Washington Wire: The Importance of Tax Expenditures’ Distributional Impact

Published by Michael Novogradac on Monday, April 1, 2013
Journal thumb April 2013

The Senate Budget Committee last month held a hearing on reducing the deficit by “eliminating wasteful spending in the individual and corporate tax code.” This hearing is the latest reminder that tax reform and deficit reduction will involve changes to tax expenditures, although it’s too soon to tell which expenditures will be affected or to what degree.

Other than those few who call for the elimination of all tax expenditures, most parties involved in the tax reform discussion agree that tax expenditures should be evaluated before being limited, eliminated or otherwise changed. At last month’s Senate Budget Committee hearing, and in related developments so far this year, one recurring criterion that has emerged is that of distributional impact, meaning who primarily benefits from an expenditure.

The March 5 Senate Budget Committee hearing was billed as a discussion about reducing the deficit by eliminating wasteful spending in the individual and corporate tax code. In her opening statement, Senate Budget Committee Chairman Patty Murray, D-Wash., said, “ … at a time when we absolutely must cut where we can, looking at ways we can close special tax breaks that aren’t targeted to help the middle class or our economy just makes sense.”

CBO Studying Distributional Impact
At a Feb. 13 House Budget Committee hearing, Congressional Budget Office (CBO) Director Douglas Elmendorf revealed that the CBO was examining how various tax expenditures benefit different income segments. BNA reported that in response to a question from Rep. Gwen Moore, D-Wis., Elmendorf said, “We have work under way on the distribution of tax expenditures. And it’s not finished yet, and I don’t want to speak ahead of not having completed that analysis.” He did not provide an estimate on when CBO would complete the analysis.

Related Analysis
Similarly, Section 272 of the proposed “American Jobs and Closing Tax Loopholes Act of 2010,” would have mandated that the Joint Committee on Taxation prepare an analysis for each tax expenditure extended by the bill. The proposed analysis would include 10 criteria, the fifth of which was a “description of the direct and indirect beneficiaries of the tax expenditure, including identifying any unintended beneficiaries.”

Evaluating Income Tax Credits
So for affordable housing, community development, historic preservation and renewable energy stakeholders, the question becomes: who benefits from the low-income housing tax credit (LIHTC), new markets tax credit (NMTC), historic tax credit (HTC) and the renewable energy production tax credit (PTC) or investment tax credit (ITC)?

Unfortunately, misunderstanding of or misinformation about these tax credits in particular, and federal tax expenditures in general, often results in expenditures such as the LIHTC, NMTC, HTC and energy tax credits being unfairly lumped in with all corporate tax expenditures. This categorization ignores a key attribute these programs share: while most often claimed by corporations, the greatest share of the benefit created by the LIHTC and NMTC is targeted toward low- and moderate-income taxpayers. Similarly, HTCs and energy tax credits generate considerable gains for local economies and the workforce.

Who Benefits from Low-Income Housing Tax Credits?
Taking the LIHTC as an example, in 2010, members of Ernst & Young’s Quantitative Economics and Statistics (QUEST) group wrote an article for BNA’s Daily Tax Report entitled “Lowering Business Tax Rates by Repealing Tax Expenditures: An Industry Analysis,” wherein they wrongly suggested “eliminating the low-income housing tax credit . . . would fall most heavily on the finance and insurance industries.” Affordable housing advocates know this claim is patently false – the burden would fall most heavily on low-income families seeking affordable rental housing. This assertion misses a key inherent difference between tax expenditures that create direct social and economic impacts and other tax expenditures.

The LIHTC is a purchased tax benefit, and substantially all of the net economic benefit of the LIHTC goes to low-income families, not to corporations. The LIHTC, because it is a purchased tax benefit, should be distinguished from other tax expenditures. In reality, the finance and insurance industries would suffer very little financially if the LIHTC was repealed. On the other hand, low-income families would be significantly adversely affected. If the LIHTC was repealed in exchange for lower marginal corporate tax rates, corporations would save on income taxes without making LIHTC investments. Meanwhile, without the LIHTC, more than 80,000 affordable housing rental units wouldn’t be built. Over five years, more than 400,000 low-income families would be adversely affected. 

It’s important to also note that the LIHTC is considered a corporate tax expenditure because over time, the LIHTC community has increased the program’s efficiency by seeking large dollar investments from large corporations. If the LIHTC was marketed, as it once was, to individual investors in smaller increments, it could be considered an individual tax expenditure. However, such a move, would make it less efficient and lead to less net capital for acquisition, rehabilitation and development of affordable rental housing.

Who Benefits from New Markets Tax Credits?
As my colleague Cyle Reissig reported in the December 2012 Journal of Tax Credits, the NMTC Working Group is preparing an analysis, in preparation for potential legislative discussions, to endorse a program extension and defend against tax reform that might consider terminating the NMTC. The NMTC Working Group will publish its analysis upon completion.

In the meantime, data reported by the Community Development Financial Institutions (CDFI) Fund suggests the NMTC has generated significant benefits for low-income communities. According to the CDFI Fund’s “Year in Review” report, released in late February, in 2012 funds allocated through the NMTC program have created 31,405 jobs, and an estimated 52,448 construction jobs have been spurred by NMTCs. The report says that 578 businesses were financed in 2012 and nearly 2,967 housing units created. Since the program’s inception, the CDFI Fund reports that the program has created more than 111,200 jobs, built more than 7,400 housing units and financed more than 1,781 businesses.

Of the more than $5 billion in loans and investments in low-income communities made in 2012, 70 percent were in severely distressed communities. Severely distressed communities are areas that have significantly higher poverty rates and lower median family incomes than those required under the NMTC program; areas that have unemployment rates at least 1.5 times the national average; and/or areas that have been designated for economic development through other programs, such as brownfields, empowerment zones and renewal communities. In other words, the NMTC is benefiting the communities in most need of investment and those communities that otherwise may not be considered for development.

Conclusion
Returning to the March 5 Senate Budget Committee hearing, consider the following from witness Jared Bernstein, Ph.D., a senior fellow at the Center for Budget and Policy Priorities, who noted, “Of course, just as not every spending program should be cut, neither should all tax expenditures be repealed or reduced.”

Bernstein suggested three criteria be used to evaluate the utility of tax expenditures: revenue forgone, efficiency and fairness. In terms of revenue forgone, the LIHTC, NMTC, HTC and energy tax credits are dwarfed by dozens of larger tax expenditures. (For more information, see the Feb. 7, 2013 post at novogradac.wordpress.com.)

In terms of efficiency, Novogradac & Company has analyzed the efficiency of these tax credits compared to that of comparable cash grants and have found, simply, that when compared to cash grant programs, tax credits are a more efficient way for the federal government to support affordable housing, community development, renewable energy and historic preservation. (See Novogradac’s “Historic Rehabilitation Tax Credit Recapture Survey,” “NMTC Program Outperforms Comparable Cash Grant Program,” and “Low-Income Housing Tax Credit Special Report,” for details.)

Finally, in his testimony about the fairness criteria, Bernstein discussed how certain individual income tax expenditures can amplify pre-tax trends toward higher income inequality, as their benefits flow disproportionately to those at the top of income scale. His comments did not address corporate tax expenditures in regard to fairness, but in light of the significant benefits for low- and moderate-income taxpayers generated by the tax credits described above, they pass the fairness test with flying colors.