State gives GOED’s favored few ‘vouchers’ redeemable for cash

Barely 15 months removed from triumphantly announcing that $1.3 billion in tax breaks over 20 years had lured Tesla to build its massive battery factory in the Reno area, Nevada Gov. Brian Sandoval last December followed up by securing a commitment from upstart electric car company Faraday Future to locate its manufacturing plant in North Las Vegas in return for $215 million in tax relief over the next decade.

With the deals came promises that a state still struggling to shake the residue of economic malaise had turned the corner toward rejuvenation. “It will light up everyone in the region,” Steve Hill, Gov. Sandoval’s point man on economic development, told the Reno Gazette-Journal in regard to Tesla. “Property values will go up. The prosperity of the region will be materially changed.”

Likewise, following the Faraday announcement, the governor predicted in the Las Vegas Review-Journal that the arrangement “is going to change the trajectory and economy in Southern Nevada and the state.”

For Nevada taxpayers and business owners living in the here and now, however, the excitement of handing out a total of $1.5 billion in tax incentives to Tesla, owned by a Silicon Valley billionaire, and Faraday, the brainchild of a Chinese billionaire, might be somewhat tempered by a sobering reality.

Sandwiched between these two signature achievements for Gov. Sandoval was a third: In June 2015, lawmakers gave final approval to the biggest tax hike in Nevada history, a $1.1 billion potpourri of revenue sources, including higher sales taxes and $500 million per biennium in new levies on state businesses.

It’s an intriguing contrast: As state policymakers in pursuit of bigger budgets conjure up more innovative means to dig deeper into the pockets of Nevada businesses and residents, they simultaneously in pursuit of economic development promote more creative ways to deplete the state’s general fund by bestowing tax advantages upon favored interests.

Nevada is not unusual in this approach, or course. Lawmakers and governors from coast to coast now routinely manipulate tax policy to lure jobs and investment or promote activity they deem desirable, creating a ripe climate for savvy business interests to gain advantage and to play states against each other in search of the most lucrative giveaway.

Whether this is more effective than simply fostering a regulatory and business atmosphere attractive to entrepreneurship in general remains a matter of contention, but it is certainly an overt acknowledgement of the importance a low-tax environment plays in creating and sustaining a healthy state economy.

Yet empowering the bureaucracy or political class rather than marketplace to reward or punish also carries the very real risk of nurturing destructive tendencies such as corruption, cronyism and rent-seeking, skewing policy at the expense of individuals or entities lacking power, privilege or political connections.

It exacerbates the perception that our political system serves primarily to protect influential elites at the expense of the ordinary citizen, that the powerful manipulate the levers of government to distort markets and the regulatory apparatus to enrich themselves, thus betraying the concept of opportunity and a level playing field for all.

To a large extent, the populist revival now coursing through the political scene highlights how such concerns resonate with a great many Americans. Yet rather than dial back the backscratching and special-interest logrolling, politicians at virtually every level — often with the best of intentions — continue to shower special dispensation on those who least need it.

Consider the trendy new economic development tool known as the “transferable tax credit” — which represents a significant portion of the generous packages that attracted both Tesla and Faraday to Nevada.

Under the concept of transferable tax credits, the company to which a state awards such benefits may not in many cases be the entity that actually cashes them in. Instead, as The Wall Street Journal noted in a June 2014 article on the subject, the credits “may wind up in the hands of businesses that don’t need government help” or were never intended to receive them.

Fairly rare a decade ago, transferable tax credits took off initially when star-struck politicians saw their potential to entice film production companies to make movies in their states. Nevada joined the fray in 2013, when lawmakers approved $80 million in tax abatements for movie makers.

Today, the concept has expanded to a wide array of industries in 46 states, including Nevada. The Tesla deal includes $195 million in tradable tax credits, while the Faraday legislation includes $38 million of them. Not only do these credits help the companies mitigate their Nevada tax obligations, they could enable them to turn a tax bill into a profit.

That’s because business receiving transferable tax credits have the option of either using them to offset their state tax bill or selling them to a company that may have a higher tax obligation in the same state. For instance, many movie production companies don’t have large state tax liabilities — any credit granted may exceed the amount they owe. But if the credit is transferable, they may sell the excess for, say, 80 or 90 cents on the dollar to a business trying to lower its own tax bill.

