Tax Policy: New Markets Tax Credit Appears to Increase Investment
by Investors in Low-Income Communities, but Opportunities Exist
to Better Monitor Compliance (31-JAN-07, GAO-07-296).
The Community Renewal Tax Relief Act of 2000 authorized up to $15
billion of allocation authority under the New Markets Tax Credit
(NMTC) to stimulate investment in low-income communities. The act
mandated that GAO report on the program to Congress by January
31, 2004, 2007, and 2010. Two subsequent laws authorized an
additional $1 billion in NMTC authority for certain qualified
investments and extended the program for 1 year with an
additional $3.5 billion of authority. This report (1) describes
the status of the NMTC program, (2) profiles NMTC program
participants, (3) assesses the credit's effectiveness in
attracting investment by participating investors, and (4)
assesses IRS and the Community Development Financial Institutions
(CDFI) Fund compliance monitoring efforts. To conduct the
analysis, GAO surveyed NMTC investors, conducted statistical
analysis, and interviewed IRS and CDFI Fund officials.
-------------------------Indexing Terms-------------------------
REPORTNUM: GAO-07-296
ACCNO: A65436
TITLE: Tax Policy: New Markets Tax Credit Appears to Increase
Investment by Investors in Low-Income Communities, but
Opportunities Exist to Better Monitor Compliance
DATE: 01/31/2007
SUBJECT: Allocation (Government accounting)
Data collection
Economically depressed areas
Income statistics
Internal controls
Investments
Monitoring
Program evaluation
Program management
Tax administration systems
Tax credit
Taxes
Policies and procedures
Community Development Financial
Institutions Fund
New Markets Tax Credit Program
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GAO-07-296
* [1]Results in Brief
* [2]Background
* [3]The NMTC Investment Process
* [4]Legislative Changes Created Targeted Populations
* [5]Authorized Allocation Rounds End in 2008
* [6]CDEs Are Using NMTC Allocations to Invest in Low-Income Comm
* [7]NMTC Allocations and Investments in CDEs and Low-Income Comm
* [8]The Ability of Investors to Use Tiered Investment Structures
* [9]The CDFI Fund's Data Collection Systems Are Operational
* [10]Financial Institutions and Individuals Are the Primary NMTC
* [11]NMTC Investors Tend to Be Financial Institutions with Larger
* [12]The Average Expected Return on NMTC Investment Has Declined
* [13]CDEs Apply for More NMTC Allocations Than Are Available and
* [14]Businesses Primarily Receive Loans from CDEs That They Use C
* [15]The Communities Receiving the Investment Tend to Be More Hig
* [16]NMTC Investors Report That the NMTC Increases Investment in
* [17]NMTC Investors Reported That They Increased Their Investment
* [18]Statistical Analysis Suggests That Some NMTC Investment by P
* [19]Further Analysis Is Needed to Determine Whether the Economic
* [20]IRS and the CDFI Fund Monitor NMTC Compliance, but Additiona
* [21]IRS's Compliance Study Methodology Could Be Improved to Be M
* [22]The CDFI Fund Has Systems and Procedures in Place to Monitor
* [23]IRS and the CDFI Fund Have an MOU for Compliance Monitoring,
* [24]Investors in CDEs Play a Role in Ensuring NMTC Compliance
* [25]Conclusions
* [26]Recommendations for Executive Action
* [27]Agency Comments
* [28]Appendix I: Objectives, Scope, and Methodology
* [29]Appendix II: Description of Data and Methodology for Statist
* [30]Description of Data
* [31]Effects of NMTC Program Participation on Investment
* [32]Literature Review and Credits
* [33]Appendix III: NMTC Investment Data by State, Fiscal Years 20
* [34]Appendix IV: Comments from the Community Development Financi
* [35]Appendix V: Comments from the Internal Revenue Service
* [36]Appendix VI: GAO Contact and Staff Acknowledgments
* [37]GAO Contact
* [38]Acknowledgments
* [39]Order by Mail or Phone
Report to Congressional Committees
United States Government Accountability Office
GAO
January 2007
TAX POLICY
New Markets Tax Credit Appears to Increase Investment by Investors in
Low-Income Communities, but Opportunities Exist to Better Monitor
Compliance
GAO-07-296
Contents
Letter 1
Results in Brief 3
Background 6
CDEs Are Using NMTC Allocations to Invest in Low-Income Communities, and
the CDFI Fund Is Tracking Program Implementation 15
Financial Institutions and Individuals Are the Primary NMTC Investors, and
CDEs Most Often Use NMTC Investments to Make Loans to Qualified Businesses
24
NMTC Investors Report That the NMTC Increases Investment in Low-Income
Communities and Statistical Analysis Indicates That These Investments May
Be Financed by Shifting Assets from Other Uses and Some New Investment 34
IRS and the CDFI Fund Monitor NMTC Compliance, but Additional
Opportunities Exist to Better Measure Noncompliance and Identify NMTC
Investors 43
Conclusions 52
Recommendations for Executive Action 53
Agency Comments 54
Appendix I Objectives, Scope, and Methodology 56
Appendix II Description of Data and Methodology for Statistical Analysis
of the Effect of NMTC Participation on Investment 61
Appendix III NMTC Investment Data by State, Fiscal Years 2003 through 2005
73
Appendix IV Comments from the Community Development Financial Institutions
Fund 75
Appendix V Comments from the Internal Revenue Service 77
Appendix VI GAO Contact and Staff Acknowledgments 79
Tables
Table 1: NMTC Allocation Rounds 14
Table 2: NMTC Claimant Types 25
Table 3: Reasons NMTC Investors Invested in the NMTC Program (in
Percentages) 26
Table 4: Investor Knowledge of CDE Operations (in Percentages) 28
Table 5: NMTC Allocations Awarded by Round 29
Table 6: CDEs That Applied for NMTC and Received Allocations by Round 29
Table 7: Top 10 States by NMTC Dollars through Fiscal Year 2005 34
Table 8: Effects of NMTC Individual Investor Participation on Wealth 41
Table 9: Growth in Net Assets Using Fixed Effects Regression and
Comparisons Based on Nearest Neighbor Propensity Score Matching 66
Table 10: Baseline Analysis: Instrumental Variables Fixed Effects
Regressions on the Full Sample 69
Table 11: Growth in Assets: Comparisons Based on Nearest Neighbor
Propensity Score Matching 71
Figures
Figure 1: NMTC Process for Using Allocated Tax Credits to Make Qualified
Low-Income Community Investments 9
Figure 2: NMTC Eligible Areas 13
Figure 3: Number of CDE Allocations by Round (Calendar Year) 16
Figure 4: Qualified Equity Investment by Calendar Year 17
Figure 5: Comparison of NMTC Investment Structures 20
Figure 6: Interaction of CDFI Fund NMTC Data Collection Systems 22
Figure 7: NMTC Loans and Investment by Type of Activity for Fiscal Years
2003 through 2005 31
Figure 8: NMTC Dollars Used in Loans with Better Rates and Terms 32
Figure 9: NMTC Investors Packaging the NMTC with Other Government
Incentives 36
Figure 10: Activities Investor Survey Respondents Undertake to Monitor CDE
Compliance 52
Abbreviations
AAS Allocation Agreement System
ATS Allocation Tracking System
BRTF Business Returns Transaction File
CDE Community Development Entity
CDFI Community Development Financial Institutions
CIIS Community Investment Impact System
CPI Consumer Price Index
CRA Community Reinvestment Act
FCOS Financial Counseling and Other Services
FEMA Federal Emergency Management Agency
GO Zone Gulf Opportunity Zone
HUB Zone Historically Underutilized Business Zone
ILR Institution Level Report
IRS Internal Revenue Service
IRTF Individual Returns Transaction File
MOU memorandum of understanding
NCMS New Markets Compliance Monitoring System
NMTC New Markets Tax Credit
SBA Small Business Administration
SCF Survey of Consumer Finances
TIN Taxpayer Identification Number
TLR Transaction Level Report
QALICB qualified active low-income community business
QEI qualified equity investment
QLICI qualified low-income community investment
This is a work of the U.S. government and is not subject to copyright
protection in the United States. It may be reproduced and distributed in
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separately.
