new investors increased with 
investment made in 2004 through 2006 to a high of 69 percent in 2006 
(through mid-December). 

Most investors that have participated in the NMTC program have only 
made one qualified equity investment. However, CDFI Fund data indicate 
that it is not uncommon for NMTC investors to participate in more than 
one QEI. For example, as of December 2006, about 55 percent of NMTC 
investors have only participated in one QEI, while 33 percent of NMTC 
investors participated in from two to five QEIs and 12 percent of 
investors participated in five or more QEIs. 

The Average Expected Return on NMTC Investment Has Declined: 

As NMTC investment structures have become increasingly complex in 
recent years, the expected rate of return for NMTC investments 
decreased.[Footnote 29] NMTC investments made in 2003 had an average 
expected rate of return, which includes any return on the equity 
investment and the tax credit, of 8.2 percent while investments in 
later years had an average expected rate of return of only 6.8 percent. 
This decline could be a result of the greater perceived risk for 
investments made at the beginning of the program. According to CDFI 
Fund officials, as the program has developed and investors have gained 
a better understanding of the manner in which the credit can be used, 
investors' perceived risk in making NMTC investments has likely 
declined. A factor contributing to the decline may be that as table 4 
shows, NMTC investors reported that they have become more familiar with 
the operations and investment portfolios of the CDEs they invested in 
after making NMTC investments. 

Table 4: Investor Knowledge of CDE Operations (in Percentages): 

Level of knowledge: Before investing in NMTC; 
Very high to moderate extent: 48.9 (39.6, 58.2). 

Level of knowledge: After investing in NMTC; 
Very high to moderate extent: 93.4 (85.5, 97.7). 

Source: GAO survey of NMTC investors. 

Note: Numbers in parentheses indicate confidence intervals. 

[End of table] 

However, even though the reported expected rate of return on NMTC 
investments has fallen, investors indicate that they remain concerned 
about the market risk of NMTC investments and the possibility that 
businesses that receive NMTC investments could default on their loans. 
For example, our investor survey indicates that an estimated 86 percent 
(78.2, 92.0) of investors said that they were at least moderately 
concerned that their investment would not achieve its expected rate of 
return, and 81 percent (71.8, 87.9) of investors said that they were at 
least moderately concerned that the business that received their NMTC 
investment would default on its loan. 

CDEs Apply for More NMTC Allocations Than Are Available and Relatively 
Few CDEs Receive Allocations: 

For all allocation rounds combined, CDEs have applied for over $107 
billion in NMTC allocation and received only about 11 percent of 
requested allocation dollars. As table 5 shows, the percentage of 
dollars awarded in relation to the dollars requested has remained 
fairly constant during the four allocation rounds, but in each round 
CDEs have applied for far more in NMTC allocations than the CDFI Fund 
has had the authority to award based on the NMTC's authorizing 
legislation. The amount awarded as a percentage of the amount requested 
varied by at most 6 percentage points over the rounds. In general, CDEs 
applied for more in allocation authority in rounds where larger amounts 
were available for allocation. 

Table 5: NMTC Allocations Awarded by Round: 

Dollars in billions. 

Round 1 (2003); 
Amount requested: $26.0; 
Amount awarded: $2.5; 
Percentage awarded: 9.6. 

Round 2 (2004); 
Amount requested: 30.4; 
Amount awarded: 3.5; 
Percentage awarded: 11.5. 

Round 3 (2005); 
Amount requested: 22.9; 
Amount awarded: 2.0; 
Percentage awarded: 8.7. 

Round 4 (2006); 
Amount requested: 28.3; 
Amount awarded: 4.1; 
Percentage awarded: 14.5. 

Total; 
Amount requested: $107.6; 
Amount awarded: $12.1; 
Percentage awarded: 11.2. 

Source: GAO analysis of CDFI Fund data. 

[End of table] 

For all allocation rounds combined, the CDFI Fund received 1,078 NMTC 
applications from CDEs and only 223, or about 22 percent, received 
allocations. As table 6 shows, between 19 percent and 25 percent of 
CDEs that applied for allocations received them in each round. 

Table 6: CDEs That Applied for NMTC and Received Allocations by Round: 

Round: Round 1 (2003); 
Number of applicants: 345; 
Number receiving allocations: 66; 
Percentage receiving allocations: 19. 

Round: Round 2 (2004); 
Number of applicants: 271; 
Number receiving allocations: 63; 
Percentage receiving allocations: 23. 

Round: Round 3 (2005); 
Number of applicants: 208; 
Number receiving allocations: 41; 
Percentage receiving allocations: 23. 

Round: Round 4 (2006); 
Number of applicants: 254; 
Number receiving allocations: 63; 
Percentage receiving allocations: 25. 

Round: Total; 
Number of applicants: 1,078; 
Number receiving allocations: 233; 
Percentage receiving allocations: 22. 

Source: GAO analysis of CDFI Fund data. 

[End of table] 

CDFI Fund officials indicated that NMTC applications will score 
particularly well to the extent that, among other things, the 
applicants commit to: (1) providing products with particularly flexible 
or nontraditional rates and terms; (2) serving severely economically 
distressed communities, including communities that have been targeted 
for redevelopment by other governmental programs; and (3) investing 
more than the minimally required 85 percent of NMTC proceeds into low- 
income communities. We observed the application reviewer training 
session in 2005 and noted that the CDFI Fund encouraged application 
reviewers to pay particular attention to types of projects and 
financing terms being proposed in the applications. One example we 
noted was that CDFI Fund officials instructed NMTC application 
reviewers to base a portion of each application's overall score on the 
commitment of the applicant to serve highly economically distressed 
areas. 

Businesses Primarily Receive Loans from CDEs That They Use Chiefly for 
Investment in Commercial Real Estate: 

CDEs that received NMTC allocations have used their allocations to make 
investments totaling $3.1 billion through fiscal year 2005, primarily 
in the form of loans to businesses in low-income communities. According 
to CDFI Fund data, these loans are used chiefly for constructing and 
rehabilitating commercial real estate and are also used to purchase 
fixed assets for businesses[Footnote 30] and to provide working capital 
for businesses.[Footnote 31] For example, these loans have been used to 
finance a range of activities, such as the rehabilitation of historic 
buildings and the operation of mixed-use real estate development. Other 
uses include the construction or operation of cultural arts centers, 
frozen pizza manufacturing, and the construction of charter schools. As 
figure 7 shows, about 75 percent of the dollar value of these loans and 
investments was used for investment in commercial real estate. 

Figure 7: NMTC Loans and Investment by Type of Activity for Fiscal 
Years 2003 through 2005: 

[See PDF for image] 

Source: GAO analysis of CDFI Fund data. 

[End of figure] 

According to data reported by CDEs to the CDFI Fund, most investment 
(88 percent) made by the CDEs in businesses comes in the form of term 
loans.[Footnote 32] According to CDFI Fund data, the most common types 
of loans being made to qualifying business with better rates and 
terms[Footnote 33] come in the form of loans with below market interest 
rates (80 percent of reported NMTC dollars) and lower-than-standard 
loan origination fees (56 percent of reported NMTC dollars). As figure 
8 illustrates, other types of favorable financial packages that 
qualifying business take advantage of include things like interest-only 
loans, loans with longer-than-standard amortization periods, and higher 
loan-to-value ratios than are traditionally required. 

Figure 8: NMTC Dollars Used in Loans with Better Rates and Terms: 

[See PDF for image] 

Source: GAO analysis of CDFI Fund data. 

[End of figure] 

The Communities Receiving the Investment Tend to Be More Highly 
Distressed: 

Through their allocation agreements with the CDFI Fund, all allocatees 
are required to use at least some portion of their allocation to serve 
designated "areas of higher distress,"[Footnote 34] which may have a 
greater need for economic development funds than areas that meet the 
NMTC program's minimal requirements. For example, 51 percent of 
projects serve areas with a median income of less than 60 percent of 
area median income, and 47 percent of projects serve areas with 
unemployment rates at least 1.5 times the national average. In 
addition, over one-fourth of NMTC projects are located in federally 
designated Empowerment Zones and 51 percent of all NMTC projects are in 
Small Business Administration-designated Historically Underutilized 
Business Zones. 

NMTC projects are distributed across states. Activities reported 
through fiscal year 2005 included 583 projects, located in 45 states, 
the District of Columbia, and Puerto Rico. Table 7 shows the top 10 
states organized by the total dollar amount of NMTC investment and the 
total number of projects. Appendix III contains the full list of the 
number of NMTC projects by state. 

Table 7: Top 10 States by NMTC Dollars through Fiscal Year 2005: 

Top 10 states by amount of dollars invested: California; 
Total dollar amount of loans and investment: $303,081,270; 
Number of NMTC projects: 58. 

Top 10 states by amount of dollars invested: New York; 
Total dollar amount of loans and investment: 239,178,566; 
Number of NMTC projects: 25. 

Top 10 states by amount of dollars invested: Ohio; 
Total dollar amount of loans and investment: 201,857,969; 
Number of NMTC projects: 69. 

Top 10 states by amount of dollars invested: Maine; 
Total dollar amount of loans and investment: 153,527,250; 
Number of NMTC projects: 13. 

Top 10 states by amount of dollars invested: Wisconsin; 
Total dollar amount of loans and investment: 149,131,108; 
Number of NMTC projects: 26. 

Top 10 states by amount of dollars invested: Missouri; 
Total dollar amount of loans and investment: 146,165,868; 
Number of NMTC projects: 22. 

Top 10 states by amount of dollars invested: Massachusetts; 
Total dollar amount of loans and investment: 145,059,237; 
Number of NMTC projects: 34. 

Top 10 states by amount of dollars invested: Kentucky; 
Total dollar amount of loans and investment: 135,117,406; 
Number of NMTC projects: 44. 

Top 10 states by amount of dollars invested: North Carolina; 
Total dollar amount of loans and investment: 126,420,590; 
Number of NMTC projects: 14. 

Top 10 states by amount of dollars invested: Washington; 
Total dollar amount of loans and investment: 125,703,680; 
Number of NMTC projects: 19. 

Source: GAO analysis of CDFI Fund data. 

[End of table] 

NMTC Investors Report That the NMTC Increases Investment in Low-Income 
Communities and Statistical Analysis Indicates That These Investments 
May Be Financed by Shifting Assets from Other Uses and Some New 
Investment: 

The results of our investor survey and statistical analysis indicate 
that the NMTC may be increasing investment in eligible low-income 
communities by participating investors, which is consistent with the 
program's purpose. Increased investment in low-income communities can 
occur when NMTC investors increase their total funds available for 
investment or when they shift funds from other uses. One limitation 
with our survey is that NMTC investors responding to our survey, 
because they benefit from claiming the credit, have an interest in 
ensuring that the NMTC program continues to operate. Our survey 
indicated that most NMTC investors increased the share of their 
investment budget for low-income communities because of the credit. 
However, in many cases the survey also indicated that the credit alone 
may not have been sufficient to justify the investment and meeting 
other government regulations may be an important incentive for making 
NMTC investments. In addition, about two-thirds of investors also 
indicate that NMTC investors have a track record of investing in low- 
income communities, which may mean that some investment was shifted 
from other low-income community investments. Our statistical analysis 
suggests that corporations investing in the NMTC are shifting 
investment funds while individuals who make NMTC investments may be 
increasing their overall level of investment. Neither our statistical 
analysis nor the results of our survey allow us to determine 
definitively whether shifted investment funds came from higher income 
communities or from other low-income community investments. 

A complete evaluation of the NMTC program's effectiveness requires 
determining whether the program's economic and social benefits to low- 
income communities offset its costs, which include costs such as 
forgone tax revenue and economic distortions evidenced by shifting 
investment funds. We did not conduct this complete evaluation for this 
report because sufficient data were not available. The CDFI Fund is 
currently working with a contractor to develop plans for a 
comprehensive program evaluation, which may include some aspects of 
program effectiveness. 

NMTC Investors Reported That They Increased Their Investment in Low- 
Income Communities Because of the Credit, but Other Factors May Also 
Play a Role: 

In response to our survey, most NMTC investors said that they would 
probably or definitely not have made the same investment with the same 
terms if they had not been eligible to claim the credit. An estimated 
88 percent of investors said that they would not have made the same 
investment without the NMTC. Of these investors who would not have made 
the same investment without the NMTC, 75 percent (66.6, 82.7) also 
indicated that in the absence of the NMTC they would not have made a 
similar investment in the same community. Moreover, 64 percent (54.9, 
72.5) of investors said that they increased the share of their 
investment budget that is designated for low-income communities because 
of the NMTC. 

Most NMTC investors have experience in low-income community investment. 
Nearly two-thirds of investors have additional investment in low-income 
communities that does not qualify for the NMTC. Sixty-one percent 
(53.2, 69.4) of respondents currently had additional investments in low-
income communities that were not eligible QEIs, and 29 percent of 
investors had made one or more investments in other CDEs or similar 
organizations that mainly serve low-income communities but cannot be 
used to claim the NMTC. This interest in low-income community 
investment is also reflected in survey responses where 90 percent of 
investors said the goal of improving conditions in low-income 
communities influenced their decision to invest in the NMTC from a 
moderate to very great extent. Most investors also indicated that they 
plan to make additional NMTC investments. 

The survey responses indicate that in many cases, the credit alone may 
not have been sufficient to justify the investment. The NMTC can also 
be packaged with a number of other government incentives to make the 
investment more attractive. About half of respondents combine the NMTC 
with at least one other government incentive that can provide 
additional tax benefits to the investor. As figure 9 shows, state and 
local tax abatements are the most popular type of government incentive 
used. Some respondents that packaged the NMTC with other government 
incentives indicated that their ability to package the credit played an 
important role in their decision to make the investments, which may 
indicate that in some cases, the NMTC, in and of itself, is not a 
strong enough incentive to encourage investment in low-income 
communities. 

Figure 9: NMTC Investors Packaging the NMTC with Other Government 
Incentives: 

[See PDF for image] 

Source: GAO. 

Note: Confidence intervals for each of the categories in the figure are 
as follows: Historic Rehabilitation Tax Credits (19.6, 35.5), Historic 
Rehabilitation Easement Deduction (.1, 5.8), Brownfields tax incentive 
(7.2, 20.1), Empowerment Zone/Enterprise Community funding (15.7, 
31.8), and State/local tax abatements (28.5, 46.1). 

[End of figure] 

Meeting other government regulations may also be an important incentive 
for making NMTC investments. Over 40 percent of the investors reported 
that they use the NMTC to remain compliant with the Community 
Reinvestment Act (CRA), which rates depository institutions on their 
record of helping to meet the credit needs of their entire community. 
Seventy-one percent (58.3, 80.8) of investors that are required to 
comply with the CRA use their NMTC investment to help meet their CRA 
obligations. For investors using the NMTC to meet CRA requirements, 94 
percent (83.4, 98.8) view it as very or somewhat important in their 
decision to make the investment. 

