Tax credits’ essential issues: Part 2, design variables
[Continued from yesterday’s Part 1, unique features]
In addition to its unique features, an investment tax credit can be targeted by adjusting its design variables:
2. Design variables of an investment tax credit
An investment tax credit is a complex tool that can be calibrated to perform a variety of different tasks.
You have to set it right
Like any other tool, it cannot be evaluated in the abstract — one needs a specific set of features designed to address specific needs. Before one uses an investment tax credit, one must first specify at least the following six critical design features:
2.1 Property use. Is the tax credit aimed at a particular use of property, or is it broad? For example, the historic tax credit is ecumenical — virtually any property reuse of a historic building qualifies. The New Markets Tax Credit encompasses many uses. The LIHTC is specifically residential, as is the Washington DC tax credit. Personally, I think affordable housing is by far the clearest public-policy case, since sustainable affordable housing does not exist in economic nature (slums rational), and always costs government money.
2.2 Tenure. Even if one zeroes in to affordable residential housing, one may further specify (or not!) among ownership, shared ownership, market rental, affordable rental, public housing — or indeed, any mix-and-match combination of the foregoing.
2.3 Household bands. Are we targeting elderly, families, or supportive housing? Are we seeking to assist the very poorest (Extremely Low Income), the working poor (LIHTC), workforce housing in supply-constrained urban areas, or other groups?
One may erect towers of analysis defending any of these candidates, but in the end, tenure and household bands targeted are purely political choices.
Each of us is defending his constituency
2.4 How does a sponsor secure tax credits? Does the tax credit come ‘as of right,’ open-ended to all comers who meet its program criteria? That’s how the historic tax credit works. Or is the amount a fixed allocation for which sponsors compete, as in the LIHTC and New Markets Tax Credit? A case can be made for either, although the finite-competed model has a better track record of sharpening program efficiency as all that self-interested entrepreneurial creativity is channeled into outperforming one’s developer competitors.
I got my allocation!
2.5 Who allocates tax credits? Regardless of the securing question (previous point), a program participant always must interact with government before the credit activates.
· When a tax credit comes as of right, there is always a government inspector (in the historic credit, it’s the National Park Service and the state historic preservation officers, SHPO’s) who reviews the work to assure it meets the program specifications.
· When a tax credit is finite, and therefore competed, it is the allocator’s role to review applications and choose those it likes best.
If only there were books on tax credit allocating!
2.6 How is the tax credit monetized? If the tax credit is small relative to the taxpayer’s income, it can be directly consumed — the developer uses it directly and eliminates both market dynamics and any intermediary. (The Washington DC tax credit works this way.) Alternatively, if the tax credit is large, it must be syndicated (as in the historic, Low Income, and New Markets Tax Credits).
A case can be made that direct consumption is theoretically the most efficient — no middlemen. But as against that, direct credits are small, meaning they take more effort to allocate or administer, and there are no efficiencies of large-scale capital finance.
Even if the tax credit is properly calibrated, it may yet be unwise to introduce, for it needs several preconditions:
[Continued tomorrow in Part 3, preconditions]