United States Government Accountability Office
Washington, DC 20548
January 31, 2007
Congressional Committees
Congress established the New Markets Tax Credit (NMTC) program in the
Community Renewal Tax Relief Act of 2000^1 as part of an ongoing effort to
address one of our nation's most persistent challenges--the revitalization
of impoverished, low-income communities. Conventional access to credit and
investment capital for developing small businesses, retaining jobs, and
revitalizing neighborhoods is often limited in economically distressed
communities or in communities with large low-income populations. The NMTC
provides investors (individuals, financial institutions, other
corporations, etc.) with a tax credit for investing in communities that
are economically distressed or consist of low-income populations.
Currently, the Community Development Financial Institutions (CDFI) Fund in
the Department of the Treasury is authorized to allocate up to $19.5
billion^2 in tax credit authority to Community Development Entities (CDE)
that manage NMTC investments in low-income community development projects.
CDEs are domestic corporations or partnerships with a primary mission of
serving or providing investment capital for low-income communities or
low-income persons. Tax credit authority is the amount of investment for
which investors can claim a tax credit at rates that total, over the 7
years they can claim the credit, 39 percent of their investment. In return
for the tax credit, investors supply capital to the CDEs, which, in turn,
make investments in qualified low-income communities.
The Community Renewal Tax Relief Act of 2000 mandated that we report to
Congress on the NMTC program by January 31, 2004, 2007, and 2010. In our
report issued January 30, 2004,^3 we described the status of the NMTC
program, profiled CDEs that received first round allocations (there have
now been four rounds of NMTC allocations), and evaluated whether the
systems were in place or planned in order to ensure NMTC compliance. We
concluded progress was being made in implementing the NMTC program, but we
also recommended that Internal Revenue Service (IRS) and the CDFI Fund
work together to develop plans for designing and implementing compliance
monitoring processes. IRS and the CDFI Fund agreed with our recommendation
and have taken steps to design and implement compliance monitoring
processes.
^1 Pub. L. No. 106-554 (2000).
^2 The original legislation that authorized the program allowed for $15
billion of equity investment to qualify for the NMTC program. However, the
Gulf Opportunity Zone Act of 2005, Pub L. No. 109-135 (Dec. 21, 2005)
authorized an additional $1 billion of NMTC equity for qualified
investments in areas affected by Hurricane Katrina, and Pub. L. No.
109-432 (Dec. 20, 2006) extended the NMTC for an additional year (through
2008) with an additional $3.5 billion of NMTC allocation authority.
Based on consultations with staff at cognizant congressional committees,
this report (1) describes the status of the NMTC program; (2) profiles the
characteristics of NMTC investors, the CDEs that receive NMTC allocations,
and the businesses and communities that receive NMTC investments; (3)
assesses how effective the NMTC has been in bringing new investment to
low-income communities by the investors that have participated in the
program; and (4) assesses the steps that IRS and the CDFI Fund are taking
to ensure CDEs and investors are complying with the NMTC and evaluates how
effective these steps have been.
To accomplish these reporting objectives, we met with officials from the
CDFI Fund and IRS. We collected documents on the program's status and
efforts to monitor NMTC compliance. We also analyzed data from the CDFI
Fund on the CDEs and their investment in low-income communities and tax
return data from tax years 1997 through 2004 for investors in the NMTC
program. We used these data to report summary statistics that profile the
participants in the program and to conduct statistical analysis that
measures the effect of the NMTC on investment by participating investors.
In our statistical analysis, we compared a stratified random sample of
taxpayers that did not make NMTC investments with investors that did make
NMTC investments using fixed-effects regressions and comparisons based on
other statistical methods to measure the effect of the NMTC on corporate
investors' growth in net assets and individual investors' growth in
wealth. We also surveyed investors in the NMTC program in order to provide
additional information on the effect of the credit and characteristics of
the investors. Our overall response rate was 51 percent. We weighted our
survey responses using information on investor type and investor size to
reduce possible nonresponse bias that is associated with investor type and
size. Results from our statistical analysis and the survey are limited to
the effects of NMTC investments on the investment choices of participating
investors and do not assess the effect of this investment on the
investments by non-NMTC participants in low-income communities. Our scope
and methodology section (app. I) provides additional details on how we did
our work.
^3 GAO, New Markets Tax Credit Program: Progress Made in Implementation,
but Further Actions Needed to Monitor Compliance, [40]GAO-04-326
(Washington, D.C.: Jan. 30, 2004).
Our work was conducted from July 2006 through December 2006 in accordance
with generally accepted government auditing standards. In December 2006,
we requested written comments on a draft of this report from the Director
of the Community Development Financial Institutions Fund and the
Commissioner of the Internal Revenue Service; their comments are reprinted
in appendices IV and V.
Results in Brief
Since the CDFI Fund made its first allocations in 2003, the NMTC program
has grown in terms of the amount of tax credit authority allocated to
CDEs, the complexity of NMTC investments, and the amount of money invested
in low-income communities. As of January 2007, the CDFI Fund had made 233
NMTC allocation awards totaling $12.1 billion in allocation authority to
179 CDEs--some CDEs have received multiple allocations--which the CDEs
have used to attract nearly $5.3 billion in NMTC investment. These CDEs
with allocation awards are required to attract investment sufficient to
use the remaining $6.8 billion of allocation authority in the coming
years. The total amount per year invested by these CDEs in low-income
communities grew from about $140 million in 2003 to $2.2 billion in 2005.
As the NMTC program has grown, more investors have participated in more
complicated NMTC investment structures, such as tiered investments, which
include both equity investments and leveraged investments. The CDFI Fund
has developed data systems that track allocation agreements (which set
forth conditions such as approved uses of the allocations and approved
service areas), allocated credits, and collected data about investors, the
CDEs, and their investments in low-income communities. The CDFI Fund
combines data from these systems to monitor compliance with allocation
agreements and to help IRS determine whether laws and regulations are
being observed. All of these systems were operational in time to meet the
CDFI Fund's needs.