Nearly half of NMTC investors also reported that they make investments 
eligible for the Low-Income Housing Tax Credit, a tax credit for 
investment in rental housing targeted to lower income households. 
However, less than one-half of the investors that also invest in the 
Low-Income Housing Tax Credit view it as an alternative to the NMTC. 
One explanation for this is that these investors may be making other 
low-income community investments as a means for complying with 
government requirements such as the CRA. For example, of the survey 
respondents that participated in both the NMTC and the Low-Income 
Housing Tax Credit, nearly three quarters of these investors are also 
required to comply with the CRA. 

Statistical Analysis Suggests That Some NMTC Investment by 
Participating Investors May Be Investment Shifted from Other Assets and 
Some May Be New Investment: 

Our statistical analysis of corporations and individuals that claimed 
the NMTC indicates that some NMTC investment may be shifted from other 
uses and some investment could be new investment. Statistical analysis 
of corporations that claimed the NMTC indicates that, in general, NMTC 
investment funds are not new investment made from an increase in total 
funds available. When combined with information from the survey, this 
statistical result may indicate that corporations are shifting NMTC 
investment funds from other uses. Statistical analysis of individuals 
who invested in the NMTC indicates that in the aggregate, NMTC 
investment funds represent, at least in part, an overall increase in 
investment levels. Because corporate NMTC investment accounts for the 
majority of QEIs, the increased investment associated with 
participation in the program is likely to come primarily from funds 
shifted from other uses. 

Statistical analysis of corporations that claimed the NMTC indicates 
that NMTC investment funds are not likely to represent new overall 
investment. To assess whether NMTC investments represent new funds, we 
compared the growth rate in net assets of corporations that made NMTC 
investments to the growth in net assets of a similar group of 
corporations that did not make NMTC investments over time. We selected 
our comparison group using a stratified random sample of taxpayers 
based on total assets at the end of the tax period. We drew the 
comparison groups based on 2000 tax year data because this was the year 
before the credit could be claimed and in that year we would not expect 
any changes in behavior because of the credit. If NMTC investments 
represent new investment funds[Footnote 35] then we would expect the 
net assets of NMTC participants to grow faster over time than the net 
assets of corporations that did not make NMTC investments. Using 
multiple specifications, our results suggest that corporate claimants' 
net assets are not growing faster than similar corporations that did 
not make NMTC investments.[Footnote 36] 

Rather than new investment, NMTC investment could represent a shift of 
investment by participating corporations from high-or moderate-income 
communities to low-income communities. This conclusion follows from 
combining evidence from the survey of investors with evidence from the 
statistical analysis.[Footnote 37] Because our analysis does not show a 
faster growth rate for NMTC investors, it is possible that the credit 
has no effect on investor behavior, but instead rewards investors for 
investment in low-income communities that would have been made in the 
absence of the credit. However, the effect of the credit may also be to 
shift investment from other low-income communities or from high-or 
moderate-income communities. Although it contains some contrary 
indicators about the effect of the credit, the survey of investors that 
benefit from claiming the credit, indicated that most investments would 
not have occurred in the absence of the credit and that NMTC investors 
had increased their investments in low-income communities because of 
the credit. Therefore, we infer that the most likely effect of the 
credit is that it shifts investment by participating investors into low-
income communities from higher income communities. Further analysis of 
the components of net assets, total assets, and total liabilities, 
which are discussed in appendix II, produced inconclusive results 
regarding the source of the shifted funds. 

Shifted investment funds, in contrast to new investment funds, indicate 
that investors are decreasing investment in another asset or assets by 
some or all of the amount that they invest in the NMTC program. 
Investors might choose to shift funds for a variety of reasons, 
including a higher rate of return expected from the NMTC investment, a 
need to make an investment eligible for meeting CRA requirements, or 
the ability to establish new business relationships. Regardless of the 
reason, if funds are shifted as the result of a tax benefit, the 
shifting potentially creates other economic costs, including the 
opportunity cost of other uses of the funds, and benefits.[Footnote 38] 
These costs and any benefits that accrue to low-income communities 
should also be considered when evaluating the overall effectiveness of 
the tax credit in addition to the revenue costs of the program. 

When analyzing the effect of NMTC participation on the net assets of 
corporations, our results consistently showed no effect. Further, when 
we tested our results using different data specifications, we were 
still not able to detect an effect. However, our analysis of the NMTC's 
effect on net assets for corporations had several limitations. For 
example, the amount of NMTC investment might be small enough relative 
to a corporation's total size that our statistical models could fail to 
detect a positive effect of the NMTC investment on corporations' asset 
levels. We attempted to mitigate this problem by basing our analysis on 
firm-level data, the smallest unit of analysis available, and growth in 
assets over time. In addition, we did not have data for total 
liabilities. We calculated a corporation's total liabilities by 
subtracting stockholders' equity and retained earnings from the "total 
liabilities and shareholders' equity" line-item on the tax return. 
Additionally, our data made it difficult to identify which industry 
NMTC corporate investors participated in, another variable that would 
have helped strengthen our analysis. 

Similar analysis of individuals who invested in the NMTC indicates that 
at least some portion of their investment may represent an overall 
increase in investment (or "new" investment) rather than investment 
shifted from other uses. To assess whether NMTC investments represent 
new funds, we compared the wealth of individuals who made NMTC 
investments to the wealth of a similar group of individuals who did not 
make NMTC investments over time. If NMTC investments represent new 
investment funds[Footnote 39] then we would expect the wealth of NMTC 
claimants to grow faster over time than the wealth of nonclaimants. As 
table 8 shows, the NMTC is associated with a positive effect on the 
growth in NMTC investors' wealth. This means that NMTC investors' 
wealth is growing at a faster rate than similar investors who did not 
make NMTC investments.[Footnote 40] Thus, according to our analysis for 
individual NMTC claimants, the NMTC program investors appear to be 
increasing their investment in low-income communities because their 
QEIs represent investments that they would not have made otherwise and 
these investments are placed into low-income communities according to 
program rules.[Footnote 41] 

The increase in wealth for individuals can be broken down into its 
components, such as interest-bearing assets and business assets. The 
NMTC can have indirect effects on these components of wealth through 
its effect on after tax income. In addition to potentially producing 
ordinary returns on investment (such as dividend payments), part of the 
return on NMTC investments comes in the form of reduced tax 
liabilities. Because they are paying less in taxes, NMTC investors have 
more income available for investing in other types of assets and for 
consumption. As table 8 shows, our results are consistent with 
individuals placing at least a portion of this income into interest- 
bearing assets, such as savings accounts or certificates of deposit. As 
table 8 shows, these new NMTC assets also appear to take the form of 
business assets, including partnerships. Increases in business assets 
may be consistent with typical NMTC investment structures where many 
individuals are investing through pass-through entities. 

Table 8: Effects of NMTC Individual Investor Participation on Wealth: 

Measure: Wealth; 
Effect on growth of:[A]: Positive[B]. 

Measure: Interest-bearing assets; 
Effect on growth of:[A]: Positive. 

Measure: Dividends; 
Effect on growth of:[A]: None. 

Measure: Real estate; 
Effect on growth of:[A]: None. 

Measure: Business; 
Effect on growth of:[A]: Positive. 

Source: GAO analysis of IRS and CDFI Fund data. 

[A] Results are based on comparisons of the 2000 to 2004 growth in each 
category, comparing growth for NMTC investors and an individual tax 
return representing the closest match among non-NMTC claimants from our 
comparison group. 

[B] For categories where a positive effect is identified, our analysis 
was statistically significant at the 5 percent level. 

[End of table] 

In our analysis, NMTC participation by individuals was associated with 
greater growth in wealth, and most variables measuring this association 
were highly statistically significant. In addition, various checks that 
we performed were consistent with the results we present above. 
However, as was also the case with our analysis of corporate investors, 
several data limitations exist for our analysis of individual 
investors. For instance, we did not have direct data on asset holdings. 
Consequently, we estimated wealth based on income streams reported on 
tax returns. In addition, some assets are particularly difficult to 
measure. Business assets are especially susceptible to measurement 
errors as income streams from these assets may vary widely from year to 
year. This means that assets not generating reportable returns, such as 
stock holdings that do not generate dividends in a particular year, do 
not appear in our estimates for that year. We have attempted to 
mitigate this problem by conducting a series of tests, such as using a 
3-year average of wealth and asset variables, to confirm the 
consistency of our results. These tests and data limitations are 
discussed in more detail in appendix II. 

Further Analysis Is Needed to Determine Whether the Economic Costs of 
Shifting Investment Are Justified by Any Economic and Social Benefits 
to Low-Income Communities: 

A complete evaluation of the program's effectiveness goes beyond 
identifying whether the credit increases investment in low-income 
communities by participating investors and also requires determining 
both whether non-NMTC investors would have made the same investments 
that the NMTC investors made if the NMTC investors had not made the 
investment and whether the program's benefits to low-income communities 
offset its costs, which include costs such as forgone tax revenue and 
potential economic inefficiencies created by shifting investment funds. 
Fully examining the effectiveness of the NMTC requires addressing at 
least two main issues: where do NMTC investment funds come from and do 
NMTC investments generate economic benefits in low-income communities? 
Because of data limitations, the relative youth of the NMTC program, 
and the inherent difficulties of measuring program costs and benefits, 
a full evaluation is beyond the scope of this report. However, our 
finding that the NMTC program causes claimants to shift their 
investment portfolios suggests that the program might generate some 
additional economic costs, such as the opportunity cost of redirecting 
investment resources from other, potentially valuable uses.[Footnote 
42] Whether these economic costs are justified depends on the economic 
benefits that are generated in the low-income communities and the 
extent to which these benefits accrue to the targeted population. This 
highlights the importance of assessing the benefits of the program in 
eligible communities so that one can assess whether the costs are 
justified by the benefits of the program. 

The CDFI Fund has hired a contractor to design a comprehensive study to 
evaluate the NMTC program. The study design will be completed by mid- 
2007, and the study will begin after the design is complete. During the 
design phase, the contractor will complete five case studies of NMTC 
investments. The study could potentially evaluate the effect that the 
NMTC is having on factors such as job creation and economic growth in 
areas that receive the credit. These issues fell outside the scope of 
this report. 

IRS and the CDFI Fund Monitor NMTC Compliance, but Additional 
Opportunities Exist to Better Measure Noncompliance and Identify NMTC 
Investors: 

IRS monitors CDEs' compliance with NMTC laws and regulations, and IRS 
is conducting a compliance study but is not yet selecting CDEs to audit 
in a manner that represents all types of CDEs. The CDFI Fund monitors 
CDEs' compliance with their allocation agreements through its data 
collection systems and, on a more limited basis, by making site visits. 
The CDFI Fund has tested its data systems and developed policies and 
procedures for site visits. IRS and the CDFI Fund developed a 
memorandum of understanding (MOU) in an attempt to clarify the roles 
and responsibilities of both agencies in ensuring NMTC compliance, and 
IRS has access to CDFI Fund data. However, additional efforts could 
help IRS receive information in a more useful format. In addition to 
IRS and the CDFI Fund, investors and CDEs play a role in ensuring that 
CDEs remain compliant and the credit is not recaptured. 

IRS's Compliance Study Methodology Could Be Improved to Be More 
Representative of the Population of CDEs: 

IRS is responsible for ensuring that CDEs and NMTC investors adhere to 
NMTC laws and regulations. As part of its effort to monitor CDEs' 
compliance, IRS is conducting a study to monitor CDEs' compliance with 
NMTC legislative requirements, focusing on CDEs' compliance with the 
"substantially all" requirement to invest at least 85 percent of their 
QEIs within 1 year of receiving the investment. IRS officials said that 
they chose to focus on CDEs' compliance with the "substantially all" 
requirement because they believed that this was the area where 
noncompliance with NMTC provisions was most likely to occur. The 
current compliance study will provide IRS with some information about 
audited CDEs compliance with the "substantially all" requirement, 
including information about whether funds were invested in a timely 
manner and whether the investments were made to qualifying businesses. 
However, IRS did not select first round NMTC allocatees to audit in a 
manner that likely represents the full range of CDEs. 

IRS envisioned that its compliance study would focus on verifying that 
CDEs were in compliance with statutory requirements through examining 
CDEs' tax returns and auditing CDEs. IRS has taken steps to develop and 
implement the compliance study, such as training auditors to conduct 
NMTC examinations and developing a training manual that provides 
examiners with background on the NMTC program, key issues to consider 
when reviewing whether CDEs meet the "substantially all" requirement, 
and information to familiarize auditors with the investment structures 
that NMTC investors use to make investments. IRS is currently auditing 
20 of the 66 first round allocatees. 

IRS officials said that they initially planned to conduct examinations 
of early round CDEs using a sample of CDE tax returns that would yield 
a valid 95 percent level of confidence for the study's results. IRS 
expected that all CDEs that received early round allocations would file 
income tax returns within a year or two of the award date, and that 
shortly after all the CDEs' tax returns were filed, IRS would have 
enough returns to select a valid sample that would yield the desired 
confidence level. However, IRS changed its selection process because it 
took more time than expected for CDEs to file tax returns, and the 
volume of returns filed was not sufficient for IRS to draw a valid 
sample in a timely manner. IRS officials said that the delay for most 
CDEs occurred because of the lapse of time between the date that the 
CDE executed agreements with the CDFI Fund and when the CDE actually 
collected equity investments and began operations. 

As a result of the delay in acquiring tax returns for its study, IRS 
modified its overall compliance strategy in two ways. First, it decided 
to verify that each allocatee filed a tax return as a way to monitor 
CDEs' filing compliance. IRS intends to continue to monitor CDEs' 
filing compliance until they are confident that the entities will file 
as required.[Footnote 43] Second, IRS discontinued the sample approach 
and decided to manually review every return that it could identify. IRS 
initially requested over 80 tax returns from tax years 2003 and 2004. 
Of the returns that IRS had received by June 2006, it chose to 
facilitate audits of CDEs that filed 2004 tax year returns that had 
some indication of NMTC activity. According to IRS, because of the 
delays in when CDEs were awarded NMTC allocations and the time in which 
they began filing tax returns, IRS did not develop specific criteria 
for deciding which CDEs to audit. An IRS official said that IRS wanted 
to start its compliance study as soon as possible and the filing time 
lags created delays. IRS indicated that IRS will continue with this 
selection process until it reaches a point where there are sufficient 
returns placed in the examination stream to produce meaningful 
results.[Footnote 44] 

IRS plans to use the results of the compliance study, which will take 
several years to complete, to guide its future enforcement efforts. 
While IRS's current compliance study will provide the agency with 
information about CDEs' compliance with NMTC laws and regulations, the 
compliance study will have limited value if the audit selection process 
does not represent the full range of transactions. We have previously 
reported that taxpayer compliance studies should be representative of 
the population for which compliance is being measured and reasonably 
designed for developing compliance measures for the taxpayer population 
as a whole and for subgroups of taxpayers (such as suballocatees in the 
case of the NMTC program).[Footnote 45] IRS's current plan for its 
compliance study could be improved to adhere to these standards more 
closely. Given IRS's intent to rely on the study to guide enforcement 
efforts, the results of not having a study representative of the 
population could be lost tax revenue and increased cost through 
inefficient use of resources. 

