Wednesday, May 12, 2010

The Costs, Benefits, and Politics of Historic Tax Credits

Syndicate Trust Building, Downtown St. Louis
Count me among the many who believe that the continued, unfettered availability of the Missouri historic rehabilitation tax credit is critical to the ongoing revitalization of not only downtown St. Louis, but many other historic areas and buildings across the state. I do not doubt that Governor Nixon and his allies truly believe that their proposed changes to the program are necessary in light of the increased use of the credit over recent years, especially at a time of economic and budgetary hardship. Nonetheless, the apparent thoughtlessness with which they are approaching the issue--at least if we are to judge them by their public statements--is incredibly galling.

In these last few days of the 2010 legislative session, we will find out the extent to which Governor Nixon has been able to garner support for lowered caps on the program or other harmful modifications.  For the time being, it appears that he may be backing off some of the more controversial proposals, such as giving total control over the program to the Department of Economic Development, but significantly reduced caps remain very much on the table.  While we wait for the final results of this session, here is a quick look at the historic tax credit ("HTC") program's documented costs and benefits, and some of the political considerations that should be on the minds of the program's supporters as the fight inevitably continues.

The Costs

Missouri HTCs are a dollar-for-dollar credit against a taxpayers' liability for certain state taxes, including income tax (excluding withholding tax), bank tax, and insurance premium tax.  The credit is equal to 25% of a project's qualified rehabilitation expenditures ("QREs"), providing a powerful incentive when coupled with the 20% federal historic tax credit (and, often, "twinned" with other incentives such as the low income housing tax credit). 

There is no question that the use of Missouri tax credits, including HTCs, has greatly increased over the last decade.  As noted in a March 2010 Program Evaluation released by the Missouri Committee on Legislative Research, Oversight Division, overall tax credits (not just HTCs) have increased from $145 million redeemed in 1999 (representing 2.97% of related taxes), to $588 million redeemed in 2009 (representing 8.04% of related taxes).  In 2009, historic tax credits constituted approximately 20% of all Missouri tax credits issued (approximately $120 million out of $581 million total), and approximately 32% of all credits redeemed (approximately $186 million out of $588 million total).

An April 2010 report released by State Auditor Susan Montee states that the projected redemption of HTCs from 2005-2009 was $71.5 million, while the actual amount redeemed was almost nine times that amount.  The report lists a number of reasons for inaccuracies in these projections including greater particpation in the program than predicted, before echoing the Oversight Committee's recommendation that "[t]he General Assembly establish annual limits, cumulative limits, sunset provisions, and/or expiration dates for al tax credit programs."

On one of these points, the General Assembly had beaten Auditor Montee to the punch.  At the end of the 2009 legislative session, a $140 million annual aggregate cap was imposed on the program, as well as a per-project cap of $1,000,000 in QREs (i.e., $250,000 credit cap) for owner-occupied, single-family residences. Certain "small deals" were exempted, with projects having QRE’s of $1,100,000 or less ($275,000 in credits or less) not subject to the cap.  As these small deals are currently estimated to make up approximately 75% of historic tax projects, most supporters of the HTC program have not appeared overly concerned about this cap to date.

Chase Park Plaza, St. Louis's Central West End
Interestingly, the state's grasp of the overall impact of the HTC program and other tax credit programs on the Missouri economy seems shaky at best.  As noted by both the Oversight Committee and the Auidtor's report, information on the impact of tax credits is incomplete and uncoordinated, with multiple and duplicative reporting systems, reports that must be compiled manually, and other inefficiencies that inhibit the state's ability to budget for the effects of various tax credits.

The Benefits

Clearly, the "cost" of the HTC program in terms of dollars that are used for redevelopment, as opposed to paid to the state as taxes, is significant and growing.  To hear Governor Nixon and his (primarily Republican) allies tell it, you would think the story ends there.  The offsetting benefits of Missouri's HTC program, however, are substantial and well documented, belying his recent characterizations of the credits as a "zero sum game" when viewed in the overall context of the Missouri economy. 

Quite simply, Missouri has (or, at least until capped last year, had) the best, most effective historic tax credit program in the entire nation.  Missouri's HTC program has been dubbed a "national model" for economic development by the Wall Street Journal, with respected preservationist and consultant Donovan Rypkema noting that "the Show Me State has shown the rest of the country how to attract private capital into our historic buildings." 