As an example, let’s say Nevada, hoping to promote the new green energy agenda of Spacely Sprockets, awards the company $10 million in transferable tax credits. But Spacely Sprockets owes only $5 million under the state’s new modified business tax. After satisfying its tax bill, Spacely Sprockets may then choose to sell the remaining $5 million to Joe’s Resort and Casino for $4 million. As a result, Spacely Sprockets pockets $4 million in taxpayer cash, while Joe’s Resort and Casino saves $1 million by paying $4 million for a tax voucher worth $5 million.

Transferable credits amount to more than just simple tax relief — they often amount to outright handouts. It’s one thing to allow a business to keep a larger portion of its own money by waiving or lowering certain fees or tax obligations. It’s something else altogether to offer a business a bankable credit for a tax not owed.

“The problem with transferable tax credits is they’re sort of a slight of hand in budgeting,” said Tom Cafcas, a research analyst with Good Jobs First, a D.C.-based policy outfit that promotes corporate and government accountability in economic development.

“Why not just have a direct appropriation” rather than passing off tradable credits as a way to help one industry when in reality they might end up in the hands of another?

“Buyers of transferable credits traditionally have been large, multi-state companies, often financial firms or insurers,” noted a 2012 Reuters story. In Nevada, one could also include the gaming industry. Under state law, the ultimate holder of a transferable tax credit issued by the Silver State may redeem it against obligations accrued under the modified business tax, the insurance premium tax or the gaming percentage fee tax — a clear signal that lawmakers expect gaming and insurance companies to be among the beneficiaries of these subsidies.

The explosion in states offering sellable credits has created an expanding market for their exchange, in addition to a number of outfits that specialize in matching sellers with potential buyers, who usually pay between 65 and 90 cents on the dollar. “You are creating a cottage industry of people who stand to benefit immensely,” Mr. Cafcas said about the burgeoning number of organizations now available to handle transactions involving transferable credits.

One of those is Moss Adams LLP, a Seattle-based accounting and business consulting firm. It has done a gainful transferable tax credit business since 2007 and advertises that it can help companies “certify and transfer earned credits, identify available credits and navigate the transfer process in any state that offers these credits.”

The company website notes that in the past decade it has brokered deals involving $500 million in such credits. Rob O’Neill, a partner and CPA with Moss Adams, said selling such credits might take, on average, about 60 days. But just like in real estate, “price is everything,” he said. “Circumstances might cause a credit to sit around for nine months” if a seller isn’t happy with pending offers.

The value of a credit depends upon a number of factors. “Large companies such as Walt Disney Co. and Sony often will guarantee their credits are good, helping them to get 85 cents on the dollar or more,” Reuters reported. “Less well-known companies get around 70 cents on the dollar, with more complex credits more heavily discounted.”

Millions in Nevada credits could hit the market in coming years. Senate Bill 507, approved by the 2015 Legislature, created the Catalyst Account, an economic development pot overseen by the Governor’s Office of Economic Development and funded entirely with transferable tax credits.

The legislation originally authorized the economic development office to issue $500,000 in these credits during fiscal year 2016, increasing to $2 million in fiscal 2017 and $5 million in 2018 and each year beyond. As part of the Faraday deal, however, lawmakers adjusted the numbers to $1 million in 2017, $2 million in 2018 and 2019, $3 million in 2020 and $5 million per year after that.

The Catalyst Account exists in conjunction with the Catalyst Fund, which in 2014 and 2015 financed $11.465 million in economic development grants to 16 businesses, including large companies such as Scientific Games Corp. ($1.8 billion in revenue in 2014), Petco (value near $4.5 billion) and Barclays ($2.42 trillion in assets).

In an attempt to avoid a Nevada constitutional prohibition against state subsidies to private businesses, the money was first funneled through various local governments before reaching the intended recipients.

That approach triggered a pending lawsuit filed in 2014 by the Nevada Policy Research Institute, arguing the practice remained unconstitutional even if the grants were laundered through cities and counties.

“Either way, it’s state money and it’s state officials deciding who gets the money,” said Joseph Becker, director of the Center for Justice and Constitution, NPRI’s litigation arm.