IRS could change its strategy to make its results more useful as its 
compliance work progresses. IRS plans to audit 15 to 25 CDEs from each 
allocation round until it feels that compliance levels warrant a 
reduced number of audits. While it may be too resource intensive to 
conduct a statistically valid study with fully generalizable results, 
IRS could work with the CDFI Fund to develop criteria for determining 
which CDEs to audit. For example, IRS could use CDFI Fund data to 
categorize CDEs that invest in different types of projects or CDEs that 
use different types of investment structures for NMTC purposes. As the 
program expands and more tax return data are available for future 
rounds, IRS could use the audit results from its initial CDE audits, 
along with developing these criteria for identifying which CDEs it will 
audit, in order to produce compliance study results that will be more 
representative of the entire population of NMTC allocatees. 

The CDFI Fund Has Systems and Procedures in Place to Monitor CDEs' 
Compliance with Allocation Agreements: 

The CDFI Fund is monitoring CDEs to ensure that they remain compliant 
with their allocation agreements through the New Markets Compliance 
Monitoring System (NCMS) and, on a more limited basis, site visits. The 
CDFI Fund took steps to ensure that its data collection and reporting 
systems are reliable and valid, such as testing its data collection 
systems and the interaction between these systems multiple times before 
using them to identify CDE noncompliance. These steps help to 
reasonably ensure that the CDFI Fund data are adequately maintained and 
properly disclosed in reports. CDFI Fund databases rely on data that 
CDEs self-report to the CDFI Fund. However, the CDFI Fund has several 
mechanisms in place, such as providing written instructions to CDEs on 
how to report data and providing a help desk for CDEs to call when they 
have questions about reporting information to the CDFI Fund, that help 
ensure that the data they collect are accurate and reliable. In 
addition, data used to populate the NCMS are subject to several 
validity checks to ensure accuracy. CDFI Fund officials have also 
conducted a limited number of site visits to CDEs, one goal of those 
site visits being to ensure that data are being accurately reported. 

Our review of the CDFI Fund's NCMS system and site visits indicates 
that the CDFI Fund has instituted policies and procedures that should 
allow it to collect the information that it believes it needs to meet 
its compliance program's objectives of identifying CDEs that are no 
longer compliant with their allocation agreements. According to our 
Government Auditing Standards, agencies should develop internal 
controls, including controls that will ensure that programs operate 
effectively and efficiently and that data collected are reliable and 
valid.[Footnote 46] 

The CDFI Fund uses the NCMS to detect allocatees' noncompliance with 
their allocation agreements relating to authorized uses of NMTC 
allocations, restrictions on the use of NMTC allocations, and other 
special provisions that are included in an allocation agreement. If the 
NCMS identifies a CDE as being out of compliance with its allocation 
agreement, the CDFI Fund contacts the allocatee to let it know that the 
NCMS has identified it as noncompliant. The CDFI Fund officials then 
attempt to determine why the CDE is noncompliant and take steps 
necessary to bring the CDE back into compliance with the terms of its 
allocation agreement. 

As of January 2007, the CDFI Fund had identified nine CDEs that were 
not compliant with their allocation agreements and one CDE that was not 
in compliance with the NMTC program's "substantially all" requirement. 
For example, in one case the CDFI Fund determined through data reported 
in the NCMS that the CDE was serving communities that were outside its 
approved service area. In this case, the areas that the CDE was 
investing in still qualified for NMTC investment. In response, the CDFI 
Fund amended the CDE's allocation agreement by expanding the CDE's 
service area. Six of the noncompliance CDEs were first round allocatees 
that had not, as required in their allocation agreements, issued 60 
percent of their QEIs by the end of September 2006. The CDFI Fund is 
working with most of these allocatees to correct the problem; 
however, one first round allocatee has had its NMTC allocation revoked 
and another CDE returned its allocation as a result of not meeting this 
requirement. In the case where the CDFI Fund used the NCMS to identify 
a CDE that was failing the "substantially all" test, the CDFI Fund 
referred the problem to the IRS. In this case, the CDE was able to 
correct the problem within 6 months, the amount of time CDEs are given 
to correct failing the "substantially all" test, and further action was 
not required. 

The CDFI Fund developed policies and procedures for conducting site 
visits to CDEs where CDFI Fund officials check the validity of data 
reported by CDEs' to the CDFI Fund and obtain additional information 
about CDEs' efforts to remain compliant. These policies and procedures 
include criteria for prioritizing which allocatees warrant a site 
visit, the key information items to collect on a site visit, and a plan 
for using the information after the site visit is complete. As of 
November 2006, the CDFI Fund had conducted four site visits, two in 
2005 and two in 2006, and indicated that it intends to conduct more 
visits in the future. A CDFI Fund official indicated that the CDFI Fund 
has plans to conduct three site visits in fiscal year 2007. So far, the 
CDFI Fund has visited one multiyear allocatee, one CDE that the NCMS 
had identified as noncompliant, a CDE that participates in other CDFI 
Fund programs, and a bank that received an allocation award. 

The process of conducting a site visit goes through several steps. A 
site visit can be triggered when a CDE meets one or more of the seven 
criteria established by the CDFI Fund, which include whether the NCMS 
identified the CDE as noncompliant and whether the allocatee received 
awards in multiple allocation rounds. Once the CDFI Fund contacts the 
allocatee it intends to visit, CDFI Fund officials review the data that 
the CDE reported to the CDFI Fund and identify any areas of concern 
that the CDFI Fund will investigate during the site visit. During the 
visit, CDFI Fund officials review other documents, such as board 
meeting minutes and financial documents, and conduct interviews with 
key staff members. CDFI Fund officials also review documentation that 
the CDE maintains in order to ensure that the data the CDE reported to 
the CDFI Fund are accurate and reliable. After the site visit is 
complete, CDFI Fund officials prepare a site visit report using 
information gathered before and during the site visit. If the CDFI Fund 
does not find the CDE to be in default with its allocation agreement, 
no further enforcement action is taken. However, if the initial CDFI 
Fund report finds that the CDE is not compliant with its allocation 
agreement, the report is passed on to CDFI Fund senior management who 
then either approve or disapprove the report's finding. 

While these site visits do not yield generalizable results, they do 
supplement the information that the CDFI Fund receives through the 
NCMS. Unlike IRS, which must audit CDEs to determine if they are 
compliant with the NMTC's laws and regulations, the CDFI Fund is able 
to use data reported by CDEs as its primary mechanism for reviewing 
CDEs' compliance with their allocation agreements. As a result, the 
CDFI Fund is able to use data in the NCMS in conjunction with site 
visits that do not yield generalizable results in order to detect when 
a CDE is no longer compliant with its allocation agreement. 

If a CDE is determined to be noncompliant, the CDFI Fund can restrict 
the CDE's access to the NMTC program. According to CDFI Fund officials, 
if they find a "serious occurrence of noncompliance," such as a CDE 
failing to perform any of the transactions that it agreed to perform, 
the CDE would be found in default. To the extent possible, the CDFI 
Fund would assist the CDE in correcting the areas in which it was 
determined to be noncompliant--this could include amending or modifying 
the CDE's allocation agreement. If the CDE is not able to come back 
into compliance, the CDFI Fund could potentially bar that CDE from 
future allocation rounds, or if the CDE has not yet issued all its 
QEIs, the CDFI Fund could revoke its ability to make additional 
investments using its current allocation. Thus far, the CDFI Fund has 
not had to take these actions against any CDE as a result of the 
outcome of site visits. 

IRS and the CDFI Fund Have an MOU for Compliance Monitoring, but 
Additional Opportunities Exist to Monitor Investor Compliance: 

IRS and the CDFI Fund have cooperated in their compliance efforts. As 
part of their response to our initial NMTC report,[Footnote 47] the 
CDFI Fund and IRS developed an MOU in an effort to clarify the roles 
and responsibilities of both with respect to monitoring NMTC 
compliance. IRS and the CDFI Fund have had additional discussions to 
identify ways for the CDFI Fund to streamline the data that it provides 
to IRS. While IRS and the CDFI Fund have worked together to monitor 
NMTC compliance, the two agencies could collect additional information 
that would help the IRS monitor compliance by NMTC investors, an area 
where neither the CDFI Fund nor IRS has chosen to dedicate resources. 

According to the MOU completed in 2004, the CDFI Fund is responsible 
for carrying out the NMTC program's application and allocation 
procedures. In addition, the MOU states that the CDFI Fund will permit 
designated IRS staff to have access to CDFI Fund databases, provide IRS 
with the relevant findings and assessments of any site visits to NMTC 
allocatees conducted by CDFI Fund staff, and notify IRS of any 
potential credit recaptures. Also, on behalf of IRS, the CDFI Fund also 
includes compliance questions that CDEs respond to in its database 
regarding recapture and investments that CDEs have made in low-income 
communities. If the CDFI Fund determines from the answers to these 
questions that the CDE may be in danger of having the NMTC recaptured, 
it is to forward the information to IRS. 

According to the terms of the MOU, IRS is responsible for the 
collection and determination of any tax as deemed appropriate. In 
addition, the MOU notes that IRS is responsible for establishing 
processes and procedures to ensure that taxpayers are in compliance 
with the NMTC's tax provisions, and IRS will provide the CDFI Fund with 
quarterly information, to the extent permitted by law, regarding any 
CDEs that fail to meet the NMTC's legal requirements. 

IRS and the CDFI Fund have identified data sharing as an area where 
their cooperation could be improved. While IRS has access to CDFI Fund 
data, according to IRS officials, they have had difficulty selectively 
obtaining the information that they are most interested in from the 
CDFI Fund's data systems. According to IRS officials, a more 
streamlined format for sharing data between IRS and the CDFI Fund would 
allow IRS to better target noncompliance. CDFI Fund officials said that 
they are working with IRS to develop a streamlined compliance data 
report, and they indicated that IRS has been cooperative in working 
with them. An IRS official agreed that the two agencies are working 
together to develop a more user-friendly data report specifically for 
IRS. 

IRS is also taking steps to increase the amount of information 
available about NMTC investors. IRS is in the process of finalizing a 
new form that will require CDEs to report to IRS the amount of QEI that 
NMTC investors made at the investment's original issue. IRS currently 
does not have these data for all claimants because the CDFI Fund data 
that IRS currently uses to identify credit claimants does not track 
claimants in cases when the underlying QEI is sold to another investor. 
In addition, IRS is finalizing a second form that will require CDEs to 
notify the original equity investor in an NMTC investment if the credit 
is being recaptured. With these forms and the CDFI Fund data, IRS will 
have a complete record of the initial NMTC investors in a CDE and how 
much they invested. 

However, further steps could be taken to identify NMTC investors and 
ensure that only eligible taxpayers claim the credit and that they 
claim the correct amounts. NMTC investors are allowed to sell their 
equity share in a CDE, which determines their NMTC eligibility, to 
other investors after the initial investment has taken place, and 
neither the IRS nor the CDFI Fund tracks NMTC investors after the 
original investment. IRS officials indicated that the forms they are 
finalizing cannot be used to track the selling of an investor's equity 
share in a CDE because they will not be refiled if the investment is 
sold to another investor after the original investment. As a result, 
IRS and the CDFI Fund will not be able to identify all NMTC investors 
and the amount of QEI that they made if an investor's equity share in a 
CDE is sold after the original investment. When evaluating other tax 
credits, we have noted that IRS is responsible for ensuring that 
taxpayers claim those tax credits for which they are entitled.[Footnote 
48] If IRS and the CDFI Fund developed ways to identify investors and 
the amounts they invested, even when NMTC investors sell their equity 
shares in a CDE, they would be better able to ensure that credits are 
claimed correctly. 

Our analysis of IRS and CDFI Fund data indicates that many NMTC 
investments may be sold after the original QEI is made in the CDE, 
making it difficult for IRS to identify all eligible NMTC claimants and 
the amounts that they are eligible to claim. When we compared potential 
tax credit claimants in IRS's databases to claimants in the CDFI Fund's 
database, we noted that more investors were identified as being 
eligible to claim the credit in IRS's taxpayer data than in the CDFI 
Fund's data on claimants when a QEI is originally issued. 

According to IRS, requiring individual investors to report sales of 
NMTC investments could place an undue burden on taxpayers. However, IRS 
told us that this would be useful information for its compliance 
monitoring efforts--both for identifying investors eligible to claim 
the NMTC on their tax returns and for identifying tax credit investors 
if IRS is forced to recapture the credits from investors when a CDE is 
no longer compliant with the "substantially all" requirement.[Footnote 
49] The CDFI Fund already collects information from CDEs in its 
database identifying the initial investors and how much NMTC eligible 
investment has been made by investors that did not participate in 
tiered equity or leveraged NMTC transactions. Further, a NMTC investor 
with prior experience investing in CDEs and a representative of a CDE 
said that in their experience, CDEs are already able to identify 
subsequent holders of NMTC qualified equity investments when one NMTC 
investor sells its equity share in a CDE to another investor, and CDEs 
could potentially be able to report that information to the CDFI Fund 
or IRS. In the case where investors in a partnership that has NMTC 
investments sell their share in the partnership, it may be more 
difficult for CDEs to identify who the correct tax credit claimants 
would be, although the CDE would still know which partnerships own QEI 
in the CDE. 

Currently, neither IRS nor CDFI Fund data make it possible to identify 
completely who is eligible to claim the tax credit and how much they 
are entitled to claim. As more NMTC investments are being resold and 
complicated investment structures are becoming more common, limits on 
IRS's ability to monitor investor compliance could make IRS vulnerable 
to a loss of tax revenues caused by taxpayer noncompliance, fraud, and 
abuse, and it could become increasingly difficult for IRS to identify 
tax credit claimants if it is forced to recapture the credit. If CDEs 
reported more complete information about initial NMTC investors and 
subsequent sales of the equity shares in the CDE that are linked to 
NMTC eligibility to the IRS or the CDFI Fund, IRS would have better 
information to track investor compliance. 

Investors in CDEs Play a Role in Ensuring NMTC Compliance: 

Investors that responded to GAO's NMTC survey indicated that they are 
concerned about the possibility of the credit being recaptured and that 
they play an active role in ensuring that CDEs remain compliant with 
the laws and regulations that apply to the NMTC program. An estimated 
82 percent (74.0, 89.0) of our survey respondents indicated that they 
are "moderately" to "very highly" concerned about the possibility that 
the credit could be recaptured. Nearly all investors, 97 percent, 
reported that they make some effort to ensure that CDEs remain 
compliant so that the investors avoid recapture. About 72 percent of 
the survey respondents said that they have regular discussion with 
CDEs, and 84 percent said they receive regular reports from CDEs. 
Nearly one-quarter of NMTC investors said that they audit the CDEs in 
which they made NMTC investments. Figure 10 shows the activities that 
NMTC investor survey respondents undertake to monitor CDE compliance. 

Figure 10: Activities Investor Survey Respondents Undertake to Monitor 
CDE Compliance: 

[See PDF for image] 

Source: GAO. 