According to a March 2010 evaluation of the HTC program conducted by the Missouri Growth Association, economic impacts of the program include $670 million in new sales/use and income taxes for state and local governments, $2.9 billion in leveraged private investment, significant property tax collections, $75 million in earnings tax revenue in St. Louis City and Kansas City, and significant job impacts (more on jobs below).  The MGA points to many projects that would not have occurred but for the HTC program, concluding that the program "pays for itself in economic impacts to the state."  Governor Nixon's own executive branch--if not the governor himself--recognizes these benefits:  the Missouri Department of Natural Resources continues to call historic preservation "a major source of new jobs and additional revenue for municipalities, counties, and the state itself," with the economic benefits of the HTC "extend[ing] far beyond the initial investment in buildings and communities."

Old Post Office, Downtown St. Louis
An analysis of the benefits of HTCs is not complete without taking into account the corresponding benefits of federal tax credits.  As detailed in Rutgers University's First Annual Report on the Economic Impact of the Federal Historic Tax Credit (March 2010), Missouri ranks #1 in federal tax credit-aided historic rehabilitation, with $419 million such rehabilitation in fiscal year 2008. 

The national impacts of that one year of activity were immense: 7,200 jobs generated an additional $796 million in output, $299 million in income, $396 million in GDP, and $94 million in taxes.  The in-state retention rate of those benefits was 76%, with 5,300 jobs generating $518 million in output, $225 million in labor income, $275 million in gross state product, and $85 million in taxes. 

The benefits accruing to Missouri residents from the federal program are a direct result of Missouri's own superlative programCiting the state program's effect on the use of the federal tax credits, the MDNR has noted that "it is this winning combination that has enticed developers from other states to join local developers in hiring workers to rehab historic buildings in communities across Missouri."  In addition, the MDNR points to a 2004 National Park Service report concluding that the success of Missouri's HTC program "is reflected in the fact that rehabilitation using the federal tax credits doubled" after Missouri's program was passed in 1997. 

The Politics  

Irrespective of the results of this year's legislative session, the fight between supporters of Missouri's HTC program and those who would prefer to scale it back significantly is likely to continue in upcoming years.  As proponents of the program continue to organize their efforts, here are some talking points that I think need to be hammered home to ensure minimal damage to the program.

      Hatchet Job on Hugely Successful Program = Political Malpractice

In the last week, Governor Nixon seems to have backed off his calls for a major overhauling of the HTC program, at least for now.  Until very recently, though, he has been on record as calling for a wholesale overhaul of Missouri's entire tax credit program.  As noted by a spokesman for Economic Development Director David Kerr, "[w]e want to reform the entire tax incentive program back to square one."  The astonishing thing about these type of statements is that, on their face, they appear to view HTCs in a vacuum, without regard for the relative success of the HTC program as compared to other credits, incentives, and programs that might be better suited for reform efforts, the significant and quantifiable economic benefits HTCs generate, or the effects that reform may have on the market for HTCs.

Continental Building, Midtown St. Louis
On this last point, it is critical to understand that an efficient market for tax credits is what allows Missouri's program to be so successful.  Unlike federal HTCs, Missouri HTCs are transferable to tax-paying corporations and individuals, allowing developers to obtain up-front cash for projects by selling the anticipated credits for a discount (typically $0.90 to $0.95 on the dollar).  Purchasers know that the credits will be issued as long as apolitical, objective criteria are met, creating the certainty necessary for the tax credit market to thrive.

Supporters of changes to the HTC program need to carefully consider the extent to which their efforts might affect this market.  Measures such as caps--and, even worse, subjecting the issuance of HTCs to appropriations--not only will cause direct negative impacts to rehabilitation efforts (e.g., less credit dollars available for projects), but may have unintended, yet devastating, effects on the entire program. 

A state-by-state report issued by the National Trust for Historic Preservation's Center for State and Local Policy notes that the success of state HTC programs varies widely, and lists the key elements that make for a successful program. These elements include, among other things, transferability of the credits, objective criteria for determining eligible projects, the absence of caps, and appropriate rates (20-30%).  Until modified last year to include certain caps, Missouri's HTC program included every single one of these characteristics. 

As noted in the National Trust report, "a limit or cap on the amount of credit" is one of two factors that "greatly influence[s] the effectiveness of the state historic tax credit." An annual aggregate program cap, even if relatively high, "alters the nature of the program and can produce a perverse result, rewarding projects that do not require an incentive while excluding projects that cannot proceed without the state incentive."  It is clear that even further reductions to the cap enacted last year (not to mention far worse ideas such as having the credits subject to a political appropriations process) have the potential to do real damage to an incredibly successful, nation-leading program.

