May 19, 2012

What Is The Point Of Tax Credits?

Patrick Laverty

A state will offer tax credits in order to incentivize a certain behavior that they wish. The holder of those credits then then use them to offset their own tax liability to the state. I have a friend who earns tax credits in various states by building affordable housing. Sometimes, his tax credits exceed his tax bill, so those credits become useless. Except, the state does allow the credits to be transferred. He'll then sell those earned credits to another business for cash and for less than the value of the credits. It's win-win-win. My friend wins because he gets cash, the other business wins because they're getting discounted money in the form of the credits and the state wins in that they get the affordable housing they desire.

Rhode Island has gotten into this game as well with the RI Film and TV Office. The state wanted to incentivize movies and television shows being made in Rhode Island, so they hand out tax credits for filming in RI and hiring Rhode Island businesses and citizens.

According to Ted Nesi, 38 Studios has applied for $12M in film tax credits for this year and has also submitted an application for $8.7M in credits for last year. So how in the world is 38 Studios going to justify applying for these tax credits? Are they going to get into the movie or television business now? The Film Office's definition of a motion picture does include video games, but only for theatrical or television purposes. I don't know that the definition fits.

If for some reason the state grants these requests, the only logical use for them is to sell them. Go back to the original scenario I described. A state wants a certain outcome, they incentivize it, someone grants the outcome and ends up with a surplus of credits in some instances. That's not what's seems to be happening here. It appears that 38 Studios would be applying for the tax credits for the sole purpose of selling them. If they plan to make a movie or television show and film it in RI with RI businesses and citizens, then great, give them the credits. If the sole purpose is to sell them, then no, the applications should not be approved.

During Governor Chafee's press conference yesterday, he also said that he will be proposing a bill that would cap the amount of tax credits to a single source at $5M. That's just in case you were wondering how the Governor felt about the state handing 38 Studios all this money.

I think if Chafee wants to go the distance on this one, add in that the credits cannot be transferred. Or, if that's too draconian, add in a provision that they cannot be transferred unless some portion of them (at least 50%?) have already been used by the requestor. To me, that makes perfect sense. It fits the original intended purpose of tax credits.

Bottom line, make a film or disallow the applications.

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Here's the problem with your solution. Let's say Steven Spielberg wanted to come to Rhode Island and make a movie for 10 million dollars (round numbers - easier math). He arrives in RI and sets up a Rhode Island LLC - which you need to qualify for the credits, in this case Schindler's List LLC. The company then hires Rhode Islanders, and RI businesses by the score to make the movie and spends 10 Million in RI. That would qualify him for a 2.5 Million dollar tax credit. Here's the problem, Schindler's List LLC has no RI tax liability and will be closed after the picture is completed - hence the tax credits are useless to him, unless he sells them for cash. In this case, the tax credit only makes sense and provides an incentive for Schindler's List to be shot in RI if and only if the credits can be sold. Here's the big difference between the movie, however, and 38 studios. The movie comes to RI rents hotels, cars, equipment,- hires gaffers, grips, extras, catering, insurance the list is endless. 38 Studios has programers in a room - no hotels, rental cars, day players etc. A movie of TV show being shot here creates exponentially more small business economic activity than a programmer in a room. Now, if the state grants 38 Studio's request, that means less available credits for movies and TV because the total amount is capped at 15 million. Why gut the program for one company, which provides little small business opportunity at the expense of actual movies and TV shooting which employs far more Rhode Island small businesses?

Posted by: Jim at May 19, 2012 8:29 AM

Tax credits are just another form of central economic planning. They give politicians additional power to tinker with the economy and favor some businesses at the expense of others. A stable economy based on real-world market forces does not need tax credits for certain industries; in fact the practice is quite harmful in the long term, even if the short-term benefits are "obvious" and quantifiable. It appears that a report was prepared for the state by a paid "consultant" professor from URI that claims 4000 jobs created and an 800% return on the tax credit investment. To say that the report is painfully shortsighted, quantitatively-biased, and falls victim to the broken window fallacy would understate how utter disturbing it is to read it with the knowledge that it is being used to inform or justify public policy. It is possible that indoor prostitution was legal in Rhode Island when the "consultant" received payment for the report - some additional investigation could be conducted in that regard.