Banks and individuals constitute the majority of NMTC claimants,
accounting for 70 percent of NMTC claimants through 2006, though banks and
other corporations account for the largest share of NMTC investment. Banks
and other corporations that invested in the credit had relatively large
net assets, and individuals who invested in the NMTC had, on average,
higher incomes than other taxpayers. Most investors made only one
investment in a CDE: 55 percent of investors made a single investment
while 12 percent made five or more investments. The CDEs applied for far
more allocation dollars than were available. They received only about 11
percent of $107 billion in allocation authority for which they applied.
Data reported through fiscal year 2005 indicate that businesses in
low-income communities received investments from CDEs to fund over 580
NMTC projects, totaling over $3 billion of investment. The projects were
funded primarily by loans from the CDEs and were used chiefly to finance
commercial real estate construction and rehabilitation. The communities
where the investment projects were located were dispersed across states
and about 90 percent were located in areas designated as "areas of high
distress" because of factors such as low median incomes or high
unemployment rates.
The results of our survey and statistical analysis are consistent with the
NMTC program increasing investment in eligible low-income communities by
the investors that participate in the program and with this investment
coming primarily from funds shifted from other uses. Such a shift would be
one indicator that the NMTC program is effective because the NMTC sought
to increase investment in eligible low-income communities. An estimated 64
percent of the NMTC investors reported that they increased the share of
their investment budget for low-income communities because of the credit.
One limitation of our survey is that the population of NMTC investors we
surveyed benefit from claiming the credit and have an interest in ensuring
that the NMTC program continues in the future. However, in many cases the
survey also indicated that the credit alone may not have been sufficient
to justify the investment and meeting other government regulations may be
an important incentive for making NMTC investments. Any increased
investment in low-income communities because of the credit can occur when
NMTC investors make new investment by increasing their total funds
available for investment or when they shift funds from other uses in
higher income communities. Our statistical analysis suggests that in
general corporate NMTC investors are not increasing their overall level of
investment to participate in the NMTC program. Taking this information
together with information from our survey of investors, we infer that the
most likely effect of the credit is that corporate investors, which make
the majority of investments in CDEs, are shifting investment into
low-income communities from higher income communities. Our statistical
analysis indicates that unlike corporate investors, participating
individual investors as a group appear to be making at least some new
investment to participate in the NMTC program. This finding that corporate
and individual NMTC investors appear to be increasing investment in
low-income communities is not, in and of itself, sufficient to determine
that the credit is effective. For example, it was beyond the scope of our
analysis to determine whether investment by NMTC investors reduced such
investments by non-NMTC investors. A complete evaluation of the program's
effectiveness also requires determining the costs of the program,
including any behavioral changes by taxpayers that may be introduced by
shifted investment funds. In addition, such an evaluation requires an
assessment of the program's economic and social benefits. For example, to
the extent a community experiences a reduction in poverty and increases in
employment opportunities as a result of the program, possible "spillover"
benefits to the community may include reductions in crime and improvements
in the health status of community residents. The CDFI Fund is working with
a contractor to develop plans for a comprehensive evaluation of the NMTC,
which may include evaluating the program's effectiveness.
IRS and the CDFI Fund have taken steps to monitor compliance with the
requirements of the NMTC program, but additional opportunities exist to
better measure noncompliance and identify NMTC investors. IRS is
conducting a compliance study focusing on whether CDEs comply with the
"substantially all" test imposed by the Internal Revenue Code, which
requires that CDEs invest at least 85 percent of a qualified equity
investment (QEI) in a low-income community within 1 year of receiving the
investment. However, because CDEs did not file initial returns as soon as
IRS expected, IRS was not able to select CDEs to audit in a way likely to
produce findings that are representative of the full range of CDE
activity. However, as the program expands and more CDEs make NMTC
investments, IRS should have more CDEs to choose from when selecting CDEs
to audit for its compliance study, and IRS could use CDFI Fund data to aid
in developing criteria for selecting which CDEs to audit. The CDFI Fund is
focusing on ensuring that CDEs fulfill their allocation agreement
requirements. The CDFI Fund monitors CDE compliance primarily through its
data systems and, to a lesser extent, by making site visits. The data
systems are designed to enable the CDFI Fund to identify when a CDE falls
out of compliance with its allocation agreement. However, neither IRS nor
the CDFI Fund currently have sufficient information to enable the IRS to
identify NMTC investors and the amount of credit that the investors are
entitled to claim, particularly when the original investments are sold to
others. CDEs may be a useful source of information because they need to
know who their investors are, even when investments are sold, in order to
submit appropriate reports to those investors. If IRS or the CDFI Fund
developed ways to identify investors and the amounts they invested, even
when NMTC investors sell their equity share in a CDE after the original
investment is made, the IRS would be better able to ensure that credits
are claimed correctly.
To ensure that IRS is reviewing the full range of NMTC transactions and
that the conclusions of its compliance study are more representative of
all CDEs with NMTC allocations, we recommend that IRS use CDFI Fund data
and the results of its current NMTC compliance study to develop criteria
for selecting which CDEs to audit as part of its future compliance
monitoring efforts. Additionally, to ensure that eligible taxpayers claim
the correct amount of NMTC on their tax returns and IRS is able to
identify all tax credit claimants in the event of a CDE falling out of
compliance with NMTC regulations, we recommend that IRS work with the CDFI
Fund to further explore options for cost effectively monitoring investor
compliance and developing a way to identify NMTC claimants, even in
instances where the original investor sells its equity share in a CDE, and
the amount of NMTC investment that investors made. In commenting on this
report, both the Acting Director of the CDFI Fund and the Commissioner of
Internal Revenue agreed with our recommendations (their responses are
reprinted in appendices IV and V).
Background
As we noted in a past report, the NMTC was created in an effort to
increase the amount of capital available to low-income communities,^4
facilitate economic development in these communities, and encourage
investment in high-risk areas.^5 In order to achieve these goals, the
program allows investors that provide eligible capital to low-income
communities and businesses to reduce their tax liability by 39 percent of
the amount of the investment over a 7-year period.
^4 A low-income community is defined as a census tract (1) in which the
poverty rate is at least 20 percent or (2) outside a metropolitan area in
which the median family income does not exceed 80 percent of median
statewide family income or within a metropolitan area in which the median
family income does not exceed 80 percent of the greater statewide or the
metropolitan area median family income. After October 22, 2004, the
Secretary of the Treasury was authorized to issue regulations designating
targeted populations that may be treated as low-income communities and
procedures for determining which entities are qualified active low-income
community businesses with respect to such populations. In addition, the
definition of a low-income community included certain areas not within
census tracts, tracts with low population, and census tracts with high
migration rural counties.
^5 [41]GAO-04-326 .
The NMTC Investment Process
The process of making an NMTC investment involves several steps and a
number of stakeholders. Before applying for an NMTC allocation, the
applicant must apply for and be certified as a CDE, which is an entity
that manages investments for community development.^6 Once an organization
has been certified as a CDE by the CDFI Fund, it is then eligible to apply
for an NMTC allocation.
Both for-profit and nonprofit CDEs may apply for and receive NMTC
allocations (once a CDE is awarded with an allocation, it is often
referred to as an allocatee). However, only a for-profit CDE can offer
NMTCs to investors. Therefore, when a nonprofit CDE receives an NMTC
allocation, it must transfer the allocation to one or more for-profit
subsidiary CDEs (referred to as suballocatees). NMTC applicants submit
standardized application packages in which they respond to a series of
questions about their track records, the amounts of NMTC allocation
authority being requested, and their plans for using the tax credit
authority.