What is maddening is that these type of considerations do not seem to even be taken into account by those who, in reference to all Missouri tax credits, want to "reform the whole thing from scratch."  Do supporters of "reform" view HTCs on par with all other tax credit programs?  Are there certain programs which have proven to be economic drivers and therefore might be better off left alone, or at least treated differently than other programs?  Are there offsetting benefits that need to be considered, while carefully crafting changes specifically designed to minimize unintended consequences?  At least to this member of the general public, there does not seem to be any sort of cost-benefit analysis like this going on.  Taking a hatchet to a job that clearly requires a scalpel is, in my view, political malpractice.    

      Jobs, Jobs, Jobs

The job-creating impacts of historic preservation in Missouri have been clear from the early days of the HTC program.  As noted in the December 2001 report "Economic Impacts of Historic Preservation in Missouri"  conducted by Rutgers University, the total economic impacts of HTC-supported Missouri projects created 6,871 jobs in Missouri, plus 4,918 additional jobs outside of Missouri.  From the perspective of relative efficiency, Donovan Rypkema contended in 2008 that for every million dollars of manufacturing production in Missouri, 13.9 jobs are created--while one million dollars used in the rehabilitation of a historic Missouri building creates 20.2 jobs on average. 

More recently, the 2010 MGA report concluded that the HTC program is "associated with" (although, the report is careful to note, not necessarily caused) 43,150 new or retained jobs with an average salary of $42,732.  Annual job growth associated with HTC programs is higher than expected, with higher than expected increases in "high-paying sustainable jobs." 

In this economy, any program that has a proven record of creating jobs (or at least being correlated with abnormally high job growth) is, in my view, a success--and one that a politician negatively impacts at his or her peril.

      Harming Program Results in $$ Leaving Missouri

One might choose to ignore the positive economic impacts of Missouri HTCs and simply accept Governor Nixon's contention that this is a "zero sum game"--that one dollar not used for a state tax credit project results in one (and only one) dollar available for other state needs such as education.  Even then, though, it is difficult to ignore the dollars that would be lost to Missouri as a result of harmful changes to the HTC program.  Again, Missouri is the top-ranked beneficiary of federal historic tax credits, resulting in milions of dollars of in-state investment that otherwise would have been paid to the federal government.  Missouri's success is a direct result of its own exemplary state HTC program, which is highly complementary with the federal program.

To the extent Missouri's HTC program becomes less attractive to tax credit purchasers, those federal benefits are likely to decrease.  Missouri's economy will lose investments that would have been made in its own communities, either to taxes paid to the federal government or, more likely, to investments made in other states with more favorable tax credit programs.  Supporters of the HTC program need to make it clear that, even under Governor Nixon's worldview, limiting the program is not an economically neutral proposition if dollars that could have been invested in Missouri begin being invested elsewhere.

      Historic Preservation is a Liberal and Conservative Issue

Washington Avenue Historic District, St. Louis
The "but for" argument--that numerous successful developments in Missouri would not have occurred without the HTC program in its current form--is a powerful one. On the other hand, you might be able to say that about any number of tax incentive programs, many of which are disdained by preservationists. For example, a developer of new fringe construction might say that, but for tax increment financing or other public assistance, the project would not have been economically viable. Although there are a number of ways to distinguish the "but for" aspects of TIF deals versus historic rehab projects, I think that it is most helpful to focus on why historic preservation should be a preferred development choice, such that harming a program that greatly facilitates preservation is disfavored.

On that point, there is a lot for both those on the left and the right to champion.  Of course, preservation, conservation, and other "green" issues are often considered to be the domain of liberals--and as the saying goes, the greenest building is the one that is already built. 

However, historic rehabilitation is--or at least should be--an easy sell to fiscal conservatives and others on the right as well.  Of course, many conservatives are conservationists in their own right.  But even those for whom historic preservation and urban infill are not a priority can appreciate the benefits of a program that encourages development, creates jobs, and leaves tax dollars in private hands for investment at the local level (not, of course, that any of those issues are the sole domain of conservatives).  Whether a legislator or other politician is on the right or left, I think that there are a lot more reasons to be supportive of the HTC program than to be against it.

      Disingenuous Demagoguery ≠ Positive Reform

Political-speak on tax credit reform more often than not revolves around pitting various groups and interests against each other, such as "urban versus rural," and "education versus development."  Such demagogic characterizations might make for good political theater, but they do little to illuminate the true nature of the economic issues that are at stake. 

Again, this simply is not a zero sum game--in order for urban and development interests to "win," it is not necessary for rural and education interests to "lose."  As noted in the MGA report, "the value of credits issued are far less than the volume of private investments that otherwise would not have been created."  These investments lead to additional economic benefits for the state, including tax revenues (used for education, among other things) that would not have existed but for the development activity.