I was unable to find a real explanation or stated purpose in the film tax credits law or on the RI Film and TV Office website, which is troubling in itself, but presumably the politicians consulted their crystal ball and thought this was a good sector of the economy in which to invest for some reason or other. You'd have to ask them why it is better than any other arbitrary sector of the economy. In any case, the video game industry has very little to do with the film industry, so it's anyone's guess why video game companies are eligible for the tax credits. If the politicians wanted "exposure" for Rhode Island scenery and landmarks, as would be the result of a movie or show filmed in Rhode Island, then video games do nothing to further that cause.

It's entirely possible that a sale of tax credits to the highest bidder could be more economically efficient than forcing them to be used by a company. The whole scheme is still a grossly inefficient and harmful mess, but at least it decentralizes some of the decision-making, uses a price mechanism, and spreads the benefits to additional companies. It makes a mockery of the tax credits law itself, but it was already a mockery to begin with. Just like the case of rent controls, there is often an inverse relationship between what economists know is bad policy and what is politically attractive to the central planners at the state house or in the EDC.

Posted by: Dan at May 19, 2012 8:50 AM

When I took economics, right after the Civil War, the professor lectured on the old "S&H Green Stamps". For those who don't remember those, when you bought goods, usually groceries, you received Green Stamps in proportion to the amount spent. These could be "spent" at an S&H Green Stamp store. They were "free money".

The professor made the point that the consumer "won" only when one store gave them out, absorbing the extra cost for a competitive advantage. As soon as all stores "gave" them out, the competitive advantage was lost. All of the stores simply raised their prices to absorb the cost of the Green Stamps.

The relevance? It has been about 20 years since the idea of tax credits to "incentivize" movie production really took hold. Now, almost all states offer them and movie producers "shop" for the best deals. This puts pressure on the states to continuously increase the amount of credits to achieve competitive advantage. We have already reached the point of diminishing returns. I am reminded of the old saw about the manufacturer who is losing $.50 per item produced but "hopes to make it up in volume".

Movie tax credits have now become institutionalized in the movie business. So, the state which decides to be the "first man off the train" will suffer a competitive disadvantage. It does not help that movie profits have become "thin". Taking them away might have the same effect as removing "historic credits" had on the renovation of aging buildings. Once you have institutionalized something as "part of the game",taking it away can have disastrous results.

Posted by: Warrington Faust at May 19, 2012 9:13 AM

Jim, I'm going to guess that you're more tuned in to the inner workings of the RI film tax credits, but I have a couple questions based on your scenario.

If the Spielberg production has zero tax liability, why apply for them? Free money? Is $2.5M more important to a movie maker than choosing the right location?

Second, you described how the Spielberg production would be using hotels, catering and lots of other RI services. Each of those are taxed. The taxes that the production pays on those things could be offset by the tax credits they gained. So my suggestion would hold. Use at least a majority for yourself, sell the rest.

Posted by: Patrick at May 19, 2012 10:09 AM

The problem I have with this is that the special deals and things like tax credits for specific cottage industries take a LOT of time to craft and administer, and the results aren't proportional to the costs.

Rhode Island is a $50 Billion dollar economy, when our legislature focuses on $75M loans or $15M tax credits, they make headlines, but not a measurable effect on the economic picture.

Every time the film credits are on the chopping block, a few dozen people who work in the industry swarm the state house and make their case for their own $50M industry. It's compelling, but only because nobody is advocating the downside, which is a slightly less-friendly tax climate for the rest of the $50,000M economy.

Posted by: mangeek at May 19, 2012 11:55 AM


To answer your questions:

1.) "If the Spielberg production has zero tax liability, why apply for them? Free money? Is $2.5M more important to a movie maker than choosing the right location?"

The answer is simple. The tax credits can be sold on the open market to those who do have a significant tax liability. Regarding choosing the right location, you can make virtually anyplace look like anyplace else. A Providence street can easily be made to look like a New York city street, just add a flurry of yellow cabs, 100 extras, and change the street signs and voila, you're in New York city. That, by the way is all accomplished with local paid help and materials.

2.) "Second, you described how the Spielberg production would be using hotels, catering and lots of other RI services. Each of those are taxed. The taxes that the production pays on those things could be offset by the tax credits they gained. So my suggestion would hold. Use at least a majority for yourself, sell the rest."

These are income tax credits, not sales tax, or meals tax, or boiler inspection tax credits. They can only be used to offset Rhode Island income taxes. The movie would have little or no Rhode Island income - hence no direct use for the tax credit other than off setting 25% of the production budget. Twenty-five percent might not sound like that big a deal, however, if you were shopping for say a new car that costs $20,000 at dealer A and the identical car could be had at dealer B for $15,000, where would your car shopping dollars be most likely to be spent - all things being equal.