The CDFI Fund staff and a group of external reviewers who have experience
in business, real estate, and community development finance then review
the applications and score them based on the following four areas: (1)
community impact, (2) business strategy, (3) capitalization strategy, and
(4) management capacity. The applicants can receive a score of up to 25
points in each of the areas, and CDEs can obtain up to 10 additional
"priority points" for demonstrating that they have track records of
successfully investing in low-income communities and/or that they intend
to invest in unrelated entities. After being reviewed and scored by three
different reviewers (and, in some cases, a fourth reviewer if a scoring
anomaly exists), the applicants are ranked and NMTC allocation awards are
made in descending order of the highest aggregate scores to applicants
that met minimum thresholds in each of the four areas.^7 The CDFI Fund
makes award determinations in this order until the allocation authority is
exhausted. The CDFI Fund also provides a written debriefing to each CDE
that does not receive an allocation in order to provide them with reasons
their application did not receive an NMTC award and to provide the CDE
with suggestions on how to be more competitive for NMTC awards when
applying in future rounds.
^6 Community development financial institutions and specialized small
business investment companies automatically qualify as CDEs and only need
to register as CDEs rather than apply for certification.
^7 For more information on how NMTC awards are determined and the criteria
that the CDFI Fund uses to select which CDEs will receive allocations,
refer to [42]GAO-04-326 , pp. 5-9.
As figure 1 shows, after the allocations are made to the CDEs, investors
make equity investments, by acquiring stock or a capital interest, in the
CDEs to receive the right to claim tax credits on a portion of their
investment.^8 In turn, the CDE must invest "substantially all"^9 of the
proceeds into qualified low-income community investments (QLICI). Eligible
investments include, but are not limited to, loans to or investments in
businesses to be used for developing residential, commercial, industrial,
and retail real estate projects; and purchasing loans from other CDEs.
^8 Beginning in the year the investment is made, investors are entitled to
claim the credit for a 7-year period with 5 percent of the investment
claimed in each of the first 3 years and 6 percent in each of the last 4
years. Investors are allowed to carry the credit back 1 year and carry the
credits forward for a 20-year period.
^9 "Substantially all" means that CDEs must use (within 12 months) at
least 85 percent of investor proceeds in years 1 through 6 and 75 percent
in year 7 of the investment. CDEs can satisfy this requirement by two
methods: (1) direct tracing of investments to specific qualified
low-income community investments or (2) showing that at least 85 percent
of their aggregate gross assets are invested in qualified low-income
community investments.
Figure 1: NMTC Process for Using Allocated Tax Credits to Make Qualified
Low-Income Community Investments
aOnly a for-profit CDE can receive qualified equity investment from NMTC
investors. These CDEs can then make investments in other CDEs that could
be for-profit CDEs or nonprofit CDEs or they can directly invest the NMTC
funds in low-income communities. However, both for-profit and nonprofit
CDEs can receive allocations from the CDFI Fund. If a nonprofit CDE
receives a NMTC allocation from the CDFI Fund, it must transfer the
allocation authority to a for-profit CDE before NMTC investments can be
made.
Once a qualifying investment has been made in a CDE and the CDE has
invested the funds in an eligible low-income community, the investor can
claim the tax credit over the course of 7 years. In addition, equity
investors may receive returns on their investments in the form of
dividends or other income that they receive from the CDE during the period
in which they are eligible to claim the credit. The NMTC investor is still
usually allowed to claim the NMTC for the full 7-year period even if the
business that the CDE provides investment to defaults on its loans or
files for bankruptcy. However, in the case of a business that receives
NMTC funds going bankrupt, the ability of the investor to recover its
initial equity investment in a CDE would depend on the assets and
financial condition of the CDE as well as the original agreement that the
CDE entered into with the investor.
The NMTC is a nonrefundable tax credit, meaning that taxpayers do not
receive payments for tax credits that exceed their total tax liability. In
addition, taxpayers that are eligible to claim the tax credit may sell
their investment, along with the right to claim any remaining tax credits,
to another investor after the initial NMTC investment. For example, an
investor may make an equity investment in a CDE that would allow it to
claim the credit and then sell its equity share in the CDE to another
investor, thereby transferring the right to claim the remaining credits to
this investor. The original investor may choose to sell its equity share
in a CDE, and consequently its right to claim the credit, because it does
not have a tax liability for that year or other reasons, such as the
timing of the original investment.^10
Once investors begin claiming the credit on their tax returns, three
things can trigger a recapture event (meaning that the investor will no
longer be able to claim the credit because the investment no longer
qualifies for NMTCs). The NMTCs can be subject to a recapture if the CDE
(1) ceases to be certified as a CDE, (2) does not satisfy the
"substantially all" requirement, or (3) redeems the investment. In
general, a recapture event means that the investors that originally
purchased the equity investment and subsequent holders of the investment
are required to increase their income tax liability by the credits
previously claimed plus interest for each resulting underpayment of tax.
^10 For example, an investor may have an interest in beginning a
particular NMTC project at a time before all of the final investors have
made their investments. In that case, the original investor could make the
entire original equity investment with the intention of selling its equity
share in the CDE to other investors at a time when the financing could be
finalized.
Legislative Changes Created Targeted Populations
Two recent legislative changes have increased the number of areas where
NMTC investments can be made. First, the American Jobs Creation Act of
2004^11 added "targeted populations" to the eligibility criteria for NMTC
investments. Second, Congress also expanded the NMTC program in 2005,^12
providing an additional $1 billion of allocation authority to be made
available to CDEs with a significant mission of recovery and redevelopment
of low-income communities in the Gulf Opportunity Zone (GO Zone), which
are specified areas in Louisiana, Mississippi, and Alabama that were
affected by Hurricane Katrina during 2005.
In general, targeted populations were introduced to give CDEs flexibility
in making investments serving individuals and groups that reside or work
in communities that might not otherwise fall under the NMTC program's
geographically based definition of a low-income community. Currently,
regulations defining targeted populations have not been finalized.
However, the CDFI Fund and IRS have provided guidance for what qualifies
as a targeted population.^13 These guidelines specify that the targeted
populations, which are individuals or an identifiable group of
individuals, must meet tests to qualify as low-income communities and the
businesses or entities receiving the investments must also meet certain
criteria.^14
In IRS's recently provided guidance, the definition of GO Zone targeted
populations is similar to the definition for low-income targeted
populations with some differences. In cases where a business is located
within the GO Zone, it does not mean that it automatically qualifies for
NMTC investment dollars. First, the GO Zone targeted population need not
qualify as low-income individuals as defined above, but rather the
population must consist of individuals who lack access to loans or equity
investments because they were displaced from their principal residence or
lost their principal source of employment because of Hurricane Katrina.
Second, the NMTC investment must serve targeted populations in census
tracts within the GO Zone that meet certain requirements, including that
they contain one or more areas designated by the Federal Emergency
Management Agency (FEMA) as flooded or having sustained extensive or
catastrophic damage as a result of Hurricane Katrina.
^11 Pub. L. No. 108-357 (2004).
^12 Pub. L. No. 109-135 (2005).