As might be expected, the majority of HTCs do in fact benefit projects in Missouri's two largest urban areas, St. Louis and Kansas City.  Nonetheless, the vast majority of historic rehabilitation projects are for relatively small projects, with small communities all over the state benefiting from the HTC program.  As noted by one commentator, most HTCs in Missouri "have not gone to large-scale redevelopment projects, but rather to small homeowners and developers. . . . The people that really benefit from this tax credit are not the big developers, but rather, the independent 'mom and pop' in communities across the state."  The 2010 MGA Report concurs, stating that "[i]t appears as though smaller communities that know how to use the [HTC] program do so quite well and see positive economic impacts from its use."  With tens of thousands of eligible properties across the state, the benefits to smaller communites will only continue to increase over time.

Some of the most unhelpful dialogue comes not from Governor Nixon, but from his Republican allies (on this issue) in the General Assembly.  Senator Jason Cromwell (R-Cape Girardeau), for example, repeatedly characterizes Missouri's HTC program as a "bailout for big businesses" that benefits "fat cat developers," with the popularity of the credits often "traced to the pockets of big businesses and special interests."  Senator Cromwell further contends that none of Missouri's tax credit programs "have done anything to add real jobs or help small businesses, the economic engine of Missouri."
Wainwright Building, Downtown St. Louis
I suppose the "big businesses" that would be interested in the HTC program would be those that have large tax liabilities (and therefore can benefit from the credits), while the "special interests" that benefit from the program are the very developers and other real estate professionals that make historic rehabilitation projects possible. 

I don't really see what demonizing those who benefit from the HTC program accomplishes or even is intended to demonstrate.  Is Senator Cromwell's point that we should destroy a program that has proven to be a primary driver of the Missouri economy because we don't like that "fat cats" benefit from the program in the process?  The last time I checked, real estate development was not an altruistic venture.  And even if you don't like the "fat cats," what about the contractors, suppliers, and other small business that would be hurt by a slow-down in rehabilitation development activity?  As far as the notion that the HTC program has not created jobs or helped Missouri businesses, that, quite simply, is false.

By the way, how do those outside of St. Louis and Kansas City think the appropriations process would help them in future historic rehabilitation projects? Isn't that almost certain to benefit disproportionately the "politically-connected, big-city, fat cat developers"? Senator Cromwell's contention that tax credits are now "a reward to contributing to a campaign" and are the subject of "backroom deals" does not ring true, at least with respect to the HTC program. Currently, the issuance of HTCs is based on objective criteria and, as far as I know, is not susceptible to political pressures. That is almost certainly unlikely to be the case if there are finite credits to be obtained, with the Department of Economic Development or other political agency picking the winners and losers.
By the time the Missouri General Assembly ends its 2010 legislative session this week, we will know the extent to which Governor Nixon has been successful in his efforts to reform the HTC program.  Of course, the fight will not end there, as future attacks on the HTC program are almost certain.  It will be critical for the program's defenders, such as the Missouri Coalition for Historic Preservation and Economic Development, to continue organizing, raising money, and lobbying against efforts to enact wholesale "reform" of the program. 

I do not mean to suggest that Governor Nixon and his allies in the legislature are acting foolishly even to consider reforms to Missouri's tax credit system.  The budgetary crisis faced by the state requires painful choices.  It may very well be possible to make thoughtful, targeted changes to the HTC program that would help the state's economy in the long run, with minimal negative effects on the overall program.

What I primarily object to is the seemingly mindless modification of a hugely successful program without regard to the benefits that offset its costs, and that (in my view) make it less of a candidate for major reform than other credits or programs that are truly geared toward very specific interest groups and do not significantly benefit the overall state economy.  There is at least one way the historic tax credit is distinguishable from many of these other state credits and programs:  it has been proven to work.  Missouri's historic tax credit program has a long-term track record of achieving extremely beneficial results for the state in creating jobs, increasing tax revenues, and breathing new life into our historic communities and buildings.

As far as anyone could tell from the public discussions on the issue, neither the governor nor the legislature appear to be approaching the issue in a way that suggests they understand the enormous benefits of the program or the disastrous effects on the tax credit market their actions might have.  If materially harmful changes to the HTC program are thoughtlessly enacted or continue to be threatened in the future, then its supporters will need to push measures that overturn or mitigate those taken by the program's opponents--and ensure that they pay a political price.

1 comment:

  1. I have to say, I also believe that the continued availability of the Missouri historic rehabilitation tax credit is critical to the ongoing revitalization of downtown St. Louis. To keep St. Louis beautiful, the downtown needs to have access to these funds.