Note: Confidence intervals for the data presented in this graphic are 
as follows: receive regular reports from the CDE (75.8, 90.3), receive 
independent audit reports about the CDE (74.4, 89.9), have regular 
discussions with the CDE (62.8, 80.6), make regular site visits to the 
CDE (33.8, 52.5), created the CDE and staff it ourselves (25.3, 42.3), 
audit the CDE (16.1, 32.5). 

[End of figure] 

Conclusions: 

The purpose of the NMTC program is to encourage investment and 
development in low-income communities. Our analysis indicates that the 
program may be accomplishing part of that objective. In our investor 
survey, most participating investors said that they increased 
investment in low-income communities because of the credit. The 
statistical analysis also showed an increase in investment, with 
individuals adding new investment and corporations shifting funds from 
other uses. However, some of the survey evidence may be less consistent 
with the credit increasing investment (e.g., the prior experience of 
most NMTC investors with low-income community investment) and, because 
of data limitations, our statistical evidence may only establish an 
association between the credit and increased investment, not that the 
program causes the increase. In any case, the indication that the 
program increases investment is not sufficient to support conclusions 
about the program's effectiveness, nor is the fact that the credit 
shifts investment an indicator of a lack of effectiveness. For example, 
more information is needed about the economic and social benefits that 
the low-income communities receive from the investment. This 
information is only now likely to be available given that the program's 
implementation was delayed. 

IRS and the CDFI Fund are implementing a compliance monitoring system 
in the context of a program that is growing and that is attracting 
investors that use increasingly complex and sophisticated investment 
structures. As IRS moves forward with its NMTC compliance study, more 
rigorous development of criteria for selecting which CDEs to audit 
could help it better identify the most common compliance issues facing 
CDEs. Additionally, more complete information on who is eligible to 
claim the tax credit and the amounts that they are eligible to claim 
would be useful to IRS in helping ensure that only eligible taxpayers 
claim the NMTC, and a complete list of eligible NMTC claimants would 
assist IRS should the IRS need to recapture NMTCs. 

Recommendations for Executive Action: 

To ensure IRS is reviewing the full range of NMTC transactions and that 
the conclusions of its compliance study are more representative of all 
CDEs with NMTC allocations, we recommend that IRS use CDFI Fund data 
and the results of its current NMTC compliance study to develop 
criteria for selecting which CDEs to audit as part of its future 
compliance monitoring efforts. 

Additionally, to ensure that eligible taxpayers claim the correct 
amount of NMTC on their tax returns and IRS is able to identify all tax 
credit claimants in the event of the credit being recaptured, we 
recommend that IRS work with the CDFI Fund to further explore options 
for cost effectively monitoring investor compliance and developing a 
way to identify NMTC claimants, even in instances where the original 
investor sells its equity share in a CDE, and the amount of QEI that 
each investor made. 

Agency Comments: 

We received written comments on a draft of this report from the Acting 
Director of the CDFI Fund and the Commissioner of Internal Revenue; 
their comments are reprinted in appendices IV and V. Both the IRS and 
the CDFI Fund agreed with our recommendations. We also incorporated 
technical corrections to the draft report that we received from both 
IRS and the CDFI Fund where appropriate. 

In its response to the draft report, the CDFI Fund characterized GAO's 
study as indicating that the NMTC has been a highly successful tool for 
increasing the flow of investments into low-income communities. While 
our findings do suggest that the NMTC appears to increase investment by 
participating investors in low-income communities, we also note that 
further information is needed to fully assess the effectiveness of the 
NMTC program. 

We are sending copies of this report to the interested congressional 
committees, the Commissioner of Internal Revenue, the Director of the 
Community Development Financial Institutions Fund, and other interested 
parties. We will make copies available to others on request. In 
addition, the report will be available at no charge on the GAO web site 
at [Hyperlink, http://www.gao.gov]. 

If you or your staff have any questions on matters discussed in this 
report or would like additional information, please contact me at (202) 
512-9110 or at brostekm@gao.gov. Major contributors to this report are 
acknowledged in appendix VI. 

Signed by: 

Michael Brostek: 
Director, Tax Issues: 

List of Committees: 

The Honorable Max Baucus: 
Chairman: 
The Honorable Charles E. Grassley: 
Ranking Minority Member: 
Committee on Finance: 
United States Senate: 

The Honorable John F. Kerry: 
Chairman: 
The Honorable Olympia J. Snowe: 
Ranking Minority Member: 
Committee on Small Business and Entrepreneurship: 
United States Senate: 

The Honorable Christopher Dodd: 
Chairman: 
The Honorable Richard S. Shelby: 
Ranking Minority Member: 
Committee on Banking, Housing, and Urban Affairs: 
United States Senate: 

The Honorable Charles B. Rangel: 
Chairman: 
The Honorable Jim McCrery: 
Ranking Minority Member: 
Committee on Ways and Means: 
House of Representatives: 

The Honorable Nydia M. Velázquez: 
Chair: 
The Honorable Steve Chabot: 
Ranking Minority Member: 
Committee on Small Business: 
House of Representatives: 

The Honorable Barney Frank: 
Chairman: 
The Honorable Spencer Bachus: 
Ranking Minority Member: 
Committee on Financial Services: 
House of Representatives: 

[End of section] 

Appendix I: Objectives, Scope, and Methodology: 

Based on consultations with staff at cognizant congressional 
committees, the objectives of this report are to (1) describe the 
status of the New Markets Tax Credit (NMTC) program; (2) profile the 
characteristics of NMTC investors, the Community Development Entities 
(CDE) that receive NMTC allocations, and the businesses and communities 
that receive NMTC investments; (3) assess how effective the NMTC has 
been in bringing new investment to low-income communities by the 
investors that have participated in the program; and (4) assess the 
steps that the Internal Revenue Service (IRS) and Community Development 
Financial Institutions (CDFI) Fund are taking to ensure CDEs and 
investors are complying with the NMTC and evaluate how effective these 
steps have been. 

In order to accomplish these objectives, we used a number of methods of 
analysis. We met with officials from the CDFI Fund and IRS. We 
collected documents on the program status and efforts to monitor NMTC 
compliance. We also analyzed data from the CDFI Fund on the CDEs and 
their investment in low-income communities and tax return data from tax 
years 1997 through 2004 for investors in the NMTC program. We used 
these data to report summary statistics that profile the participants 
in the program and to conduct statistical analysis that measures the 
effect of the NMTC on investment. We also surveyed investors in the 
NMTC program in order to provide additional information on the effect 
of the credit and characteristics of the investors. 

To evaluate investment in the CDEs by NMTC investors, we used data from 
the CDFI Fund's Allocation Tracking System (ATS) on investments 
reported through mid-December 2006. We used the ATS data to report on 
the type and size of qualified equity investment (QEI) made in the CDE 
and the CDE that received the investment. We also used the ATS to 
analyze the equity investors in the NMTC program. To report on 
qualified low-income community investments (QLICI) from the CDE to the 
corresponding qualified active low-income community business (QALICB) 
we analyzed data from the Community Investment Impact System (CIIS). 
Specifically, we used data from the CIIS Transaction Level Report (TLR) 
for fiscal years 2003 through 2005, which provides information on each 
transaction made as part of a QLICI. To assess the reliability of the 
ATS and the TLR data sources, we reviewed the CDFI Fund's data quality 
control procedures and subsequently determined that the data were 
sufficiently reliable for our purposes. 

We also reviewed tax data on NMTC investors from IRS's Individual 
Returns Transaction File (IRTF) and Business Returns Transaction File 
(BRTF). We identified NMTC claimants using data on original claimants 
(at the time the QEI was made) from the CDFI Fund's ATS and used their 
tax return information to determine how NMTC investors differ in size 
from all taxpayers. In cases where we could not locate a corporation's 
tax return because the NMTC investor was a subsidiary of a larger 
parent corporation, we used IRS's National Account Profile to link the 
subsidiary to its parent corporation. In these cases, the parent 
corporation's tax return was used in our analysis. In addition, because 
original claimants may sell their investment, and along with it their 
NMTC credit, we identified further claimants as those individuals or 
corporations that indicated they were eligible to claim the NMTC on 
their tax returns. This information came from IRS's IRTF or BRTF on the 
New Markets Tax Credit Form (Form 8874) or as part of the General 
Business Credit (Form 3800). To assess the reliability of the IRS data 
sources, we reviewed the IRS's data quality control procedures and 
subsequently determined that the data were sufficiently reliable for 
our purposes. 

To obtain information from investors on the effectiveness of the NMTC, 
we designed and implemented a Web-based survey to gather information on 
the investors' motivations and methods. We used CDFI Fund data and 
interviews with investors to determine the proper points of contact for 
NMTC investors. Our survey population consists of NMTC claimants and 
their proxies for cases in which the individual claimant was not 
principally responsible for deciding to make the NMTC investment. In 
some cases, one person was designated as the contact point for a group 
of investors responding to the survey. 

The survey asked a combination of questions that allowed for open-ended 
and close-ended responses. Because some investors invested with more 
than one CDE and because not all investors participated in tiered or 
leveraged investment structures, the instrument was designed with skip 
patterns directing investors to comment only on the prepopulated CDE 
and type of investment structure that they utilized. Therefore, the 
number of survey respondents for each question varied depending on the 
number of CDEs in which the investor made a QEI and whether the 
investor had used tiered or leveraged structures. 

We pretested the content and format of the questionnaire with 
knowledgeable investors. During the pretest, we asked the investors 
questions to determine whether (1) the survey questions were clear, (2) 
the terms used were precise, (3) the questionnaire placed an undue 
burden on the respondents, and (4) the questions were unbiased. We also 
assessed the usability of the Web-based format. We received input on 
the survey from a CDFI Fund official and made changes to the content 
and format of the final questionnaire based on pretest results. 

The survey was conducted using self-administered electronic 
questionnaires posted on the World Wide Web. We sent e-mail 
notifications to investors beginning on August 2, 2006.[Footnote 50] We 
then sent each potential respondent a unique password and user name by 
e-mail to ensure that only members of the target population could 
participate in the appropriate survey. To encourage respondents to 
complete the questionnaire, we sent e-mail messages to prompt each 
nonrespondent approximately 2 weeks and 3 weeks after the initial e- 
mail message. We also arranged for contract callers to do phone follow- 
ups from September 6 to September 8, 2006. We closed the survey on 
October 3, 2006. 

Because we attempted to collect data from every investor in the 
population, there was no sampling error. However, the practical 
difficulties of conducting any survey may introduce errors, commonly 
referred to as nonsampling errors. For example, differences in how a 
particular question is interpreted, the sources of information 
available to respondents, how the responses were processed and 
analyzed, or the types of people who do not respond can influence the 
accuracy of the survey results. We took steps in the development of the 
surveys, the data collection, and the data analysis to minimize these 
nonsampling errors and help ensure the accuracy of the answers that 
were obtained. A second, independent analyst checked all the computer 
programs that processed the data. 

The response rate for this survey was 51 percent. We conducted a 
nonresponse bias analysis by looking at the response rates for eight 
cells defined by the four types of investors surveyed (financial 
institutions, individuals, nonfinancial corporations, and other) and 
the size of the investor's total assets (in the case of corporations) 
or adjusted gross income (for individuals). We collected this 
information primarily from the investor's most recent tax return filed 
with IRS. In cases where we could not identify a tax return (primarily 
because the corporation had recently been acquired or merged with 
another corporation) we relied on public information on the 
corporation's total assets from its most recent annual report. 
Investors were placed in one of two size categories, either less than 
the median or greater than the median. 

Individuals with adjusted gross income less than the median for 
individuals using the NMTC had the highest response rate at 63 percent 
followed by financial institutions with a response rate of 56 percent 
for financial institutions with income above the median and 53 percent 
for financial institutions with income below the median. Individuals 
with incomes above the median had the lowest response rate at 32 
percent. 

Differential response rates across analytic subgroups raise the 
possibility of nonresponse bias. If the respondents provided different 
responses than the nonrespondents, the survey estimates would be 
biased. We have weighted the respondents by type and income to reduce 
this source of nonresponse bias. Unfortunately, there may be other 
sources of nonresponse bias that we are unaware of and unable to adjust 
for. 

A statistician used the data on size and type of investor to create 
weights that allowed us to project the survey responses to the entire 
population by assuming that the nonrespondents would have answered the 
questions as the respondents did. We have treated the respondents as a 
stratified, random sample and calculated sampling errors as an estimate 
of the uncertainty around the survey estimates. Ninety-five percent 
confidence intervals are given in parentheses after the estimates. We 
are 95 percent confident that each of the confidence intervals in this 
report will include the true values in the study population. 

We also used IRS tax data to develop statistical analysis that measures 
the effect of the NMTC on investment and addresses the question of 
whether NMTC investments represent new or shifted funds. Using the tax 
returns of NMTC investors as determined from CDFI Fund and IRS data 
(see above) we used a multistage sampling methodology to draw a 
comparison group of tax returns. These methods are more fully described 
in appendix II. To develop our statistical methodology, we relied on 
academic journal articles and interviewed experts in the research 
fields of individual savings and wealth and corporate taxation. 

To study the effectiveness of the steps that IRS and the CDFI Fund are 
taking to ensure CDEs and investors are complying with the NMTC and the 
effectiveness of these measures, we met with officials from the CDFI 
Fund and IRS. We also collected documents on the program status and 
efforts to monitor NMTC compliance. 

We performed our work at GAO Headquarters and the IRS office in New 
Carrollton, Maryland, from July 2006 through December 2006 in 
accordance with generally accepted government auditing standards. 

[End of section] 

Appendix II: Description of Data and Methodology for Statistical 
Analysis of the Effect of NMTC Participation on Investment: 

This appendix describes our data and methodology for assessing whether 
participation in the NMTC program affects investment by NMTC investors 
in low-income communities. The NMTC program may affect investment by 
increasing the overall level of investment (i.e., creating "new" 
investment) or by causing NMTC investors to shift investment from other 
uses to investment eligible for the credit. The methodology that we use 
to detect these changes in investment follows the methodology used in 
the retirement savings literature. This literature generally compares 
the wealth or financial assets of participants in retirement savings 
plans to that of nonparticipants to detect any effect of participation 
on savings.[Footnote 51] In our assessment of the NMTC program, we 
compare the wealth or assets of NMTC program participants to that of a 
group of similar nonparticipants to detect any effect on investment. 