^13 IRS Notice 2006-60, I.R.B. 2006-29.
^14 Under the new guidelines, a qualifying business for a targeted
low-income population is any corporation (including nonprofit
corporations) or partnership that meets one of the following three tests:
(1) at least 50 percent of the entity's gross income is derived from
sales, rentals, service, or other transactions with individuals who are
low-income persons; (2) at least 40 percent of the entity's employees are
low-income individuals; or (3) at least 50 percent of the entity is owned
by low-income individuals.
Figure 2 illustrates the effect that recent legislative changes have had
on the census tracts that are eligible to receive NMTC investments. As the
figure shows, geographically, a large portion of the country qualifies for
NMTC investment, and there are eligible areas in every state. The figure
also shows the area of the GO Zone where NMTC investments can be made in
both eligible low-income communities and specified targeted populations as
a result of additional allocation authority made available for areas
affected by Hurricane Katrina.
Figure 2: NMTC Eligible Areas
Note: All unshaded areas identified as "Not NMTC eligible" could receive
NMTC investment funds if CDEs serve targeted populations in those areas
under the American Jobs Creation Act of 2004 (Pub. L. No. 108-357). In
addition, targeted populations in areas shaded in black in the GO Zone may
receive NMTC investment because they meet the definition of a GO Zone
targeted population.
Authorized Allocation Rounds End in 2008
Congress initially provided a schedule for allocating annual NMTC
authority to CDEs for calendar years 2001 through 2007.^15 However, as we
also reported in 2004, the CDFI Fund did not make any NMTC allocations to
CDEs until 2003 because it needed to complete various start-up tasks for
the new program, such as establishing the rules for using allocations.
Because the initial allocations were not made until 2003, the CDFI Fund
combined the allocation amounts available for 2001 and 2002 and awarded
those NMTC allocations in 2003. The allocation amounts designated for 2003
and 2004 were then combined and awarded in 2004. Table 1 shows the current
schedule for allocation rounds. Since 2004, allocation awards have been
made to CDEs annually.
Table 1: NMTC Allocation Rounds
Dollars in billions
Round Allocation year Original allocation years Amount allocated
Round 1 2003 2001-2002 $2.5
Round 2 2004 2003-2004 3.5
Round 3 2005 2005 2.0
Round 4 2006 2006 4.1^a
Round 5 2007 2007 3.9^a
Round 6 2008 2008 3.5^b
Total $19.5
Source: CDFI Fund.
aThe amounts available to be allocated in Round 4 and Round 5 were
increased by $600 million and $400 million respectively because of
increased NMTC allocation limits targeted toward the GO Zone.
bCongress initially only authorized NMTC allocation authority through
2007. However, the Tax Relief and Health Care Act of 2006 (Pub. L. No.
109-432) extended NMTC allocation authority for 1 year (through 2008) with
an additional $3.5 billion of NMTC allocation authority.
As of January 2007, there have been four completed rounds of NMTC
allocations, and the CDFI Fund is receiving applications for the 2007
round of NMTC allocation awards, which will be announced in September
2007. The 2007 allocation awards were originally scheduled to be the last
authorized round of NMTC allocation awards. However, in December 2006,
Congress passed and the President signed the Tax Relief and Health Care
Act of 2006,^16 which extends the NMTC for an additional year (through the
end of 2008) with an additional $3.5 billion of NMTC allocation authority.
Regulations are also required to be drafted to ensure that nonmetropolitan
areas receive a proportional allocation of qualified equity investments.
^15 The original allocation schedule was $1 billion in 2001, $1.5 billion
in 2002, $1.5 billion in 2003, $2 billion in 2004, $2 billion in 2005,
$3.5 billion in 2006, and $3.5 billion in 2007.
CDEs Are Using NMTC Allocations to Invest in Low-Income Communities, and the
CDFI Fund Is Tracking Program Implementation
The CDFI Fund has completed four rounds of NMTC allocations, which CDEs
are using to attract investment. The investment structures used to
complete these deals have taken a variety of forms, including combining
debt and equity in limited liability partnerships in order to invest in a
CDE--called leveraging. In addition, the CDFI Fund has developed four main
data collection systems to track efforts to implement and monitor the
expanding NMTC program.
NMTC Allocations and Investments in CDEs and Low-Income Communities Have
Increased in Number and Amount
Beginning in 2003, the CDFI Fund awarded NMTC allocations of varying
amounts to a number of CDEs. The CDFI Fund has awarded 233 NMTC
allocations to 179 different CDEs totaling $12.1 billion over the course
of the four completed NMTC allocation rounds. As figure 3 shows, the CDFI
Fund made awards to the largest number of CDEs in 2003, when the fund
awarded NMTC allocations to 66 CDEs, and it made awards to the smallest
number of CDEs in 2005 when 41 CDEs received allocations. In its most
recent allocation round in 2006, the CDFI Fund made allocations to 63 CDEs
for a total of $4.1 billion of tax credit authority. The largest award to
a single CDE in this allocation round was $143 million, while the median
award was $60 million.
^16 Pub. L. No. 109-432 (2006).
Figure 3: Number of CDE Allocations by Round (Calendar Year)
The CDEs receiving allocations were able to attract an increasing number
of QEIs. As of December 2006, investors had made nearly 1,400 QEIs in
CDEs, and as more allocation rounds have taken place, the number of QEIs
has grown. Relatively few QEIs were made in 2003 when the program was in
its early stages, but the number of QEIs increased significantly in both
2004 and 2005. This pattern of growth reflects increases in NMTC
allocation authority and increased time for CDEs to establish business
relationships with potential investors. In addition, more QEIs were made
in CDEs that received allocations in 2003 and 2004 than in CDEs that
received NMTC allocations in 2005. As of December 2006, 749 QEIs had been
made in first round NMTC allocatees, 478 QEIs had been made in second
round NMTC allocatees, and 154 QEIs had been made in third round
allocatees.^17
As figure 4 shows, the CDEs were generally able to attract increasing
dollar amounts of qualified equity investment. QEI grew from about $140
million of investment in 2003 to over $2.2 billion of investment in 2005,
and as of mid-December 2006, CDEs had recorded nearly $1.5 billion in NMTC
investment for the year--totaling $5.3 billion over the period. CDEs are
required to invest the remaining $6.8 billion of allocation authority
awarded to this point during the coming years. At the same time, the size
of the QEIs varied considerably across CDEs. According to CDFI Fund data,
the largest QEI made through December 2006 was $113 million, while the
median QEI during this period was about $1.8 million.
Figure 4: Qualified Equity Investment by Calendar Year
Note: Amount of QEI in 2006 is through mid-December.
^17 As of December 2006, only six QEIs had been made into fourth round
allocatees. The 2006 NMTC allocations were not announced until the summer
of 2006, which may explain the relatively small amount of investment
activity into fourth round allocatees at the time of this report.
The CDEs used this QEI to make investments in 583 qualified NMTC projects
totaling $3.1 billion through fiscal year 2005.^18 Nearly all of these
investments have been to qualified active low-income community businesses
(QALICBs) in qualifying areas. However, according to CDFI Fund data, a
small number (about 1 percent) of the investments were made to other CDEs,
as permitted under NMTC regulations. As more NMTC allocation awards are
made and more NMTC investment transactions are completed, additional
information will be available about the size and type of NMTC investments.