The creation of the Catalyst Account was, in part, intended to avoid the potential constitutional pitfalls of the Catalyst Fund, which currently sits unfunded but could be replenished at the discretion of lawmakers.

The push to make transferable tax credits a major component of the state’s economic development efforts carries with it obvious budget ramifications. Because a transferable credit can be shifted from a company with minimal tax liability to another with a significant obligation, general fund receipts will suffer.

“No one knows for sure how much transferable tax credits cost states,” noted a 2013 paper for the Pew Charitable Trusts, “but it seems clear that the total is billions of dollars a year.”

At this point, the only transferable credits granted by the economic development office include $10.3 million allotted under the film production incentive program and $9.6 million of those promised to Tesla.

None of the credits was used in fiscal year 2014, but in fiscal year 2015, movie credits valued at $974,252 were sold and redeemed, according to the Governor’s Office of Economic Development. The beneficiaries of the credits were media giant CBS and gaming behemoth Caesars Entertainment.

CBS, whose Nevada radio affiliates give it a modified business tax liability in the state, purchased and redeemed a $102,913 credit that the economic development office originally issued to the makers of the movie “In the Spotlight.”

Caesars reduced its gaming tax obligation by purchasing an $871,339 tradable credit that state officials doled out to entice the makers of “Sin City Saints” to film in Nevada.

So far in fiscal year 2016, $20,849.24 in film tax credits have been redeemed against the modified business tax, according to the state Department of Taxation.

Those numbers may soon rise. In its most recent forecast, the Nevada Economic Forum — a five-member panel created in 1993 to determine the revenue available for each two-year budget cycle, thus shielding lawmakers from political fallout over spending projections — estimated that during fiscal years 2015-2017 transferable credits could reduce the state’s tax take by as much as $100 million.

The forum anticipates that the full $10 million issued under Nevada law for film production companies could come off the books by the end of fiscal year 2016, while up to $90 million promised Tesla could be redeemed through fiscal 2017.

In addition, the economic development office in March approved a $750,000 transferable tax credit for Hyperloop Technologies as part of its plan to build a test track in North Las Vegas to conduct experiments on a transport system that would move people using aluminum tubes at speeds of up to 680 mph.

The $100 million may seem relatively modest when stacked against Nevada’s $7.3 billion biennial budget, especially since current law leaves the Catalyst Account with just $8 million in transferable tax credits to throw around through 2020.

“The amount of money we’re talking about would make no overall difference in the tax rates,” said Steve Hill, executive director of the Governor’s Office of Economic Development. But a few more major “outlier” deals such as those reached to land Tesla or Faraday could significantly up the ante.

And then there’s Nevada’s film tax credit. Passed in 2013 — despite the fact that many states were trying to pull the plug on similar incentives thanks to dismal results — Nevada originally set aside $80 million in transferable tax credits under the guise of promoting growth in the state’s film industry. But a year later lawmakers shifted $70 million from the program as part of the Tesla deal, leaving only $10 million to spread around over four years before the fund was scheduled to sunset.

Supporters of the film subsidies — led by Sen. Aaron Ford, a Las Vegas Democrat — succeeded in passing legislation last year that not only removed the cap on film credits, but also made the program permanent. It now remains to be seen how much the Legislature will force state taxpayers to spend on such relief in the future.

For now, transferable tax credits remain popular with a comfortable majority of state lawmakers. Senate Bill 94, Sen. Ford’s film credit legislation, gained unanimous approval in the upper house and passed 31-7 in the Assembly. Meanwhile, Senate Bill 507, creating the Catalyst Account, also passed the state Senate unanimously and sailed through the Assembly 30-11.

A representative from the Las Vegas Chamber of Commerce spoke in favor of the legislation during a committee hearing, but there was no debate at all on either the Assembly or Senate floor.

During a committee hearing, Assemblywoman Teresa Benitez-Thompson, a Reno Democrat, did allow that with tradable credits “you are guaranteeing that at some point the money is going to come off the books even if the input has not been what we thought it would be on the front end.”

She acknowledged that the credits often end up benefitting “well-established industries that tend to be healthy and do not necessarily generate economic development in the state.”