The are several screenplays that can not economically be shot here, for example Ice Station Zebra, but many more that can easily be shot in Rhode Island. These credits - assuming Curt Shilling doesn't suck them all up will have a tremendously positive effect on Rhode Island small business - at a time when there's not anything else positive going on.

To Mangeeks point about the race to the bottom, Massachusetts offers film and TV tax credits with a much lower threshold (300K in RI, 50K in Mass). That is why commercial production in that mid price range in Rhode Island is all but dead.

Posted by: Jim at May 19, 2012 6:21 PM

"These credits... will have a tremendously positive effect on Rhode Island small business"

Except that they don't. They're not magical, they're not even especially effective compared to other government spending. If anything, they put a few people to work for a few weeks or months, mostly as temporary contractors.

Remember that Simpsons episode about the monorail? That's what this kind of tax credit is about. Charming out-of-towners come and convince our leaders that the solution to our problems is as simple as investing in their particular pet-industry.

Here's a really simple Good Governance policy: Never listen to anyone who tells you that the answer to your problems is to hand them money.

Posted by: mangeek at May 19, 2012 8:03 PM

Posted by Mangeek:

"Charming out-of-towners come and convince our leaders that the solution to our problems is as simple as investing in their particular pet-industry."

Both from my own personal knowledge, and coverage of the scandal in the Boston papers, I know that the Tamsters rip off movie people terrifically. For instance, when Spielberg made his movie here, his Teamster "driver" cost im $2,000 a day. Admittedly, the Teamster was charged with carrying Spelberg's baby around. Bad back, don'tcha know.

I wonder if the Teamsters aren't the leading proponents, they were in Massachusetts until the papers got ahold of it.

Posted by: Warrington Faust at May 19, 2012 8:50 PM

I truly love all the commenter who have absolutely no concept what they are talking about.

The facts are that the film and TV tax credits incentivize work that would otherwise go to other states and leave our contractors with nothing to do. That is a fact. No credits and watch this work go to other states that are not afraid to offer tax relief to increase economic activity.

Sorry, but that's a fact - lower taxes more people work - hence more tax revenue.

Posted by: Jim at May 19, 2012 10:29 PM

What you've missed, Jim, is that a state can create the same end tax level as tax credits by having low, fixed taxes. The level-tax system has a number of advantages that politically-awarded tax credits do not, which are mainly that the fixed system facilitates planning, and investment is left checked by market efficiencies. This is the virtue of rules over discretion. To disprove your absolutist statement, one only has to take it to its logical conclusion - that all industries require special tax credits to keep them in a state. And why stop at tax credits in your hypothetical? The argument could go that if we don't shower them with an infinite number of special incentives and favors through government - catered meals, public office space, police transportation, public dry-cleaning, zero-interest loans - another state surely will. If the television and movie industry can only remain viable at its current size by receiving huge subsidies through government, which is what tax credits are in effect, then it's not an efficient use of resources in the first place and other industries should be free to use those resources instead.

You are correct only so far as that Rhode Island could lose part of its entertainment industry if it abandoned its tax credits for the industry, which is why the policy stands today. But this is not the proper end of the analysis. Politicians like easily quantifiable, immediate effects, or as George Shultz puts it, "The economist's lag is the politician's nightmare." But just like rent controls, it's almost universally recognized in the field as poor policy because price signals are calling for the reinvestment of those funds in other areas and government is the subsidy is only insulating the special interest from those market forces.

Posted by: Dan at May 20, 2012 9:15 AM

Jim, please pay close attention to what Dan just said. Think of it this way:

Giving $1M in tax breaks for film credits might directly bring $7M in economic activity, so it sounds like a win. Unfortunately, to give the $1M out, taxes on EVERYONE ELSE have to go up a little bit, which makes the overall state less competitive. You can point at the 'jobs it created' but you don't see the ones it cost, which outnumber them.

Given that the tax rate on income and sales in the state average to around 4%, each dollar of 'credits' would have to generate $25 in economic activity for this to be a self-sustaining long-term boost to the economy. There ARE government expenditures that meet those criteria, but they're almost never tax cuts.

Posted by: mangeek at May 20, 2012 10:38 AM
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