The Ability of Investors to Use Tiered Investment Structures May Have
Contributed to the Growth of the NMTC Program
Certain NMTC investment structures may have been a factor in the growth of
the program by making NMTC investments more attractive. NMTC investors
have used two primary investment structures when making QEIs in CDEs: (1)
direct NMTC investment and (2) tiered NMTC investments.^19 As of December
2006, about 54 percent of the $5.3 billion in NMTC investments were made
using tiered investment structures. In a direct NMTC investment, an
investor makes a QEI in a CDE that reinvests the money in a low-income
community. (See fig. 5 for a description of these NMTC investment
structures). In tiered investment structures, which include both equity
investments and leveraged NMTC investments, investors provide equity or
loans to a pass-through entity that combines funds from several sources,
and the pass-through entity makes the QEI in a CDE.^20 In both direct and
tiered investment structures, equity investors in a CDE are able to claim
the NMTC on their tax returns and, after leaving the equity investment in
the CDE for the 7 years during which they are eligible to claim the
credit, they can redeem their original equity stake in the CDE.
In a tiered equity investment structure, the dollars invested in the
investment fund consist entirely of equity investments from multiple
investors. These investment structures accounted for about 13 percent of
NMTC investment as of December 2006. In a tiered leveraged investment
structure,^21 a portion of the money being invested in the investment fund
comes from equity investors and a portion of the money originates from a
debt investment (loan). As of December 2006, about 41 percent of all NMTC
investment was made using the leveraged approach.
^18 This reflects data available in the CDFI Fund's databases through
fiscal year 2005 for awardees. Because of the timing of CDE reporting
requirements--CDEs are not required to report data about low-income
community investment to the CDFI Fund until 6 months after the end of
their fiscal year--it is likely that more NMTC investment has taken place
that has not yet been recorded in the CDFI Fund's databases.
^19 Unlike tiered NMTC investments, there is no standard term for one
investor making a QEI into a CDE. For the purposes of this report, we
refer to this type of transaction as a "direct" NMTC investment.
^20 Before making an investment in a CDE or in another pass-through
entity, investors may set up a partnership as a pass-through entity.
^21 In Rev. Rule 2003-20, 2003-1 C.B. 465, the IRS, based on the facts
presented in the ruling, approved this method of structuring NMTC
investments.
Figure 5: Comparison of NMTC Investment Structures
aInvestors in a CDE cannot redeem any of the original QEI during the
7-year period while they are allowed to claim the credit. However, equity
investors can receive a return on their investment in a CDE, in the form
of dividends or partnership income, for example.
The leveraged investment structure may make NMTC investment more
attractive to some investors because it allows investors to invest in the
CDE who may not be able to claim tax credits but could still benefit from
the economic returns. The investment structure can be used to separate the
tax benefits of the investment from the economic benefits of the
investment. For example, an investment fund partnership makes a $1 million
leveraged qualified equity investment in a CDE where $400,000 of the money
comes from the equity investors in the partnership and the other $600,000
comes from a bank as an interest-only loan to the investment partnership
with a balloon payment after 7 years. The CDE that receives the QEI
reinvests the money by loaning "substantially all" of the $1 million to a
QALICB. In this structure, the economic and tax benefits are separated:
the bank receives interest payments on the loan to the CDE and, after 7
years, the bank will also be entitled to collect principle payments on the
loan while the equity investors are entitled to claim the NMTC for 7
years, totaling 39 percent of the total $1 million QEI--not just the
$400,000 that was originally invested as equity. NMTC equity investors may
also receive a return on their investment, in the form of dividends or
partnership income, for example, during the 7-year period while they can
claim the credit. However, neither the investment fund partnership nor the
underlying investors can redeem any portion of the QEI during this period
and still remain eligible to claim the credit.
The leveraged investment structure may also offer a more attractive
combination of risk and return than direct investment. From the bank's
perspective in the example above, this investment structure may be
attractive because the loan-to-value ratio^22 is more favorable than it
would have been if the debt was not being combined with the investors'
equity. The more favorable ratio may compensate the bank for assuming a
greater degree of risk, most notably if the business that receives the
loan from the CDE defaults on its loan agreement. In that case, the bank's
investment is only secured by the equity in the original investment
partnership ($400,000 in the example above). From the equity investor's
perspective, if the business defaults on its loan, they are still allowed
to claim the full amount of the credit--as long as the business that
receives the funds is a qualifying business in the year the loan is made.
^22 Loan-to-value ratio is the relationship, expressed as a percentage,
between the amount of a loan and the value of the asset that the loan is
being used to finance. In the example above, if 100 percent of the
proceeds were reinvested in a CDE as a QEI, the loan-to-value ratio would
be 60 percent because a $600,000 loan is being issued to finance a project
with a total cost of $1 million.
As the NMTC program has grown, investors have used more complicated
investment structures, such as tiered investments. According to CDFI Fund
data, 81 percent of investors making NMTC investments through December
2006 used tiered (including both equity and leveraged) NMTC investment
structures, with investors in more recent years being more likely to use
tiered structures. For example, 69.1 percent of investors making QEIs in
2003 and 2004 used tiered structures, while 87.5 percent of investors
making QEIs in 2005 and 2006 used tiered structures.
The CDFI Fund's Data Collection Systems Are Operational
The CDFI Fund uses four data collection systems to administer and monitor
the NMTC program. All of these data collection systems were operational
before they were needed to collect data and to help the CDFI Fund monitor
NMTC compliance. These data collection systems include (1) the Allocation
Agreement System (AAS), (2) the Allocation Tracking System (ATS), (3) the
Community Investment Impact System (CIIS), and (4) the New Markets
Compliance Monitoring System (NCMS). Figure 6 illustrates how the AAS,
ATS, and CIIS, combine to populate the NCMS, which the CDFI Fund uses to
monitor CDEs' compliance with their allocation agreements.
Figure 6: Interaction of CDFI Fund NMTC Data Collection Systems
A brief description of these data collection systems follows.
o The AAS contains information on the allocation agreements that
CDEs enter into with the CDFI Fund. The AAS was operational as of
August 2003 and is primarily used by the CDFI Fund's legal staff
to ensure that NMTC contracts are properly executed.
o The ATS is the primary system that the CDFI Fund uses to monitor
QEIs that have been made and track CDEs (allocatees),
suballocatees, and investors in the CDEs. The ATS contains
information reported by the CDEs on the type of QEI that is made
in the CDE, the amount of the investment, the CDE that received
the investment, whether the CDE that initially received the
allocation transferred the allocation to a suballocatee, and how
much of the allocation was transferred. In addition, the ATS
contains data reported by CDEs on the equity investors in the NMTC
program. The ATS was operational as of November 2003.
o The CIIS collects information about CDEs and the investments
that they make in low-income communities. CIIS data is collected
through two reports: the Institution Level Report (ILR) and the
Transaction Level Report (TLR). The ILR provides information on
the CDEs, as well as their loan purchases and Financial Counseling
and Other Services (FCOS) activities, and the TLR provides
information the CDEs' loans and investments in QALICBs and in
other CDEs. The CIIS began receiving data in May 2004.
o The NCMS combines data from the CIIS, ATS, AAS, and other CDFI
Fund data collection systems and is used to monitor whether CDEs
remain compliant with their allocation agreements. CDFI Fund
officials said that the NCMS has been operational since April 2005
and that the system was in place in time to allow the CDFI Fund to
monitor first round allocatees' compliance with their respective
allocation agreements.
