Enhancing, Expanding Tax Incentives is Key Part of Funding Infrastructure
Published by Michael J. Novogradac on Thursday, July 1, 2021
A key part of funding infrastructure is through the enhancement and expansion of existing Internal Revenue Code (IRC) community development and renewable energy tax incentives, as well as by creating new tax-based tools to address needs that existing incentives are not designed to address.
President Joe Biden and Congress are focused on infrastructure after enacting the American Rescue Plan, the administration’s COVID-19 relief reconciliation law. Their infrastructure deliberations center on the administration’s American Jobs Plan, the tax components of which were featured in a May 19 hearing by the House of Representatives’ Ways and Means Committee. I had the honor and privilege of testifying at the hearing about the record of success for existing tax incentives and the potential of proposed tools to build infrastructure.
The low-income housing tax credit (LIHTC), new markets tax credit (NMTC), historic tax credit (HTC), renewable energy investment tax credit (ITC) and production tax credit (PTC) have long records of success and bipartisan support. As such, they should be included in any infrastructure legislation. Furthermore, additional community development tax-based tools that complement existing incentives are also needed.
A key benefit of including those resources in infrastructure financing is they are based on a public-private partnership in which taxpayers invest equity during the higher-risk development phase of a property or business and the benefits are claimed and retained over time. This pay-for-success model works with existing financing tools and would work for proposed incentives.
Here’s how tax-code-based investment mechanisms do and could help in various areas:
Housing: Expand LIHTC, Introduce Other Incentives
The LIHTC is a proven means to drive investment in affordable rental housing, as the 4% and 9% credits have combined to finance more than 3.5 million affordable rental homes since their creation in the Tax Reform Act of 1986, according to the National Council of State Housing Agencies. The LIHTC also is an important preservation financing tool, often used to recapitalize existing affordable rental housing and extend the affordability and livability of federally assisted housing.
Yet, with all these achievements, America still faces a growing affordable rental housing crisis that predates the COVID-19 pandemic. Before COVID, nearly 11 million renter households were severely cost-burdened, meaning they spend more than half of their income on rent, per research from the Joint Center for Housing Studies of Harvard University. Analysis released in March by the National Low-Income Housing Coalition documents that there is a shortage of nearly 7 million affordable and available rental homes for extremely low-income renters in this country.
The best tool to address this need for affordable rental housing is an enhanced and expanded LIHTC. A Novogradac analysis estimates that last year’s adoption of the 4% minimum LIHTC rate will lead to the financing of approximately 130,000 additional affordable rental homes, but more can be done. The Affordable Housing Credit Improvement Act of 2021 (AHCIA, H.R. 2573/ S. 1136) provides many additional provisions to further expand and strengthen the LIHTC and Novogradac analysis projects that the AHCIA’s major unit-financing provisions could finance more than 2 million additional affordable rental homes over a 10-year period. Enacting the provisions could also create nearly 3 million jobs, add more than $119 billion in federal state and local tax revenue and create more than $345 billion in business income nationwide.
To address the need of the households earning just above the LIHTC income limits, legislation creating a middle-income housing tax credit (MIHTC) is expected to be reintroduced this year. Using the LIHTC as a model, the MIHTC would address the needs of households that fall just beyond the allowable LIHTC renter incomes (60% of area median income). Under previously proposed MIHTC legislation, states would receive tax credits based on population: for 2019, the allocation would have been $1 per capita with a $1.14 million small state minimum. An additional 5 cents per capita above this allocation would have been reserved for middle-income housing developed in rural areas.
The LIHTC and MIHTC are designed to incentivize the construction and renovation of rental homes. The production and rehabilitation of owner-occupied homes in distressed communities could similarly be assisted by passage of the Neighborhood Homes Investment Act (NHIA). The NHIA would create a new federal tax credit that covers the gap between the cost of building or renovating homes and the price at which they can be sold, thus making renovation and new home construction possible. The NHIA would also help existing low- and moderate-income homeowners in these neighborhoods to rehabilitate their homes.
Private Activity Bonds: Increase the Limit
Private activity bonds (PABs) are a key tool to finance community development and infrastructure projects, but many uses of PABs–particularly those addressing community infrastructure needs–are subject to annual caps. Each year, the Internal Revenue Service provides states a volume cap of tax-exempt bonds set aside for private activities. In 2021, that cap is $110 per person, or a minimum of nearly $325 million for small states.
Nationally, the vast majority of capped PABs are used for housing–the most recent annual report on bond use by the Council of Development Finance Agencies (CDFA)–reports that in 2018, 91.5% of PABs went to housing: 30.4% to homebuyers and 61.1% to multifamily rental housing.
Recent legislation has included approaches to boost use of PABs, as the demand for PABs has increased at such a pace that a growing number of states are starting to reach their bond cap limit available for residential rental housing. Because of the vital role PABs in concert with LIHTCs play in the financing of affordable rental housing, increasing the bond cap limit would support the development of additional affordable rental homes.