Supporters of transferable tax credits argue the sale of a transferable credit shouldn’t be an issue. Last September, Mr. Hill told the Las Vegas Review-Journal that, “The cost to the state is the same, regardless of which company uses” a transferable credit. Mr. O’Neill of Moss Adams echoed that sentiment, saying that transferable tax credits are “here to stay.”

If Nevada or any other state has made a decision to stimulate a specific economic activity in order to promote development or economic diversification, he argued, it makes no difference who ultimately buys a transferable tax credit. “The real question is do I want that activity (the credit is designed to stimulate) in my state,” Mr. O’Neill said.

In fact, it can indeed make a difference who ultimately buys a transferable tax credit — at least politically and from a public relations standpoint, if not from a fiscal perspective.

Tom Cafcas of Good Jobs First recounts the controversy generated in Oregon when it was revealed that corporate giant Walmart made $11 million in 2009 by purchasing credits intended to promote green energy firms in the Beaver State.

“The problem is,” a spokesman for an Oregon government watchdog group told the Portland Oregonian, “we’re taking taxpayer money that is supposed to be accomplishing energy efficiency or power generation and instead we’re putting it into the financial market.”

Meanwhile, Oklahoma lawmakers in 2012 considered dialing back their dalliance with tradable tax credits. Concerns about cost and transparency arose after credits intended to encourage construction of more energy-efficient homes ended up in the hands of banks and insurance companies.

One Oklahoma lawmaker told National Public Radio that, “Taxpayer dollars should never be traded around to the highest bidder in a shell game like some we have seen. And any tax credit should, at minimum, benefit only the recipient.”

Mr. Hill contends this is the most likely scenario under Nevada’s program. “For a lot of these companies, they have a pretty strong chance of being able to use the credit itself” rather than sell it, he said. “Given the fact that the amounts of the credits are relatively small, for the most part the company will end up using them.”

In addition, he points out that Nevada has taken steps to ensure its transferable tax credit programs achieve their objectives by demanding that recipients meet certain standards — employment figures, wage and investment requirements, etc. — before they may actually collect them.

For instance, the state in December released the $9.6 million in credits to Tesla after an audit confirmed it had met various conditions regarding its hiring and wage policies. Likewise, film production companies must make certain minimal expenditures in the state in order to qualify for the credits, which are based on production costs.

Eligible companies must pay for an audit conducted by an independent firm confirming those investments. And if fraud is involved in the credit application process, the state has a legal mechanism to retrieve the credits at issue.

This approach is certainly preferable to handing out tradable credits up front, which puts taxpayer funds on the line immediately in the event that the business fails to achieve long-term success.

But piecemealing out the credits doesn’t completely eliminate risk. Under the Tesla deal, the company could receive up to $90 million of the $195 million it has been promised in transferable tax credits by the end of fiscal 2017 — long before the success or failure of the endeavor will likely be known.

In addition, as Bloomberg blogger Rishi Agrawal explained last year, “When credits are easily transferred to other parties, it provides a big incentive for those who normally would be unable to use the credits to still apply for them in hopes of selling them later.”

Mr. Hill acknowledges that for Nevada’s system of transferable tax credits to continue it “will have to show that it is generating good results.” And given the backdrop of Nevada’s victory in the Tesla sweepstakes and the subsequent Faraday announcement, it’s easy to understand enthusiasm for the current economic development approach in a state whose effort to diversify beyond the gaming and construction industries has for decades been characterized by blue-ribbon committees and inertia.

Ultimately, however, any measure of “results” must include more than just the splashy political optics that typically mark high-profile development deals.

It must weigh the benefit of handing out tax breaks to a favored few against the social and budgetary costs of such economic distortions.

It must examine whether empowering a largely unelected board to pick winners and losers with state tax money improves upon the tried and true method of nurturing strategies that encourage entrepreneurship and small-business creation throughout the community, such as regulatory and education reform, infrastructure development and increased access to capital.

Finally, it must consider whether asking state taxpayers to tolerate new and higher levies while simultaneously showering tax breaks on special interests might actually perpetuate the corrosive impression that those in power operate to succor and comfort entrenched and influential interests rather than promote neutral policies that enhance opportunity for all.

John Kerr, well-known Southern Nevada journalist, is also a communication fellow with the national Institute for Justice.