Financial Institutions and Individuals Are the Primary NMTC
Investors, and CDEs Most Often Use NMTC Investments to Make Loans
to Qualified Businesses
Banks and individuals constitute the majority of NMTC claimants
when qualified equity investments are originally made.^23 Taken
together, banks and individuals accounted for 70 percent of NMTC
claimants through 2006. Banks and other corporations that invested
in the credit had relatively large net assets. Individuals who
invested in the NMTC had, on average, higher incomes than other
taxpayers. The CDEs applied for far more allocation dollars than
were available, receiving only about 11 percent of $107 billion in
allocation authority for which they applied. The CDEs made
investments in low-income communities, most often in the form of
term loans to businesses.^24 The businesses that received these
loans used them for a variety of purposes but chiefly to finance
new commercial real estate construction and rehabilitation. The
communities where the investment projects were located were
dispersed across states, and about 90 percent of projects were
located in areas designated as "areas of high distress" because of
factors such as low median incomes and high unemployment rates,
including businesses in highly distressed areas, such as federally
designated Empowerment Zones and Enterprise Communities.
NMTC Investors Tend to Be Financial Institutions with Larger Net
Assets and Individuals with Higher Incomes
Although the NMTC program has attracted a variety of types of
investors, as table 2 indicates, banks and individuals make up the
majority of investors, accounting for 70 percent of NMTC
investors. Other corporate investors, such as real estate
development firms and insurance companies, and still other types
of investors, including estates and trusts, make up the remainder
of investors in the CDEs. Banks and other regulated financial
institutions also account for the majority of NMTC investment
funds.
^23 NMTC claimants are a subset of the overall population of NMTC
investors. Some investors are pass-through entities designed to pool funds
before making an investment in a CDE, but they do not claim the tax credit
on tax returns. Additionally, because the CDFI Fund does not track when an
investor sells its equity share in a CDE to another investor (and thereby
transfers the right to claim the tax credit), the data here are not
reflective of all NMTC claimants. The data presented here, unless
otherwise noted, originate from the CDFI Fund's databases.
^24 Term loans are loans that often only require interest payments until
the last day of their term at which time the entire principle amount is
due.
Table 2: NMTC Claimant Types
Investor type Number of claimants Percent of claimants
Bank or other regulated financial 155 37.8
institution
Individual investor 132 32.2
Other corporate investor 76 18.5
Other 47 11.5
Total 410 100.0
Source: GAO analysis of CDFI Fund data.
Corporations and individuals that claim the tax credit differ from
other taxpayers in several key ways. Corporations investing in the
NMTC tend, on average, to have larger total assets. For example,
the average total assets for corporations that made NMTC
investments was $98.3 billion in tax year 2003, while the average
total assets^25 for all corporations was $9.9 million (the average
total assets for banks, the most common type of corporate NMTC
claimant, was close to $990 million in 2003).^26 Similarly,
individual NMTC investors had larger adjusted gross incomes than
other individuals who filed tax returns in tax year 2003.^27 The
average adjusted gross income for individual NMTC investors was
about $1.2 million, while the average income for all individual
taxpayers was about $47,600.
^25 In most cases, median net assets for businesses and median adjusted
gross incomes for individuals would have been more appropriate comparison
measures. However, we were unable to use the available data to determine
median values for each measure presented here. As a result, we present
averages instead of medians.
^26 The source of the comparison data for both businesses and individuals
is IRS's Statistics of Income division data file for taxpayers that filed
tax returns in tax year 2003, the most recent year with available data.
^27 The measure of income used for individuals is adjusted gross income
from their individual income tax form 1040. Adjusted gross income is a tax
paying unit's income after subtracting certain deductions from total
income. As a result, when we refer to individual investors, we are
referring to tax paying entities--adjusted gross income on the form 1040
could include income from multiple individuals who are living in the same
household or married taxpayers.
In response to our survey, NMTC investors indicated that they
decided to participate in the NMTC program for a variety of
reasons.^28 As table 3 shows, our investor survey revealed that
the majority of NMTC investors indicated that the ability to claim
the tax credit (over 75 percent of investors) and obtain a return
on their investment (82 percent of investors) played at least a
moderately important role in their decision to make an NMTC
investment. Investors also indicated that improving conditions in
low-income communities (90 percent) and creating and retaining
jobs (78 percent) were at least moderately important motivations.
About 40 percent of investors also noted that the credit played an
important role in helping them remain compliant with other
government regulations.
Table 3: Reasons NMTC Investors Invested in the NMTC Program (in
Percentages)
Very great to
Reason moderate Little or no extent
Obtain the tax credit 76.7(67.9, 84.1) 23.3(15.9, 32.1)
Obtain return on investment 82.1(73.8, 88.6) 17.9(11.4, 26.2)
Improve conditions in low-income 90.1(82.7, 95.1) 9.9(4.9, 17.3)
communities
Comply with government regulations 41.2(33.4, 48.9) 58.8(51.1, 66.6)
Create or retain jobs 77.8(69.1, 85.0) 22.2(15.0, 30.9)
Expand lending relationships with 52.0(42.9, 61.0) 48.0(39.0, 57.1)
special purpose borrowers
Source: GAO survey of NMTC investors.
Note: Numbers in parentheses indicate confidence intervals.
^28Our survey had a 51 percent response rate. We have used type of entity
and size of entity to adjust the data for nonresponse bias. If
nonrespondents differ in their responses to survey questions beyond the
variables used in our adjustment, our estimates will not reflect this
difference. We have assumed that the respondents are a stratified random
sample of the population. All percentage estimates from the survey are
represented at the 95 percent confidence level. In most cases confidence
intervals are only reported where at least one estimate's margin of error
is greater than 8 percentage points, plus or minus. Where providing
comparable statistics in charts and tables, we have provided all
confidence intervals. For additional information about our survey
methodology, see app. I.
Over time the number of new investors in the CDEs that receive
NMTC allocations has increased. For example, 19 percent of
investors that made their first QEIs in 2003 were new investors.
The CDFI Fund defines new investors as investors making their
first investment in a particular CDE. The percentage of new
investors increased with investment made in 2004 through 2006 to a
high of 69 percent in 2006 (through mid-December).
Most investors that have participated in the NMTC program have
only made one qualified equity investment. However, CDFI Fund data
indicate that it is not uncommon for NMTC investors to participate
in more than one QEI. For example, as of December 2006, about 55
percent of NMTC investors have only participated in one QEI, while
33 percent of NMTC investors participated in from two to five QEIs
and 12 percent of investors participated in five or more QEIs.
The Average Expected Return on NMTC Investment Has Declined
As NMTC investment structures have become increasingly complex in
recent years, the expected rate of return for NMTC investments
decreased.^29 NMTC investments made in 2003 had an average
expected rate of return, which includes any return on the equity
investment and the tax credit, of 8.2 percent while investments in
later years had an average expected rate of return of only 6.8
percent. This decline could be a result of the greater perceived
risk for investments made at the beginning of the program.