NMTC: Make it Permanent
Since its inception in 2000, the NMTC has incentivized significant private investment, leading to the growth and revitalization of thousands of low-income communities. According to Treasury, for every $1 invested by the federal government, the NMTC incentive generates more than $8 of private capital.
Unlike the LIHTC, which finances only affordable rental housing, the NMTC finances a wide variety of low-income community businesses, including manufacturing businesses, hotels, arts centers, office buildings, charter schools, medical clinics, day care centers, large commercial developments, small-business expansions, mixed-use developments and homes for sale.
Last year’s five-year extension of the NMTC at the $5 billion level provided stability, but there remains unmet need for private capital. Low-income communities have been disproportionately affected by the pandemic and suffered from a lack of private investment dating from the 2008-2009 Great Recession and beyond.
Congress can add further stability by passing the New Markets Tax Credit Extension Act (H.R. 1321/S. 456), which would make the NMTC an indefinite provision of the IRC, maintain it at its $5 billion annual allocation authority, index it to inflation like the LIHTC and allow the NMTC to reduce the alternative minimum tax (AMT).
Such legislation would provide long-term certainty, encouraging more investors to enter the market, thereby further increasing the effectiveness and efficiency of the NMTC to bring private capital to low-income communities.
An increase in NMTC allocation authority would further help. Last year, the House passed the Moving Forward Act, which not only included the provisions of the NMTC Extension Act, but also provided $4.5 billion in additional NMTC allocation authority to help address the disproportionate impact of the pandemic on low-income communities, particularly communities of color.
HTC: Update and Enhance
An incentive created more than 40 years ago, the HTC has spurred the rehabilitation and preservation of myriad historic structures in urban, suburban and rural small-town communities located in all 50 states, the District of Columbia and Puerto Rico. Since its inception, the National Park Service (in partnership with Rutgers University) estimates the HTC has leveraged more than $109 billion in private investments for more than $173 billion in HTC-related rehabilitation investment and created nearly 3 million jobs.
In addition to preserving important structures, the HTC is a climate-friendly tool. The greenest building is one that is already built and can be brought back to productive economic use. Reuse of existing buildings conserves the embodied energy of the existing materials of these buildings and helps to curb urban sprawl.
The Historic Tax Credit Growth and Opportunity Act, introduced in the House April, makes some long-needed improvements to the HTC, which has not been meaningfully improved since 1980. The changes could help the HTC be much more powerful in helping to restore historic properties throughout America, especially in small towns.
Another bill, the REHAB Act (H.R. 1483), would reestablish and increase the non-historic rehabilitation credit to finance improvements of properties that are at least 50 years old and near public transit. A bonus credit of 25% would be available to finance affordable housing and infrastructure.
Renewable and Clean Energy Incentives: Extend, Add More
RETCs play a critical role in spurring the production of clean energy in order to combat climate change. There are a number of incentives that Congress uses to encourage investment in clean energy technologies such as solar, wind (onshore and offshore), biomass, carbon sequestration, fuel cells, energy storage and many more.
The ITC and PTC are the tools primarily used to incentivize renewable energy production. Since the enactment of RETCs, the renewable energy industry has grown considerably. For instance, the Solar Energy Industries Association (SEIA) estimates there is more than 97 GW of cumulative solar electric capacity, enough clean energy to power close 18 million average American homes.
However, it’s important to keep this growth in perspective. Solar energy still only represents about 3% of energy generation in the United States. And solar is not being built fast enough to address climate concerns.
The rapid growth to date in clean energy production has not only helped in the battle to decarbonize our energy supply, but it employed hundreds of thousands of Americans. The solar industry supported more than 230,000 jobs in 2020 and the renewable energy industry supports more than 300,000 American jobs with respect to power plants that have enough capacity to power more than 48 million American homes.
While the current RETC provisions are effective at maintaining short-term growth, additional incentives are needed to address the existential threat tied to the worst consequences that could result from climate change.
Investor Market: Loosen Restrictions
In addition to enacting legislation to increase and expand community development and green energy tax incentives, Congress should consider ways to increase the value of tax credits and expand and deepen the pool of investors.
Several provisions in the Internal Revenue Code could be changed to encourage investment. One method would be to eliminate basis adjustment for community development and clean energy tax credits. That would create policy parity among various tax incentives, since the LIHTC already is excluded from the basis adjustment.
Such IRC provisions as the AMT, base erosion anti-abuse tax, at-risk limits and passive activity rules also limit the ability of taxpayers to invest in tax credits. Changing the restrictions concerning those provisions would expand the pool of potential investors.
Congress could also allow business tax credits to reduce regular tax liability by more than the current 75% limit and could also increase the period that investors can carry back tax credits.
Simple changes in the tax code could result in significant investment in infrastructure.
Existing and proposed federal community development and clean energy tax incentives have strong bipartisan and bicameral support as a result of their proven record. As Congress considers legislation to invest in infrastructure, it must include the expansion and enhancement of the existing tax code provisions, as well as some additional targeted community development resources.
The tax code already encourages investment in infrastructure. Existing provisions should be expanded and new tools should be added.