Our statistical analysis of the effectiveness of the NMTC program in 
stimulating investment depends on the distinction between new and 
shifted investment. If our analysis detects new investment, this 
outcome is consistent with program goals because it may indicate 
increased investment in low-income communities that would not have 
occurred in the absence of the credit. If we do not detect new 
investment, it is possible that the credit has created no change in 
behavior and investors are just receiving a subsidy for investments 
that they would have made anyway, which is not consistent with the 
goals of the program. However, the investment could also be shifted 
from other communities. The implications for the effectiveness of the 
program in the case of shifted investment are more ambiguous. It could 
mean that (1) the credit has induced investors to shift investments 
from assets invested in other low-income communities, which means that 
although the credit has generated investments in projects that would 
not have occurred otherwise, it has not increased investment in low- 
income communities, or (2) NMTC investments represent funds shifted 
from higher income communities. The first outcome is not consistent 
with the NMTC's broader goal of increasing investment in low-income 
communities as a whole. The second outcome is more consistent with 
program goals because, as with new investment, it may indicate 
increased investment funds available to low-income communities. 
Finally, in the case of both new and shifted investment, NMTC 
investment may reduce investment by non-NMTC investors (called crowding 
out) which is also inconsistent with the broader goal of the program. 
Our data and methodology do not allow us to detect crowding out, and 
for this reason, we confine our analysis to the effect of the credit on 
the investment behavior of participants in the NMTC program. 

A limitation of our statistical analysis is that in the case of no 
detected change in the overall level of investment, we cannot 
distinguish between the possible types of shifting or between shifting 
and the possibility that there has been no change in investment 
behavior. However, if we combine evidence from our survey of investors 
with evidence from our statistical analysis, our analysis may provide 
some indication that the effect of the program on investment in low- 
income communities by NMTC investors is shifted investment. The survey 
of investors that benefit from the tax credit indicated that most 
investments would not have occurred in the absence of the credit 
(inconsistent with the notion that the credit has no effect on investor 
behavior), and that NMTC investors had increased their investments in 
low-income communities because of the credit (inconsistent with the 
first shifting outcome above). Therefore, we use the second shifting 
outcome described above to interpret our statistical results in cases 
where we detect no overall increase in the level of investment by NMTC 
investors. 

Description of Data: 

We identified NMTC investors using both CDFI Fund data and IRS data. We 
collected data on original claimants (at the time the QEI was made) 
from the CDFI Fund. We also identified investors from IRS's Returns 
Transaction File data as those claiming a positive amount for the 
credit on their tax returns in tax years 2001 through 2004. There were 
differences in the number of claimants identified from the two 
different sources with the IRS data resulting in more investors. The 
source of these differences is unclear as they could indicate 
incomplete CDFI Fund data, missing taxpayer identification numbers 
(TIN) in the CDFI Fund data, or a large turnover in credits. In the 
latter case, investors may not be responding to the incentives of the 
credit themselves but to the terms constructed by the original 
investor. However, this is not necessarily the case as some investors 
we spoke with that had purchased the credit from the original investor 
indicated that they intended to participate but that the original 
investor was necessary due to timing issues. Because of the uncertainty 
over which set of investors is the most relevant for our analysis, we 
estimated results using both the full sample (IRS and CDFI Fund 
claimants) and CDFI Fund claimants only. Our conclusions were the same 
for both groups; however, we are only reporting results for the full 
sample of NMTC investors identified in IRS and CDFI Fund databases. 

Our analysis of these data indicated that NMTC claimants were generally 
higher income (individuals) or had higher total assets (corporations) 
than the average taxpayer. This prompted us to identify our basic 
comparison group using a stratified random sample of taxpayers based on 
adjusted gross income for individuals and total assets at the end of 
the tax period for corporations. We oversampled high income and total 
asset taxpayers relative to an unstratified random sample from the same 
populations. We used quintiles to stratify our sample and drew a random 
sample of about 4,000 returns per quintile.[Footnote 52] We chose our 
quintiles and drew the comparison groups based on 2000 tax year data 
because this was the year before the credit could be claimed and in 
that year we would not expect any changes in behavior due to the 
credit. 

For individuals, we collected all available data from Form 1040 and 
information from Schedules C and F to form a panel of taxpayers for tax 
years 1997 through 2004. The data include more than 24,000 individual 
tax filers and about 80 percent of filers (including NMTC investors) 
are in the panel for all 8 years. For corporations, we used income data 
from Form 1120 and balance sheet data from Schedule L to form a panel 
of corporate taxpayers for tax years 1997 through 2004. These data 
include more than 14,000 corporate tax filers and about 56 percent of 
corporate filers were present in at least 7 years. (Forty-eight percent 
were present for all 8 years and 57 percent of NMTC investors were in 
all years.) Both individual and corporate NMTC investors were 
identified using TINs contained in CDFI Fund data and the New Markets 
Tax Credit Form (Form 8874) or as part of the General Business Credit 
(Form 3800) in the IRS data. The total number of NMTC claimants 
identified from these sources was 753. 

We also estimated asset values for individuals because, unlike IRS 
balance sheet data for corporations, the IRS data for individuals were 
limited to income streams and did not include asset levels. We followed 
the methods used in the Survey of Consumer Finances (SCF) to estimate 
asset holdings using income streams and rates of return.[Footnote 53] 
We also expanded on the SCF approach by using more sophisticated 
modeling to develop estimates of home equity. Rather than attribute to 
each household the median home value within its income group (as the 
SCF does), we estimated home equity using the November 1999 Wave (12) 
of the 1996 Survey of Income and Program Participation. Our controls 
included total income, age, marital status, and region.[Footnote 54] We 
then applied these estimated coefficients to tax return information on 
total income, age, filing status, and region of residence to generate 
estimates of home equity for each household using 2000 tax data. 
Negative values were set to zero, and the consumer price index (CPI) 
(research series)[Footnote 55] was used to adjust the year 2000 
estimates for earlier and later years.[Footnote 56] 

Effects of NMTC Program Participation on Investment: 

We assessed the effects of NMTC participation by comparing the level of 
assets and growth in assets of NMTC participants with the level and 
growth in assets of corporations and individuals that did not 
participate in the NMTC program.[Footnote 57] We used regression 
techniques to compare the level of assets of NMTC investors and the 
relevant comparison group. The results of these models indicate whether 
the assets of NMTC claimants are higher than those of our comparison 
group controlling for other individual and corporate characteristics. 
However, it is possible that this approach is simply picking up the 
likelihood that NMTC claimants systematically have higher assets than 
their counterparts (despite our efforts to choose an appropriate 
comparison group using a stratified random sample). Therefore, we used 
several methods, including regression and propensity score techniques, 
to compare the growth of assets over time.[Footnote 58] Differences in 
growth rates between NMTC investors and the comparison group do not 
depend on differences in the level of assets. 

Our baseline model for corporate investors is a fixed effects model of 
the following form[Footnote 59]: 

Y(it) = X(it)Beta + µ(it): 

For corporate investors, Y(it) represents the log of total assets, 
total liabilities, or net assets; X(it) represents control variables 
which include the lag of net assets, the NMTC participation dummy, year 
dummies, and region dummies; and µ(it) represents a random error 
term.[Footnote 60] Additional control variables are not used because 
they are included in the fixed effect. These variables include 
corporate-level characteristics, such as industry, that do not change 
over time. 

Statistical analysis of this baseline model indicates that corporate 
NMTC investment funds are more likely to represent investment funds 
shifted from other uses. Although there was some evidence that NMTC 
investors have higher levels of net assets than those in our comparison 
group, this result was not robust over different specifications of the 
model. On the other hand, our analysis of growth rates showed no 
statistically significant effect of NMTC investment status on the 
growth of net assets. This result means that NMTC investors are not 
investing at rates different from non-NMTC investors. Unlike the case 
of asset levels, this result was robust across several specifications 
involving regression and propensity score methods, as indicated in 
table 9.[Footnote 61] In addition, the result was qualitatively the 
same for each quintile, when we used only years 2001 through 2004 in 
the analysis, when we used median regression, and when our analysis 
included only banks. 

Table 9: Growth in Net Assets Using Fixed Effects Regression and 
Comparisons Based on Nearest Neighbor Propensity Score Matching: 

Specification[A]: Nearest neighbor matching; 
Average effect: - 2,883.972; 
Coefficient: [Empty]; 
Standard error: 6,740.992. 

Specification[A]: Matching - CDFI Fund indentified investors; 
Average effect: -19,000.000; 
Coefficient: [Empty]; 
Standard error: 41,265.206. 

Specification[A]: Baseline regression - full sample; 
Average effect: ; 
Coefficient: 0.009; 
Standard error: 0.091. 

Specification[A]: Quintile one; 
Average effect: ; 
Coefficient: 0.002; 
Standard error: 0.012. 

Specification[A]: Quintile two; 
Average effect: ; 
Coefficient: 0.020; 
Standard error: 0.090. 

Specification[A]: Quintile three; 
Average effect: ; 
Coefficient: - 0.065; 
Standard error: 0.614. 

Specification[A]: Quintile four; 
Average effect: ; 
Coefficient: - 0.065; 
Standard error: 0.306. 

Specification[A]: Quintile five; 
Average effect: ; 
Coefficient: 0.662; 
Standard error: 1.134. 

Specification[A]: Banks only; 
Average effect: ; 
Coefficient: 0.082; 
Standard error: 0.061. 

Specification[A]: Tax years 2001 through 2004; 
Average effect: ; 
Coefficient: -0.100; 
Standard error: 0.133. 

Specification[A]: Median regression; 
Average effect: ; 
Coefficient: 0.000; 
Standard error: 0.003. 

Source: GAO analysis of IRS and CDFI Fund data. 

Note: No coefficients were significant at the 10 percent or better 
level. 

[A] Unless otherwise noted the dependent variable is the difference in 
the inverse hyperbolic sine of net assets. This transformation was used 
instead of the related log transformation to better address zero and 
negative values. 

[End of table] 

Further analysis included using instrumental variables for predicting 
participation in the NMTC. However, we did not find important 
differences between participants and nonparticipants based on location 
and participation in other general business credits. We concluded that 
the problem of endogeneity[Footnote 62] may not be a significant issue 
for corporations because corporate participants are likely to be 
exposed to a similar set of investment options as nonparticipants and 
individual corporate characteristics that affect participation are 
captured in the fixed effect. We also attempted to identify the source 
of the shifted investment funds by dividing net assets into components, 
total assets and total liabilities. However, these results were 
inconclusive as they were not consistent enough to reach any strong 
conclusions. 

A limitation of our analysis of corporations is that the amount of NMTC 
investment might be small relative to a corporation's total size. This 
means that our statistical models could fail to detect a positive 
effect of the NMTC investment on corporations' asset levels even if 
such an effect exists. We attempted to mitigate this problem by 
analyzing firm-level data, the smallest unit of analysis available, and 
growth in assets over time. 

We assessed the effect of NMTC participation on level and growth of 
assets for individuals in a manner similar to the analysis for 
corporations. Our baseline model for individual investors is a fixed 
effects model of the following form: 

y(it) = N(it) + X(1it)Beta + V(it): 

where y is the dependent variable, wealth, for household i at time t; N 
is an indicator for NMTC investment (which is endogenous, i.e., 
correlated with the error term); X is a set of exogenous control 
variables; and are coefficients; and it is an error term. 

However[Footnote 63], unlike the analysis of corporate investors, we 
analyzed the effect of NMTC on individuals by estimating an 
instrumental variable[Footnote 64]s version of the baseline model to 
account for possible endogeneity of the NMTC participation variable. We 
concluded that this problem is likely to be worse for individuals than 
for corporations because individuals are less likely to have the same 
information about the various business tax incentives so that the 
decision to participate is not random and likely to be correlated with 
other explanatory variables. We chose as our instrumental variables the 
dollar amount of allocation in the state of residence and the presence 
of other general business credit[Footnote 65]s. These variables are 
likely to be highly correlated with NMTC participation but not with 
levels of household wealth. 

To implement the instrumental variables model, we first estimated N as 
follows: 

Nit = X1it + X2it + it: 

where X2 contains our instrumental variables and the other variables 
are defined as in the baseline model. This regression is used to 
predict NMTC participation using presence of a general business credit 
deduction and the cumulative NMTC allocation in state of residence as 
instrumental variables.[Footnote 66] We then estimated the baseline 
fixed effects model with Yit as the log of wealth and Xit as control 
variables, which include balance due, an NMTC participation dummy 
(instrumented), year dummies, and region dummies.[Footnote 67] In order 
to test the effect of NMTC participation on the components of wealth, 
we also ran regressions with Yit as the log of business assets, real 
estate assets, dividend assets, and interest bearing assets. Like 
wealth, these asset levels were measured in thousands of dollars and 
adjusted into constant dollars using the CPI research series. The 
results of this analysis for asset levels of individuals are presented 
in table 10. The coefficient for NMTC investor in the wealth column 
indicates that the log of wealth (in thousands of dollars) is 
significantly higher than for noninvestors. 

Table 10: Baseline Analysis: Instrumental Variables Fixed Effects 
Regressions on the Full Sample: 

Variable: NMTC investor; 
Wealth: Coefficient: 2.346; 
Wealth: Standard error: 0.331; 
Interest assets: Coefficient: 2.719; 
Interest assets: Standard error: 0.665; 
Business assets: Coefficient: 17.287; 
Business assets: Standard error: 0.950. 

Variable: Total income (log); 
Wealth: Coefficient: 0.245; 
Wealth: Standard error: 0.006; 
Interest assets: Coefficient: 0.587; 
Interest assets: Standard error: 0.011; 
Business assets: Coefficient: 0.360; 
Business assets: Standard error: 0.016. 

Variable: Balance due; 
Wealth: Coefficient: 0.038; 
Wealth: Standard error: 0.002; 
Interest assets: Coefficient: -0.031; 
Interest assets: Standard error: 0.005; 
Business assets: Coefficient: 0.070; 
Business assets: Standard error: 0.006. 

Variable: New England; 
Wealth: Coefficient: -0.071; 
Wealth: Standard error: 0.084; 
Interest assets: Coefficient: 0.269; 
Interest assets: Standard error: 0.169; 
Business assets: Coefficient: 0.324; 
Business assets: Standard error: 0.242. 

Variable: East North Central; 
Wealth: Coefficient: -0.242; 
Wealth: Standard error: 0.078; 
Interest assets: Coefficient: 0.028; 
Interest assets: Standard error: 0.156; 
Business assets: Coefficient: 0.517; 
Business assets: Standard error: 0.223. 

Variable: West North Central; 
Wealth: Coefficient: 0.003; 
Wealth: Standard error: 0.097; 
Interest assets: Coefficient: -0.315; 
Interest assets: Standard error: 0.196; 
Business assets: Coefficient: 0.363; 
Business assets: Standard error: 0.279. 

Variable: South Atlantic; 
Wealth: Coefficient: -0.134; 
Wealth: Standard error: 0.063; 
Interest assets: Coefficient: -0.170; 
Interest assets: Standard error: 0.127; 
Business assets: Coefficient: 0.155; 
Business assets: Standard error: 0.181. 

Variable: East South Central; 
Wealth: Coefficient: -0.232; 
Wealth: Standard error: 0.101; 
Interest assets: Coefficient: -0.319; 
Interest assets: Standard error: 0.203; 
Business assets: Coefficient: 0.437; 
Business assets: Standard error: 0.289. 

Variable: West South Central; 
Wealth: Coefficient: 0.135; 
Wealth: Standard error: 0.086; 
Interest assets: Coefficient: 0.301; 
Interest assets: Standard error: 0.172; 
Business assets: Coefficient: 0.630; 
Business assets: Standard error: 0.246. 

