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Tax Credit Reform: Glass Half Full? Maybe Some Moisture

IFP Analysis Shows Reform Package Falling Short
Backgrounder (2-pg PDF) News Release (2-pg PDF) March 17, 2010

At a time demanding great strides in Iowa budget reform, pending tax-credit legislation developed by Democratic state legislators at best offers only baby steps. Although promoted as way to save more than $115 million through tax credit reforms, the provisions actually will produce a tiny fraction of that amount, with almost none for the 2011 budget. Given a scandal in Iowa’s high-profile film tax credit program and unprecedented shortfalls in state revenues, the timing remains optimal for reform. Recommendations by the Governor’s Tax Credit Review Panel for curbing the growth of tax expenditures, and analyses by the Iowa Fiscal Partnership and other experts, demonstrate the excessive nature of many business tax credits and their lack of transparency, accountability and public purpose. It is difficult to imagine a better time for fiscally sustainable reforms of tax credits and other tax expenditures than lawmakers have in the closing weeks of the 2010 session.

Through a largely closed-door legislative process, however, legislators crafted for a bill without public testimony or expert review and makes very minimal changes to current law. While the Governor called for action on the Tax Credit Review Panel’s recommendations to build $52 million in savings into his proposed Fiscal Year 2011 budget, the legislative package rejects almost all of that panel’s recommendations.

Major recommendations of the Tax Credit Review Panel were to:
— Provide a five-year sunset on all tax credits;
— Eliminate the refundability of the Research Activities Credit (RAC) for large companies;
— Eliminate the film tax credit;
— Eliminate of the transferability of other credits;
— Place all business credits under a $185 million cap;
— Reduce the rate for the School Tuition Organization Tax Credit; and
— Impose an income test for the Tuition and Textbook Tax Credit.

By comparison, the legislative package would:
— Establish a statutory panel of legislators to review a set of tax credits in each of the next five years;
— Reduce the size of the supplemental Research Activities Credit (but not the regular RAC) for large companies while increasing it for smaller ones;
— Suspend the film tax credit until July 2012;
— Reduce the credit cap for the five business credits under the $185 million cap and for the Venture Capital Fund of Funds; and
— Reduce caps by 10 percent for select other business credits, including the School Tuition Organization Tax Credit.

Statutory Panel
As passed by House and Senate committees, the bill (HF2527/SF2380) establishes a 10-member panel of legislators to review a set of tax credits over a schedule over the next five years, based upon sound tax principles. While the goal is greater oversight and transparency of tax credits and expenditures, the legislation provides no additional access to information about tax credits and expenditures than exists today. A number of states have adopted transparency legislation that would make the recipients of tax credits a public record in order to determine who benefits from the credits and assess their public benefit to the state. Last session, the General Assembly took an initial step in this direction by requiring that recipients of RACs receiving more than a $500,000 credit to be made public, but the bill advancing in the Statehouse goes no further in providing transparency. To expect the legislative panel to conduct a serious review of tax credits also will require significant research and staffing, which are not part of the legislation.

Research Activities Credit
The Governor’s Tax Credit Review Panel recommended ending the refundability of the Research Activities Credit for firms with $20 million or more in annual sales (refundability means that any amount of the RAC over what a recipient would owe in taxes is paid out as a direct subsidy). RAC refunds are projected to cost around $50 million over each of the next four years, based on the latest Department of Revenue projections, with most of these refunds going to very large corporations. Eliminating the refundability for corporations with gross sales over $20 million or capping the credit at $250,000 for any one corporation would produce $20 million or more in FY2012 and twice that in FY2013.

The legislative proposal reduces the size of the supplemental RAC for companies with gross sales over $20 million, while increasing it for smaller companies, but it does not make any changes to the far larger automatic RAC. The net effect of these changes will likely be an eventual revenue gain of less than $10 million per year, but much less if anything in FY2011.

Film Tax Credit
While the Governor’s Tax Credit Review Panel called for repeal of the film tax credit, the bill approved by the House and Senate Ways & Means committees would simply suspend it until July 2012. This is unlikely to have much additional impact, as the scandals, subsequent suspension, and the Attorney General’s determination that the current credit was only 25 percent of eligible costs have largely stopped new applications for funding. There still will be costs associated over the next several fiscal years with the film tax credit for films that received approval prior to the suspension. The suspension, rather than repeal, however, requires the General Assembly to take action in the future if the credit is to be repealed or further modified.

Credit Caps
Proposed changes that appear to be behind much of the claim that lawmakers’ plan “saves” the state money or reduces liability relates to the reduction, but not restructuring, of two of the existing caps. Neither of those caps currently are close to being reached. The cap of $185 million on five credits that was instituted last year would be reduced to $120 million, but revenue projections for the five credits (which include the suspended film tax credit) are far below that figure. The reduction of the Venture Capital Fund of Funds cap from $100 million to $60 million is for a credit that has yet to have any money draw down and currently does not have a liability close to the $60 million cap. Although these two provisions reduce caps by $105 million, they are expected to be largely cosmetic and have no impact in at least the next two fiscal years.

Other Credits
The legislative proposal makes a number of other revisions to much smaller tax credits, but most are not projected to have a significant impact, based upon Department of Revenue projections on their use. The school tuition organization cap is reduced by 10 percent, which, if projections are accurate, would result in an actual $350,000 reduction in the amount of the credit claimed. The Governor’s Tax Credit Review Panel recommendation on this credit, however, would produce a much larger reduction.

While the legislative panel may offer recommendations in the future for curbing tax credits, the current bill draft is more cosmetic than real in taking a balanced approach to the state budget. Meanwhile, a number of tax reforms — such as combined reporting and limiting the total exclusion of capital gains income from the individual income tax — are not addressed. These provisions would close tax loopholes that shelter profits from any state income tax liability. Coupled with significant reforms to the RAC and adoption of other recommendations from the Governor’s Tax Credit Review Panel, such reforms could produce real state savings of $115 million or more in FY2012 and future budget years.

It is not too late for Iowa lawmakers address these issues and include some water in the tax credit reform glass.

To better view the tables below, click on either table for a larger image.

Table 1

A joint effort of the Iowa Policy Project and the Child & Family Policy Center (logos).