Whac-A-Mole, LIHTC Style, Take Two

Published by Michael Novogradac on Tuesday, February 22, 2011 - 12:00am

As discussed in a previous blog posting, as America faces unprecedented budget deficits, attention is directed to ways to cut spending, raise revenue and reduce federal tax expenditures. This attention results in public statements popping up, almost at random, that inaccurately describe spending programs, tax provisions and federal tax expenditures.

As they pop up, however, efforts must be undertaken to Whac the inaccuracy back into the hole, lest an isolated inaccuracy becomes the common opinion.

Many affordable housing advocates, like me, believe that the greatest current risk to preserving the low-income housing tax credit (LIHTC) rental production program isCorporate Tax Reform – not because of the philosophical foundation of Corporate Tax Reform, but because of misinformation about the LIHTC, in particular, and federal tax expenditures, in general.  The LIHTC is consistently lumped in with all federal tax expenditures claimed by corporations, as if all federal tax expenditures are alike.

One key distinction is nearly always missed – hence, this second edition of Whac-A-Mole, LIHTC Style. 

The Latest ‘Mole’

Three members of Ernst & Young’s Quantitative Economics and Statistics (QUEST) group recently wrote an article for BNA’s Daily Tax Report entitled “Lowering Business Tax Rates by Repealing Tax Expenditures: An Industry Analysis,” wherein they say (and yes this is a quote from their article):

“eliminating the low-income housing tax credit . . . would fall most heavily on the finance and insurance industries”

Why it Should be ‘Whac’-ed

Affordable housing advocates throughout the country know that such a statement is patently false – the burden would fall most heavily on low-income families seeking affordable rental housing.  Period.

So what did QUEST miss?  They missed the philosophical difference between tax expenditures that create direct social impacts and those that create—at most—spillover social impacts; for the purposes of this comparison, I will classify tax expenditures as those that are Direct Social Impact Tax Expenditures (DSITEs) and Spillover Social Impact Tax Expenditures (SSITEs).

The finance and insurance industries would financially suffer very little if the LIHTC was repealed.  They would simply lose the opportunity to invest in DSITEs at a market yield.  The real cost is that if you trade repeal of the LIHTC for lower marginal corporate tax rates, then corporations save income taxes without making investments in DSITEs.  You lose 80,000+ a year in affordable housing rental units.  These units will simply not be built without corporations investing in the LIHTC.

Conversely, if you eliminate a particular SSITE-for example the Section 199 manufacturing deduction-and lower the marginal corporate tax rate, then corporations, (in this example manufacturing corporations) have higher taxable income and a lower tax rate. After combining the offsetting effects of the two changes, these corporations may or may not pay any higher overall taxes.  On the other hand, if every industry gave up a pro-rata share of SSITEs then conceptually, corporations could trade higher taxable income for a lower tax rate, and the net tax liability across all industries would be the same, but the marginal tax rate would be lower.

Corporate Tax Reform = Corporate Windfall?

If you include DSITEs in the calculus, then corporations get a windfall in lower overall taxes.  Economically, they get the economic benefit of having invested in DSITEs without having to make the third party investment needed to acquire the tax benefits.

It is particularly unfortunate that members of Ernst & Young’s QUEST group made the generalization that they did in the BNA article, because they assisted in a report about the LIHTC about 15 months ago, entitled “Low-Income Housing Tax Credit Investment Survey,” wherein they documented the investment structure and economic benefits of the LIHTC.

To the authors’ credit, they did identify the social impact nature of tax expenditures. In theBNA article, they say:

“Most tax expenditures were initially enacted by Congress because of their potential social and economic benefits. Tax provisions such as the R&E credit, for example, can have important public spillover effects and can encourage innovation.”

However, they failed to take the next step, which is to note that some tax expenditures have direct—not spillover—effects.

If there must be a debate about DSITEs, including the LIHTC, , it should be focused on the social welfare benefits versus the government costs of the particular expenditure.  In this debate, tax theoreticians and experts should begin distinguishing DSITEs from SSITEs.  DSITEs should not be collateral damage in the Corporate Tax Reform debate.

Speak Up Mr. President

President Obama and Secretary Geithner have said that Corporate Tax Reform should not add to the deficit.  They should also say publicly that Corporate Tax Reform should not be paid for by taking benefits from low-income working families.