Variable: Mountain; 
Wealth: Coefficient: -0.125; 
Wealth: Standard error: 0.081; 
Interest assets: Coefficient: -0.062; 
Interest assets: Standard error: 0.162; 
Business assets: Coefficient: 0.236; 
Business assets: Standard error: 0.232. 

Variable: Pacific; 
Wealth: Coefficient: -0.227; 
Wealth: Standard error: 0.075; 
Interest assets: Coefficient: -0.008; 
Interest assets: Standard error: 0.150; 
Business assets: Coefficient: 0.103; 
Business assets: Standard error: 0.214. 

Variable: Year 1998; 
Wealth: Coefficient: 0.097; 
Wealth: Standard error: 0.016; 
Interest assets: Coefficient: 0.061; 
Interest assets: Standard error: 0.032; 
Business assets: Coefficient: 0.068; 
Business assets: Standard error: 0.046. 

Variable: Year 1999; 
Wealth: Coefficient: 0.158; 
Wealth: Standard error: 0.016; 
Interest assets: Coefficient: -0.025; 
Interest assets: Standard error: 0.032; 
Business assets: Coefficient: 0.099; 
Business assets: Standard error: 0.046. 

Variable: Year 2000; 
Wealth: Coefficient: 0.372; 
Wealth: Standard error: 0.016; 
Interest assets: Coefficient: 0.338; 
Interest assets: Standard error: 0.032; 
Business assets: Coefficient: 0.259; 
Business assets: Standard error: 0.046. 

Variable: Year 2001; 
Wealth: Coefficient: 0.211; 
Wealth: Standard error: 0.016; 
Interest assets: Coefficient: 0.210; 
Interest assets: Standard error: 0.032; 
Business assets: Coefficient: 0.270; 
Business assets: Standard error: 0.046. 

Variable: Year 2002; 
Wealth: Coefficient: 0.061; 
Wealth: Standard error: 0.016; 
Interest assets: Coefficient: -0.267; 
Interest assets: Standard error: 0.033; 
Business assets: Coefficient: 0.405; 
Business assets: Standard error: 0.046. 

Variable: Year 2003; 
Wealth: Coefficient: 0.069; 
Wealth: Standard error: 0.017; 
Interest assets: Coefficient: -0.687; 
Interest assets: Standard error: 0.033; 
Business assets: Coefficient: 0.569; 
Business assets: Standard error: 0.047. 

Variable: Year 2004; 
Wealth: Coefficient: 0.072; 
Wealth: Standard error: 0.017; 
Interest assets: Coefficient: -0.920; 
Interest assets: Standard error: 0.035; 
Business assets: Coefficient: 0.506; 
Business assets: Standard error: 0.050. 

Variable: Constant; 
Wealth: Coefficient: 3.383; 
Wealth: Standard error: 0.055; 
Interest assets: Coefficient: -3.022; 
Interest assets: Standard error: 0.110; 
Business assets: Coefficient: -8.314; 
Business assets: Standard error: 0.156. 

Variable: Number of observations; 
Wealth: Coefficient: 186,241; 
Wealth: Standard error: ; 
Interest assets: Coefficient: 186,241; 
Interest assets: Standard error: ; 
Business assets: Coefficient: 186,241; 
Business assets: Standard error: . 

Variable: Number of groups; 
Wealth: Coefficient: 24,933; 
Wealth: Standard error: ; 
Interest assets: Coefficient: 24,933; 
Interest assets: Standard error: ; 
Business assets: Coefficient: 24,933; 
Business assets: Standard error: . 

Variable: Overall R-squared; 
Wealth: Coefficient: 0.157; 
Wealth: Standard error: ; 
Interest assets: Coefficient: 0.190; 
Interest assets: Standard error: ; 
Business assets: Coefficient: 0.038; 
Business assets: Standard error: . 

Source: GAO analysis of CDFI Fund and IRS data. 

Notes: The dependent variables are in log form and all bold type 
indicates significance at the 5 percent level. Further, "NMTC investor" 
is instrumented using total income (log), balance due, allocations in 
state of residence (log), presence of another general business credit 
(log), region, and year. The Middle Atlantic is the omitted region and 
1997 is the omitted year. 

[End of table] 

The coefficients of these regressions should not be used to generate 
numeric estimates of the magnitude of the effect that the NMTC has on 
asset levels. In some cases, the fit of our models is poor and it is 
difficult to estimate the value of some types of assets, in particular 
business assets. Our results for both the baseline analysis and 
propensity scoring are intended to illustrate the direction of the 
effect that the NMTC has on participating individuals' investments. 

Nonetheless, these results show that NMTC participants have higher 
levels of wealth and business assets than those in the comparison group 
after controlling for individual fixed effects, year, region, and tax 
balance due--a proxy for risk attitudes. These results are consistent 
across four of five quintiles, using data for years 2001 through 2004 
only, and using 3-year averages for the dependent variable. However, it 
may be that these differences in asset levels are simply picking up the 
likelihood that NMTC claimants systematically have higher assets that 
their counterparts. (The summary statistics show that individual NMTC 
investors have higher asset levels on average than the comparison group 
despite our use of a stratified random sample where comparison 
households were chosen based on levels of adjusted gross income in tax 
year 2000.) Therefore, as an alternative measure of the effect of NMTC 
participation, we compare the growth in assets between the two groups 
using closest neighbor propensity score matching to further narrow the 
comparison group and estimate the effect of NMTC participation on asset 
growth.[Footnote 68] We used year 2000 data to estimate propensity 
scores for future participation in the NMTC. The specification for our 
propensity scoring is as follows: 

Prob(N=1) = G(XiBeta ): 

Where N represents any NMTC participation from 2001 through 2004; 
X includes age, balance due, total income, presence of another general 
business credit, wage earnings, and dividend earnings; 
and G( · ) is the cumulative standard normal distribution. 

We then estimated the effect of NMTC participation on the change in the 
log of wealth asset levels from 2000 through 2004. Our results show 
that individuals who participate in the NMTC have higher growth in 
interest bearing assets, business assets, and wealth which is 
consistent with the results we obtained for our instrumental variables 
regressions. For example, the first column in table 11 indicates that 
the growth in wealth for NMTC investors was significantly higher than 
that of noninvestors. 

Table 11: Growth in Assets: Comparisons Based on Nearest Neighbor 
Propensity Score Matching: 

Average NMTC effect: 0.881; 
Wealth: Standard error: 0.152; 
Interest- bearing assets: Average NMTC effect: 1.554; 
Interest-bearing assets: Standard error: 0.351; 
Business assets: Average NMTC effect: 3.112; 
Business assets: Standard error: 0.527; 
Real Estate assets: Average NMTC effect: 0.385; 
Real Estate assets: Standard error: 0.441; 
Dividend assets: Average NMTC effect: 0.650; 
Dividend assets: Standard error: 0.431. 

Source: GAO analysis of IRS and CDFI Fund data. 

Notes: Average effects are on the difference in the log of the asset 
from 2000 to 2004 and bold type denotes significance at the 1 percent 
level. 

[End of table] 

Literature Review and Credits: 

To develop our methodology, we relied heavily on savings literature, 
which generally compares the wealth or financial assets of participants 
in retirement savings plans to those of nonparticipants to detect any 
effect of participation on savings. The following list of publications 
provided us with important information in developing our methodological 
approach. 

1. Engen, Eric M., and William G. Gale. "The Effects of 401(k) Plans on 
Household Wealth: Differences Across Earnings Groups." NBER Working 
Paper No. 8032, 2000. 

2. Engen, Eric M., William G. Gale, and John Karl Scholz. "Do Saving 
Incentives Work?" Brookings Papers on Economic Activity, vol., no.1 
(1994). 

3. Engen, Eric M., William G. Gale, and John Karl Scholz. "The Illusory 
Effects of Saving Incentives on Saving." Journal of Economic 
Perspectives, vol. 10, no. 4 (1996). 

4. Hubbard, R. Glenn, and Jonathan S. Skinner. "Assessing the 
Effectiveness of Saving Incentives." Journal of Economic Perspectives, 
vol. 10, no. 4 (1996). 

5. Pence, Karen M. "401(k)s and Household Saving: New Evidence from the 
Survey of Consumer Finances." Finance and Economics Discussion Series 
2002-6. Washington, D.C.: Board of Governors of the Federal Reserve 
System, 2002. 

6. Poterba, James M., Steven F. Venti, and David A. Wise. "Do 401(k) 
Contributions Crowd Out Other Personal Saving?" Journal of Public 
Economics, vol. 58 (1995). 

7. Poterba, James M., Steven F. Venti, and David A. Wise. "How 
Retirement Saving Programs Increase Saving." Journal of Economic 
Perspectives, vol. 10, no. 4 (1996). 

8. Poterba, James M., Steven F. Venti, and David A. Wise. "Personal 
Retirement Saving Programs and Asset Accumulation: Reconciling the 
Evidence." NBER Working Paper No. 5599, 1996. 

We also consulted several experts in the course of our work, including 
Arthur Kennickel, Karen Pence, James Poterba, and Paul Smith, to 
discuss the methodology for our statistical analysis. They provided 
comments that we incorporated into our statistical models. 

[End of section] 

Appendix III: NMTC Investment Data by State, Fiscal Years 2003 through 
2005: 

State: California; 
Total dollar amount of loans and investment: $303,081,270; 
Percentage of all loans and investment: 9.74; 
Number of NMTC projects: 58; 
Percentage of NMTC projects: 9.95. 

State: New York; 
Total dollar amount of loans and investment: 239,178,566; 
Percentage of all loans and investment: 7.68; 
Number of NMTC projects: 25; 
Percentage of NMTC projects: 4.29. 

State: Ohio; 
Total dollar amount of loans and investment: 201,857,969; 
Percentage of all loans and investment: 6.49; 
Number of NMTC projects: 69; 
Percentage of NMTC projects: 11.84. 

State: Maine; 
Total dollar amount of loans and investment: 153,527,250; 
Percentage of all loans and investment: 4.93; 
Number of NMTC projects: 13; 
Percentage of NMTC projects: 2.23. 

State: Wisconsin; 
Total dollar amount of loans and investment: 149,131,108; 
Percentage of all loans and investment: 4.79; 
Number of NMTC projects: 26; 
Percentage of NMTC projects: 4.46. 

State: Missouri; 
Total dollar amount of loans and investment: 146,165,868; 
Percentage of all loans and investment: 4.70; 
Number of NMTC projects: 22; 
Percentage of NMTC projects: 3.77. 

State: Massachusetts; 
Total dollar amount of loans and investment: 145,059,237; 
Percentage of all loans and investment: 4.66; 
Number of NMTC projects: 34; 
Percentage of NMTC projects: 5.83. 

State: Kentucky; 
Total dollar amount of loans and investment: 135,117,406; 
Percentage of all loans and investment: 4.34; 
Number of NMTC projects: 44; 
Percentage of NMTC projects: 7.55. 

State: North Carolina; 
Total dollar amount of loans and investment: 126,420,590; 
Percentage of all loans and investment: 4.06; 
Number of NMTC projects: 14; 
Percentage of NMTC projects: 2.40. 

State: Washington; 
Total dollar amount of loans and investment: 125,703,680; 
Percentage of all loans and investment: 4.04; 
Number of NMTC projects: 19; 
Percentage of NMTC projects: 3.26. 

State: Minnesota; 
Total dollar amount of loans and investment: 122,587,357; 
Percentage of all loans and investment: 3.94; 
Number of NMTC projects: 13; 
Percentage of NMTC projects: 2.23. 

State: Oklahoma; 
Total dollar amount of loans and investment: 112,092,186; 
Percentage of all loans and investment: 3.60; 
Number of NMTC projects: 24; 
Percentage of NMTC projects: 4.12. 

State: Oregon; 
Total dollar amount of loans and investment: 111,464,317; 
Percentage of all loans and investment: 3.58; 
Number of NMTC projects: 14; 
Percentage of NMTC projects: 2.40. 

State: Maryland; 
Total dollar amount of loans and investment: 106,171,382; 
Percentage of all loans and investment: 3.41; 
Number of NMTC projects: 14; 
Percentage of NMTC projects: 2.40. 

State: New Jersey; 
Total dollar amount of loans and investment: 83,439,000; 
Percentage of all loans and investment: 2.68; 
Number of NMTC projects: 7; 
Percentage of NMTC projects: 1.20. 

State: Pennsylvania; 
Total dollar amount of loans and investment: 77,111,177; 
Percentage of all loans and investment: 2.48; 
Number of NMTC projects: 21; 
Percentage of NMTC projects: 3.60. 

State: Arizona; 
Total dollar amount of loans and investment: 68,476,055; 
Percentage of all loans and investment: 2.20; 
Number of NMTC projects: 8; 
Percentage of NMTC projects: 1.37. 

State: District of Columbia; 
Total dollar amount of loans and investment: 67,715,807; 
Percentage of all loans and investment: 2.18; 
Number of NMTC projects: 10; 
Percentage of NMTC projects: 1.72. 

State: Texas; 
Total dollar amount of loans and investment: 65,644,265; 
Percentage of all loans and investment: 2.11; 
Number of NMTC projects: 11; 
Percentage of NMTC projects: 1.89. 

State: Michigan; 
Total dollar amount of loans and investment: 57,541,869; 
Percentage of all loans and investment: 1.85; 
Number of NMTC projects: 10; 
Percentage of NMTC projects: 1.72. 

State: Virginia; 
Total dollar amount of loans and investment: 55,898,873; 
Percentage of all loans and investment: 1.80; 
Number of NMTC projects: 8; 
Percentage of NMTC projects: 1.37. 

State: Rhode Island; 
Total dollar amount of loans and investment: 55,235,675; 
Percentage of all loans and investment: 1.77; 
Number of NMTC projects: 3; 
Percentage of NMTC projects: 0.51. 

State: Utah; 
Total dollar amount of loans and investment: 53,884,716; 
Percentage of all loans and investment: 1.73; 
Number of NMTC projects: 14; 
Percentage of NMTC projects: 2.40. 

State: Georgia; 
Total dollar amount of loans and investment: 38,516,906; 
Percentage of all loans and investment: 1.24; 
Number of NMTC projects: 4; 
Percentage of NMTC projects: 0.69. 

State: Florida; 
Total dollar amount of loans and investment: 38,261,093; 
Percentage of all loans and investment: 1.23; 
Number of NMTC projects: 8; 
Percentage of NMTC projects: 1.37. 

State: Louisiana; 
Total dollar amount of loans and investment: 36,162,671; 
Percentage of all loans and investment: 1.16; 
Number of NMTC projects: 4; 
Percentage of NMTC projects: 0.69. 

State: Connecticut; 
Total dollar amount of loans and investment: 34,819,477; 
Percentage of all loans and investment: 1.12; 
Number of NMTC projects: 3; 
Percentage of NMTC projects: 0.51. 

State: Indiana; 
Total dollar amount of loans and investment: 26,098,460; 
Percentage of all loans and investment: 0.84; 
Number of NMTC projects: 3; 
Percentage of NMTC projects: 0.51. 

State: Tennessee; 
Total dollar amount of loans and investment: 22,249,867; 
Percentage of all loans and investment: 0.71; 
Number of NMTC projects: 21; 
Percentage of NMTC projects: 3.60. 

State: Iowa; 
Total dollar amount of loans and investment: 20,229,952; 
Percentage of all loans and investment: 0.65; 
Number of NMTC projects: 5; 
Percentage of NMTC projects: 0.86. 

State: Nebraska; 
Total dollar amount of loans and investment: 18,778,563; 
Percentage of all loans and investment: 0.60; 
Number of NMTC projects: 2; 
Percentage of NMTC projects: 0.34. 

State: Delaware; 
Total dollar amount of loans and investment: 17,000,000; 
Percentage of all loans and investment: 0.55; 
Number of NMTC projects: 1; 
Percentage of NMTC projects: 0.17. 

State: Mississippi; 
Total dollar amount of loans and investment: 16,310,758; 
Percentage of all loans and investment: 0.52; 
Number of NMTC projects: 2; 
Percentage of NMTC projects: 0.34. 

State: Colorado; 
Total dollar amount of loans and investment: 15,942,664; 
Percentage of all loans and investment: 0.51; 
Number of NMTC projects: 7; 
Percentage of NMTC projects: 1.20. 

State: Idaho; 
Total dollar amount of loans and investment: 12,890,000; 
Percentage of all loans and investment: 0.41; 
Number of NMTC projects: 10; 
Percentage of NMTC projects: 1.72. 

State: Illinois; 
Total dollar amount of loans and investment: 12,503,895; 
Percentage of all loans and investment: 0.40; 
Number of NMTC projects: 8; 
Percentage of NMTC projects: 1.37. 

State: Arkansas; 
Total dollar amount of loans and investment: 10,616,786; 
Percentage of all loans and investment: 0.34; 
Number of NMTC projects: 4; 
Percentage of NMTC projects: 0.69. 

State: West Virginia; 
Total dollar amount of loans and investment: 7,398,340; 
Percentage of all loans and investment: 0.24; 
Number of NMTC projects: 8; 
Percentage of NMTC projects: 1.37. 

State: New Mexico; 
Total dollar amount of loans and investment: 6,050,000; 
Percentage of all loans and investment: 0.19; 
Number of NMTC projects: 1; 
Percentage of NMTC projects: 0.17. 

State: Alabama; 
Total dollar amount of loans and investment: 5,000,000; 
Percentage of all loans and investment: 0.16; 
Number of NMTC projects: 1; 
Percentage of NMTC projects: 0.17. 

State: South Carolina; 
Total dollar amount of loans and investment: 3,607,755; 
Percentage of all loans and investment: 0.12; 
Number of NMTC projects: 2; 
Percentage of NMTC projects: 0.34. 

State: Alaska; 
Total dollar amount of loans and investment: 3,138,132; 
Percentage of all loans and investment: 0.10; 
Number of NMTC projects: 2; 
Percentage of NMTC projects: 0.34. 

State: Puerto Rico; 
Total dollar amount of loans and investment: 1,474,956; 
Percentage of all loans and investment: 0.05; 
Number of NMTC projects: 1; 
Percentage of NMTC projects: 0.17. 

State: Wyoming; 
Total dollar amount of loans and investment: 1,461,532; 
Percentage of all loans and investment: 0.05; 
Number of NMTC projects: 1; 
Percentage of NMTC projects: 0.17. 

State: Nevada; 
Total dollar amount of loans and investment: 588,750; 
Percentage of all loans and investment: 0.02; 
Number of NMTC projects: 1; 
Percentage of NMTC projects: 0.17. 

State: Montana; 
Total dollar amount of loans and investment: 457,200; 
Percentage of all loans and investment: 0.01; 
Number of NMTC projects: 1; 
Percentage of NMTC projects: 0.17. 

State: Hawaii; 
Total dollar amount of loans and investment: 250,000; 
Percentage of all loans and investment: 0.01; 
Number of NMTC projects: 2; 
Percentage of NMTC projects: 0.34. 

Totals; 
Total dollar amount of loans and investment: $3,112,313,380; 
Percentage of all loans and investment: 100.00; 
Number of NMTC projects: 583; 
Percentage of NMTC projects: 100.00. 

Source: GAO analysis of CDFI Fund data. 

[End of table] 

[End of section] 

Appendix IV: Comments from the Community Development Financial 
Institutions Fund: 

Department Of The Treasury: 
Community Development Financial Institutions Fund: 
601 Thirteenth Street, Nw, Suite 200 South: 
Washington, DC 20005: 

Director: 

January 17, 2007: 

Mr. Michael Brostek: 
Director, Tax Issues: 
U.S. Government Accountability Office: 
441 G Street, N.W. 
Washington, D.C. 20548: 

Dear Mr. Brostek: 

Thank you for providing the Community Development Financial 
Institutions (CDFI) Fund with the opportunity to comment on the draft 
GAO report, "New Markets Tax Credit Appears to Increase Investment by 
Investors in Low-Income Communities, but Opportunities Exist to Better 
Monitor Compliance (GAO-PUB No. 07-296)." 

The New Markets Tax Credit (NMTC) Program has grown considerably since 
GAO's initial program report in January of 2004. The CDFI Fund has now 
made 233 NMTC allocation awards totaling $12.1 billion in allocation 
authority, which to date has generated over $5.7 billion of investments 
in Community Development Entities (CDEs) serving low-income communities 
throughout the country. The tax credit has been used to support a wide 
variety of community and economic development initiatives including, 
among others, the financing of charter schools, health care facilities, 
manufacturing businesses, grocery-anchored retail centers, and numerous 
other commercial and mixed-use real estate projects. Through FY 2005, 
the NMTC Program has generated financing for the construction or 
rehabilitation of over 43 million square feet of real estate, and has 
helped to create or retain 72,000 construction jobs and 20,000 full 
time equivalent jobs in businesses in low-income communities. 

The CDFI Fund appreciates the detailed analysis and valuable 
recommendations that you have offered in this second program report. We 
were particularly encouraged by several conclusions you reached as part 
of your analysis. To cite just a few: 

* Sixty nine percent (69%) of the investors making investments in CDEs 
in 2006 had not previously made investments in those entities, 
suggesting the NMTC is fostering new community development finance 
relationships. 

* The average expected returns on NMTC investments have declined from 
8.2% to 6.8%, suggesting increased program efficiencies and investor 
confidence in the NTMC Program. 

* Communities receiving NMTC investments tend to be more highly 
distressed than minimally required under program rules. 

* Investors indicated that most investments would not have occurred in 
the absence of the credit, and that they had increased their 
investments in low-income communities because of the credit. 

* The most likely effect of the credit is that it shifts investment by 
participating investors into low-income communities from higher-income 
communities. 

Taken as a whole, these findings and others in your report suggest that 
the NMTC has been a highly successful tool for increasing the flow of 
investments into the nation's most distressed communities. 

The CDFI Fund concurs with the two Recommendations for Executive Action 
that you have provided in your report, both of which are related to 
areas of compliance that fall under the purview of the Internal Revenue 
Service (IRS). The CDFI Fund will continue to collaborate with IRS to 
help meet these compliance obligations in the most efficient and cost- 
effective manner possible. 

Thank you again for the opportunity to review and comment upon your 
draft report. We appreciate your efforts and the collaborative 
relationship that you fostered during the course of your review. 

Sincerely, 

Signed by: 

Peter Dugas: 
Acting Director: 

[End of section] 

Appendix V: Comments from the Internal Revenue Service: 

Department Of The Treasury: 
Internal Revenue Service: 
Washington, D.C. 20224: 

Commissioner: 

January 18, 2007: 

Mr. Michael Brostek: 
Director, Tax Issues: 
U.S. Government Accountability Office: 
441 G Street, N.W. 
Washington, D.C. 20548: 

Dear Mr. Brostek: 

I have reviewed your draft report titled, "New Markets Tax Credit 
Appears to Increase Investment by Investors in Low-Income Communities, 
but Opportunities Exist to Better Monitor Compliance" (GAO-PUB No. 07- 
296). I agree with the recommendations in the report, and I have 
enclosed a detailed response to address your recommendations. 

As part of our efforts to monitor compliance and ensure adherence to 
the New Markets Tax Credits (NMTC) laws and regulation, we are 
conducting a study to monitor compliance with the NMTC legislative 
requirements. Our focus has been primarily on the Community Development 
Entities' (CDEs) compliance with the "substantially all" requirement. 
This area holds the greatest potential for noncompliance with the 
Internal Revenue Code. Additionally, we continue to redirect our 
compliance program efforts as information becomes available from the 
Community Development Financial Institutions (CDFI) Fund, as additional 
examination results are collected and as new developments or trends are 
identified in the NMTC environment. In future periods, as more NMTC 
awards are made and more CDEs become active, our audit efforts will 
increase accordingly. 

In the future, increased sharing of the CDFI Fund data and our 
collection of information from audits will help develop criteria to 
streamline our examinations. Data sharing will increase our efficiency 
and ultimately limit the Government's exposure to potential 
inappropriate tax loss. We will also explore with the CDFI Fund cost 
effective options to monitor NMTC investor non-compliance. 

I appreciate the time the GAO Team spent reviewing our initial measures 
to monitor compliance with the NMTC and the good working relationship 
during the course of the review. If you have any questions or need 
additional information on our compliance study, please contact Kelly 
Cables, Director, Performance Management, Quality Assurance, and Audit 
Assistance, at (202) 283-8334. 

Sincerely, 

Signed by: 

Mark W. Everson: 

Enclosure: 

Recommendation 1: 

To ensure the IRS is reviewing the full range of NMTC transactions and 
that the conclusions of their compliance study are more representative 
of all CDEs with NMTC allocations, we recommend that IRS use CDFI Fund 
data and the results of its current NMTC compliance study to develop 
criteria for selecting which CDEs to audit as part of its future 
compliance monitoring efforts. 

Response: 

We agree with your recommendation. The use of CDFI Fund data is a 
valuable part of our compliance plan for selecting CDEs to audit. 
Currently, the IRS and CDFI Fund are working together to focus and 
enhance the informational reports that we currently receive from the 
CDFI Fund databases as part of our audit selection process. 
Additionally, as we collect more information from the audits that we 
have in process, we will be able to identify additional criteria that 
should be used to select CDEs for audits. This selection process will 
assure that our tax compliance efforts do not create the opportunity 
for tax loss nor increase those costs associated with our compliance 
efforts. In the future, we plan to continue this collaboration with the 
CDFI Fund to assure that we are able to develop a compliance plan that 
is cost efficient by using CDFI Fund data. 

Recommendation 2: 

Additionally, to ensure that eligible taxpayers claim the correct 
amount of NMTC on their tax returns and IRS is able to identify all tax 
credit claimants in the event of the credit being recaptured, we 
recommend that IRS and the CDFI Fund further explore options for cost 
effectively monitoring investor compliance and developing a way to 
identify NMTC claimants, even in instances where the Qualified Equity 
Investment (QEI) giving rise to the credit is sold, and the amount of 
QEI that each investor made. 

Response: 

We agree with your recommendation. We plan to work with the CDFI Fund 
to explore options for monitoring investor compliance and identifying 
NMTC claimants, even in instances where the QEI giving rise to the 
credit is sold, and for determining the amounts of QEI that each 
investor made. This would facilitate the identification of NMTC 
claimants in the event of a recapture and would help to ensure that 
eligible taxpayers claim the correct amount of NMTC on their tax 
returns. After these options are identified, we will evaluate them to 
determine which ones would cost effectively allow compliance monitoring 
of NMTC claimants and the amounts of QEI they made. 

Technical Comments: 

We also provided technical comments from Chief Counsel to GAO on 
January 5, 2007. 

[End of section] 

Appendix VI: GAO Contact and Staff Acknowledgments: 

GAO Contact: 

Michael Brostek, (202) 512-9110 or brostekm@gao.gov: 

Acknowledgments: 

In addition to the contact named above, Kevin Daly, Assistant Director; 
Thomas Gilbert; Evan Gilman; Tami Gurley-Calvez; Katherine Harper; 
Stuart Kaufman; Summer Lingard; Don Marples; Donna Miller; Ed 
Nannenhorn; Karen O'Conor; and Cheryl Peterson made key contributions 
to this report. 

FOOTNOTES 

[1] Pub. L. No. 106-554 (2000). 

[2] The original legislation that authorized the program allowed for 
$15 billion of equity investment to qualify for the NMTC program. 
However, the Gulf Opportunity Zone Act of 2005, Pub L. No. 109-135 
(Dec. 21, 2005) authorized an additional $1 billion of NMTC equity for 
qualified investments in areas affected by Hurricane Katrina, and Pub. 
L. No. 109-432 (Dec. 20, 2006) extended the NMTC for an additional year 
(through 2008) with an additional $3.5 billion of NMTC allocation 
authority. 

[3] GAO, New Markets Tax Credit Program: Progress Made in 
Implementation, but Further Actions Needed to Monitor Compliance, GAO-
04-326 (Washington, D.C.: Jan. 30, 2004). 

[4] A low-income community is defined as a census tract (1) in which 
the poverty rate is at least 20 percent or (2) outside a metropolitan 
area in which the median family income does not exceed 80 percent of 
median statewide family income or within a metropolitan area in which 
the median family income does not exceed 80 percent of the greater 
statewide or the metropolitan area median family income. After October 
22, 2004, the Secretary of the Treasury was authorized to issue 
regulations designating targeted populations that may be treated as low-
income communities and procedures for determining which entities are 
qualified active low-income community businesses with respect to such 
populations. In addition, the definition of a low-income community 
included certain areas not within census tracts, tracts with low 
population, and census tracts with high migration rural counties. 

[5] GAO-04-326. 

[6] Community development financial institutions and specialized small 
business investment companies automatically qualify as CDEs and only 
need to register as CDEs rather than apply for certification. 

[7] For more information on how NMTC awards are determined and the 
criteria that the CDFI Fund uses to select which CDEs will receive 
allocations, refer to GAO-04-326, pp. 5-9. 

[8] Beginning in the year the investment is made, investors are 
entitled to claim the credit for a 7-year period with 5 percent of the 
investment claimed in each of the first 3 years and 6 percent in each 
of the last 4 years. Investors are allowed to carry the credit back 1 
year and carry the credits forward for a 20-year period. 

[9] "Substantially all" means that CDEs must use (within 12 months) at 
least 85 percent of investor proceeds in years 1 through 6 and 75 
percent in year 7 of the investment. CDEs can satisfy this requirement 
by two methods: (1) direct tracing of investments to specific qualified 
low-income community investments or (2) showing that at least 85 
percent of their aggregate gross assets are invested in qualified low- 
income community investments. 

[10] For example, an investor may have an interest in beginning a 
particular NMTC project at a time before all of the final investors 
have made their investments. In that case, the original investor could 
make the entire original equity investment with the intention of 
selling its equity share in the CDE to other investors at a time when 
the financing could be finalized. 

[11] Pub. L. No. 108-357 (2004). 

[12] Pub. L. No. 109-135 (2005). 

[13] IRS Notice 2006-60, I.R.B. 2006-29. 

[14] Under the new guidelines, a qualifying business for a targeted low-
income population is any corporation (including nonprofit corporations) 
or partnership that meets one of the following three tests: (1) at 
least 50 percent of the entity's gross income is derived from sales, 
rentals, service, or other transactions with individuals who are low-
income persons; (2) at least 40 percent of the entity's employees are 
low-income individuals; or (3) at least 50 percent of the entity is 
owned by low-income individuals. 

[15] The original allocation schedule was $1 billion in 2001, $1.5 
billion in 2002, $1.5 billion in 2003, $2 billion in 2004, $2 billion 
in 2005, $3.5 billion in 2006, and $3.5 billion in 2007. 

[16] Pub. L. No. 109-432 (2006). 

[17] As of December 2006, only six QEIs had been made into fourth round 
allocatees. The 2006 NMTC allocations were not announced until the 
summer of 2006, which may explain the relatively small amount of 
investment activity into fourth round allocatees at the time of this 
report. 

[18] This reflects data available in the CDFI Fund's databases through 
fiscal year 2005 for awardees. Because of the timing of CDE reporting 
requirements--CDEs are not required to report data about low-income 
community investment to the CDFI Fund until 6 months after the end of 
their fiscal year--it is likely that more NMTC investment has taken 
place that has not yet been recorded in the CDFI Fund's databases. 

[19] Unlike tiered NMTC investments, there is no standard term for one 
investor making a QEI into a CDE. For the purposes of this report, we 
refer to this type of transaction as a "direct" NMTC investment. 

[20] Before making an investment in a CDE or in another pass-through 
entity, investors may set up a partnership as a pass-through entity. 

[21] In Rev. Rule 2003-20, 2003-1 C.B. 465, the IRS, based on the facts 
presented in the ruling, approved this method of structuring NMTC 
investments. 

[22] Loan-to-value ratio is the relationship, expressed as a 
percentage, between the amount of a loan and the value of the asset 
that the loan is being used to finance. In the example above, if 100 
percent of the proceeds were reinvested in a CDE as a QEI, the loan-to- 
value ratio would be 60 percent because a $600,000 loan is being issued 
to finance a project with a total cost of $1 million. 

[23] NMTC claimants are a subset of the overall population of NMTC 
investors. Some investors are pass-through entities designed to pool 
funds before making an investment in a CDE, but they do not claim the 
tax credit on tax returns. Additionally, because the CDFI Fund does not 
track when an investor sells its equity share in a CDE to another 
investor (and thereby transfers the right to claim the tax credit), the 
data here are not reflective of all NMTC claimants. The data presented 
here, unless otherwise noted, originate from the CDFI Fund's databases. 

[24] Term loans are loans that often only require interest payments 
until the last day of their term at which time the entire principle 
amount is due. 

[25] In most cases, median net assets for businesses and median 
adjusted gross incomes for individuals would have been more appropriate 
comparison measures. However, we were unable to use the available data 
to determine median values for each measure presented here. As a 
result, we present averages instead of medians. 

[26] The source of the comparison data for both businesses and 
individuals is IRS's Statistics of Income division data file for 
taxpayers that filed tax returns in tax year 2003, the most recent year 
with available data. 

[27] The measure of income used for individuals is adjusted gross 
income from their individual income tax form 1040. Adjusted gross 
income is a tax paying unit's income after subtracting certain 
deductions from total income. As a result, when we refer to individual 
investors, we are referring to tax paying entities--adjusted gross 
income on the form 1040 could include income from multiple individuals 
who are living in the same household or married taxpayers. 

[28] Our survey had a 51 percent response rate. We have used type of 
entity and size of entity to adjust the data for nonresponse bias. If 
nonrespondents differ in their responses to survey questions beyond the 
variables used in our adjustment, our estimates will not reflect this 
difference. We have assumed that the respondents are a stratified 
random sample of the population. All percentage estimates from the 
survey are represented at the 95 percent confidence level. In most 
cases confidence intervals are only reported where at least one 
estimate's margin of error is greater than 8 percentage points, plus or 
minus. Where providing comparable statistics in charts and tables, we 
have provided all confidence intervals. For additional information 
about our survey methodology, see app. I. 

[29] The CDFI Fund collects self-reported data on the expected rate of 
return for NMTC investments from CDEs that make investments. 

[30] The CDFI Fund defines fixed assets for businesses as a loan or 
investment that will be used to pay for any tangible property used in 
the operation of a business, but is not expected to be consumed or 
converted into cash in the ordinary course of events. Commonly financed 
fixed assets include machinery and equipment, furniture and fixtures, 
and leasehold improvements. 

[31] The CDFI Fund defines working capital as a loan or investment that 
will be used to cover any ongoing operating expenses of a business, 
such as payroll, rent, or utility expenses. 

[32] Most allocatees are using their qualified equity investments from 
investors to make loans to qualified businesses, but they can also make 
investments in other, non-related CDEs. Through fiscal year 2005, over 
99 percent of NMTC investment dollars had been made to businesses and 
less than 1 percent to other CDEs. 

[33] The CDFI Fund includes a variety of categories under what is 
considered better rates and terms for financial notes that are issued 
by CDEs as qualified low-income community investments. In general, the 
CDFI Fund deems a financial note to have better rates and terms if the 
CDEs reporting the investment indicate that the rates or terms 
associated with the investment could not have been offered by the 
allocatee or otherwise been made available in the marketplace. 

[34] For the purposes of the 2006 NMTC allocation round, the CDFI Fund 
defined "areas of higher distress" as areas (1) with poverty rates 
greater than 30 percent; (2) with median incomes of less than 60 
percent of area median income; (3) with unemployment rates at least 1.5 
times the national average; (4) that are designated Empowerment Zones, 
Enterprise Communities, or Renewal Communities; (5) that are U.S. Small 
Business Administration (SBA)-designated Historically Underutilized 
Business Zones (HUB Zone), to the extent the investment will support 
businesses that received HUB Zone certification from the SBA; (6) that 
are federally designated brownfields redevelopment areas; (7) that are 
encompassed by a HOPE VI redevelopment plan; (8) that are federally 
designated as Native American or Alaskan Native areas, Hawaiian 
Homelands, or redevelopment areas by the appropriate tribal or other 
authority; (9) that are designated as distressed by the Appalachian 
Regional Commission or Delta Regional Authority; (10) that are Colonias 
areas designated by the Department of Housing and Urban Development; 
(11) that are federally designated medically underserved areas, to the 
extent the investment will result in the support of health-related 
services; (12) that are CDFI Fund Hot Zones; (13) that are High 
Migration Rural counties; (14) that are state or local tax increment 
finance districts, enterprise zone programs, or other similar state/ 
local programs targeted toward particularly economically distressed 
communities; or (15) that are counties for which FEMA has (a) issued a 
major disaster declaration since July 15, 2005 and (b) made a 
determination that such county is eligible for both "individual and 
public assistance." 

[35] For instance, new investments might be funded by a decrease in 
dividend payouts for businesses. 

[36] See app. II for a more thorough description of the steps we took 
to verify the validity of these baseline statistical results. 

[37] As described in app. I, the survey population and the statistical 
analysis population of NMTC investors are not identical. We surveyed 
NMTC investors that we identified using CDFI Fund data, and in a 
limited number of cases we surveyed a point of contact at a pass- 
through entity rather than all of the investors in the pass-through 
entity. Our statistical analysis population of NMTC investors includes 
NMTC participants that we identified as credit claimants using both IRS 
and CDFI Fund data. 

[38] Potential economic costs are often referred to by economists as 
efficiency costs or deadweight losses. Efficiency costs result when tax 
provisions cause individuals or businesses to alter decisions like how 
much to work, how much to save, what to consume, and where to invest. 
An exception would be the case where the tax credit is offsetting a 
market failure, such as a shortage of capital funds available in low- 
income communities for reasons other than economic returns. Potential 
benefits include the extent to which a community experiences reductions 
in poverty and increases in employment opportunities as a result of the 
program; possible "spillover" benefits to the community may include 
reductions in crime and improvements in the health status of community 
residents. 

[39] This conclusion follows from the statistical evidence alone and 
does not depend on combining evidence from the survey as was the case 
for shifted investment for businesses. New investment for individuals 
is funded through a decrease in consumption (e.g., the amount spent on 
goods and services). 

[40] See app. II for more information on the methods we used to develop 
these statistical models. 

[41] Our analysis does not address the question of whether NMTC 
investment by individuals would have taken place by different investors 
if these particular investors did not make NMTC investments. Our 
analysis is limited because it only allows us to say that the NMTC 
investment was new investment by these particular investors. 

[42] To assess whether the funds would have been used in a more 
beneficial way in the absence of the program, one would need 
information on both the financial returns to the alternate use and any 
positive "spillover" benefits created by NMTC investments such as 
creating a more skilled workforce. 

[43] As of November 2006 IRS was able to verify that 61 of the 66 
allocatees that received NMTC awards in 2003 had filed tax returns. For 
those instances where they were still unable to associate a filing, IRS 
is making an effort to contact the CDE to determine why they have not 
yet filed a tax return. 

[44] IRS officials have not developed specific criteria for what 
"meaningful results" include, but they indicated that they intend to 
continue conducting NMTC audits until they are comfortable that they 
have identified any key compliance issues that may arise. 

[45] GAO, Tax Administration: New Compliance Research Effort Is on 
Track, but Important Work Remains, GAO-02-769 (Washington, D.C.: June 
27, 2002). 

[46] GAO, Government Auditing Standards, 2003 Revision, GAO-03-673G 
(June 2003). 

[47] GAO-04-326. 

[48] GAO, Tax Credits: Opportunities to Improve Oversight of the Low- 
Income Housing Program, GAO/GGD/RCED-97-55 (Washington, D.C.: Mar. 28, 
1997). 

[49] If IRS finds a noncompliant CDE, it indicated that it will request 
an investor list from the CDE to take appropriate action. If the 
investment was sold after its original issuance, IRS plans to obtain 
information from the known investors regarding the purchaser of the 
investments until the total recapture amount is accounted for. 

[50] Our survey only included tax credit claimants and, in a limited 
number of cases, a point of contact at a pass-through entity as 
identified in CDFI Fund data. It did not include lenders participating 
in NMTC leveraged transactions, which accounts for just over one- 
quarter of the total amount of QEI. Data are not available on lenders 
in leveraged transactions. 

[51] See the Literature Review and Credits section at the end of this 
appendix for a list of references. 

[52] For corporate filers, the entire population of returns was drawn 
for the top two quintiles because there were less than 4,000 total 
returns in these quintiles. For individual filers, the bottom two 
quintiles were divided into wage-only and other income groups. Most 
NMTC claimants had some business income but a few had only wage income, 
making them harder to distinguish from the "average taxpayer" for whom 
wage-only income is common. Separating wage-only and other income 
groups allowed us to minimize the number of returns drawn from the wage-
only subset of filers (who we determined to be, in general, less "like" 
the NMTC claimants). 

[53] Note that we follow the SCF in excluding tax-preferred retirement 
accounts, which may cause our wealth estimates to underestimate the 
wealth of NMTC investors relative to noninvestors as NMTC investors 
tend to have higher incomes than noninvestors. However, the exclusion's 
effect, if any, on relative growth rates is not clear. This exclusion 
is primarily caused by data limitations, as our income tax data only 
include information for taxable distributions from these accounts (not 
applicable for most filers) not contributions. For more information on 
SCF methods, see Arthur B. Kennickell "The Good Shepherd: Sample Design 
and Control for Wealth Measurement in the Survey of Consumer Finances" 
(SCF Working Paper, Federal Reserve, Washington, D.C., 2005). 

[54] Regions were chosen in accordance with U.S. Census Bureau 
divisions. 

[55] See Kenneth J. Stewart and Stephen B. Reed, "CPI Research Series 
Using Current Methods, 1978-98," Monthy Labor Review, vol. 122, no. 6 
(1999), for more information and access the data at: [Hyperlink, 
http://www.bls.gov/cpi/cpiurstx.htm]. 

[56] We are likely to be understating wealth for households in markets 
that grew at historically fast rates from 2001 through 2004. We 
predicted home equity values based on 2000 tax return data and used 
inflation adjustments to obtain values for 1997 through 1999 and 2001 
through 2004. The most likely affect is to bias our results downward 
because NMTC investors are more likely to have more expensive homes 
(they are higher income on average than noninvestors, and this factor 
is associated with higher values of home equity) and experience a 
greater increase in wealth from the increase in housing values. 
Consequently, wealth for investors would be underestimated to a larger 
degree than that of noninvestors and our analysis may underestimate the 
effect of the NMTC on the wealth of NMTC investors. 

[57] All dollar amount variables were adjusted using the CPI (research 
series). The log transformation is used for all variables except for 
net assets, which are transformed using the inverse hyperbolic sine (to 
better address negative and zero values). 

[58] The average treatment effect on the growth in assets for 
individuals was from 2000 to 2004. For corporations, the period was 
2000 to 2003 (we choose 2003 for corporate filers because of the number 
of filers not in our records for 2004). 

[59] Initial Hausman tests indicated that fixed effects estimation was 
more appropriate than random effects estimation. 

[60] The Y, X and µ variables are time-demeaned data. The inverse 
hyperbolic sine transformation is used for net assets. 

[61] Our regression techniques included using the change in the inverse 
hyperbolic sine of net assets as a dependent variable and median 
regressions of inverse hyperbolic sine and the change in inverse 
hyperbolic sine. Our propensity scoring approach was to compare the 
change in inverse hyperbolic sine of NMTC claimants to their nearest 
neighbor (closest match) based upon their propensity score using 
differences in 2000 and 2003 data. 

[62] A regression model suffers from endogeneity if one or more of the 
explanatory variables is correlated with the error term (the 
unexplained portion of the variance in the dependent variable). 

[63] The household specific effect (i) is fixed over time and 
differenced out of the equation. 

[64] An instrumental variables estimator is a method in which another 
variable that is not correlated with the error term and is (partially) 
correlated with the endogenous explanatory variable (NMTC 
participation) is used to predict the endogenous variable in a separate 
equation. 

[65] Our analysis of correlations indicated that the presence of the 
general business credit is not strongly correlated with wealth, as one 
might expect. This is likely because claiming these credits is 
relatively rare for individual filers and presence of the credit might 
be more indicative of a preference for certain types of tax planning or 
awareness of tax incentives. 

[66] STATA's panel IV regression models do not include a categorical 
variable option for the first-stage regression so we are running a 
linear probability model for the first stage. 

[67] Demographic information was not included as those variables are 
constant over the panel. 

[68] We experimented with difference-in-log specifications to measure 
growth in our fixed effects models, but the fit of the models was not 
sufficient to interpret the results. 

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