According to CDFI Fund officials, as the program has developed and
investors have gained a better understanding of the manner in
which the credit can be used, investors' perceived risk in making
NMTC investments has likely declined. A factor contributing to the
decline may be that as table 4 shows, NMTC investors reported that
they have become more familiar with the operations and investment
portfolios of the CDEs they invested in after making NMTC
investments.
^29 The CDFI Fund collects self-reported data on the expected rate of
return for NMTC investments from CDEs that make investments.
Table 4: Investor Knowledge of CDE Operations (in Percentages)
Level of knowledge Very high to moderate extent
Before investing in NMTC 48.9(39.6, 58.2)
After investing in NMTC 93.4(85.5, 97.7)
Source: GAO survey of NMTC investors.
Note: Numbers in parentheses indicate confidence intervals.
However, even though the reported expected rate of return on NMTC
investments has fallen, investors indicate that they remain
concerned about the market risk of NMTC investments and the
possibility that businesses that receive NMTC investments could
default on their loans. For example, our investor survey indicates
that an estimated 86 percent (78.2, 92.0) of investors said that
they were at least moderately concerned that their investment
would not achieve its expected rate of return, and 81 percent
(71.8, 87.9) of investors said that they were at least moderately
concerned that the business that received their NMTC investment
would default on its loan.
CDEs Apply for More NMTC Allocations Than Are Available and
Relatively Few CDEs Receive Allocations
For all allocation rounds combined, CDEs have applied for over
$107 billion in NMTC allocation and received only about 11 percent
of requested allocation dollars. As table 5 shows, the percentage
of dollars awarded in relation to the dollars requested has
remained fairly constant during the four allocation rounds, but in
each round CDEs have applied for far more in NMTC allocations than
the CDFI Fund has had the authority to award based on the NMTC's
authorizing legislation. The amount awarded as a percentage of the
amount requested varied by at most 6 percentage points over the
rounds. In general, CDEs applied for more in allocation authority
in rounds where larger amounts were available for allocation.
Table 5: NMTC Allocations Awarded by Round
Dollars in billions
Round Amount requested Amount awarded Percentage awarded
Round 1 (2003) $26.0 $2.5 9.6
Round 2 (2004) 30.4 3.5 11.5
Round 3 (2005) 22.9 2.0 8.7
Round 4 (2006) 28.3 4.1 14.5
Total $107.6 $12.1 11.2
Source: GAO analysis of CDFI Fund data.
For all allocation rounds combined, the CDFI Fund received 1,078
NMTC applications from CDEs and only 223, or about 22 percent,
received allocations. As table 6 shows, between 19 percent and 25
percent of CDEs that applied for allocations received them in each
round.
Table 6: CDEs That Applied for NMTC and Received Allocations by
Round
Number of Number receiving Percentage receiving
Round applicants allocations allocations
Round 1 345 66 19
(2003)
Round 2 271 63 23
(2004)
Round 3 208 41 23
(2005)
Round 4 254 63 25
(2006)
Total 1,078 233 22
Source: GAO analysis of CDFI Fund data.
CDFI Fund officials indicated that NMTC applications will score
particularly well to the extent that, among other things, the
applicants commit to: (1) providing products with particularly
flexible or nontraditional rates and terms; (2) serving severely
economically distressed communities, including communities that
have been targeted for redevelopment by other governmental
programs; and (3) investing more than the minimally required 85
percent of NMTC proceeds into low-income communities. We observed
the application reviewer training session in 2005 and noted that
the CDFI Fund encouraged application reviewers to pay particular
attention to types of projects and financing terms being proposed
in the applications. One example we noted was that CDFI Fund
officials instructed NMTC application reviewers to base a portion
of each application's overall score on the commitment of the
applicant to serve highly economically distressed areas.
Businesses Primarily Receive Loans from CDEs That They Use Chiefly
for Investment in Commercial Real Estate
CDEs that received NMTC allocations have used their allocations to
make investments totaling $3.1 billion through fiscal year 2005,
primarily in the form of loans to businesses in low-income
communities. According to CDFI Fund data, these loans are used
chiefly for constructing and rehabilitating commercial real estate
and are also used to purchase fixed assets for businesses^30 and
to provide working capital for businesses.^31 For example, these
loans have been used to finance a range of activities, such as the
rehabilitation of historic buildings and the operation of
mixed-use real estate development. Other uses include the
construction or operation of cultural arts centers, frozen pizza
manufacturing, and the construction of charter schools. As figure
7 shows, about 75 percent of the dollar value of these loans and
investments was used for investment in commercial real estate.
^30 The CDFI Fund defines fixed assets for businesses as a loan or
investment that will be used to pay for any tangible property used in the
operation of a business, but is not expected to be consumed or converted
into cash in the ordinary course of events. Commonly financed fixed assets
include machinery and equipment, furniture and fixtures, and leasehold
improvements.
^31 The CDFI Fund defines working capital as a loan or investment that
will be used to cover any ongoing operating expenses of a business, such
as payroll, rent, or utility expenses.
Figure 7: NMTC Loans and Investment by Type of Activity for Fiscal
Years 2003 through 2005
According to data reported by CDEs to the CDFI Fund, most
investment (88 percent) made by the CDEs in businesses comes in
the form of term loans.^32 According to CDFI Fund data, the most
common types of loans being made to qualifying business with
better rates and terms^33 come in the form of loans with below
market interest rates (80 percent of reported NMTC dollars) and
lower-than-standard loan origination fees (56 percent of reported
NMTC dollars). As figure 8 illustrates, other types of favorable
financial packages that qualifying business take advantage of
include things like interest-only loans, loans with
longer-than-standard amortization periods, and higher
loan-to-value ratios than are traditionally required.
^32 Most allocatees are using their qualified equity investments from
investors to make loans to qualified businesses, but they can also make
investments in other, non-related CDEs. Through fiscal year 2005, over 99
percent of NMTC investment dollars had been made to businesses and less
than 1 percent to other CDEs.
^33 The CDFI Fund includes a variety of categories under what is
considered better rates and terms for financial notes that are issued by
CDEs as qualified low-income community investments. In general, the CDFI
Fund deems a financial note to have better rates and terms if the CDEs
reporting the investment indicate that the rates or terms associated with
the investment could not have been offered by the allocatee or otherwise
been made available in the marketplace.
Figure 8: NMTC Dollars Used in Loans with Better Rates and Terms
The Communities Receiving the Investment Tend to Be More Highly
Distressed
Through their allocation agreements with the CDFI Fund, all
allocatees are required to use at least some portion of their
allocation to serve designated "areas of higher distress,"^34
which may have a greater need for economic development funds than
areas that meet the NMTC program's minimal requirements. For
example, 51 percent of projects serve areas with a median income
of less than 60 percent of area median income, and 47 percent of
projects serve areas with unemployment rates at least 1.5 times
the national average. In addition, over one-fourth of NMTC
projects are located in federally designated Empowerment Zones and
51 percent of all NMTC projects are in Small Business
Administration-designated Historically Underutilized Business
Zones.
NMTC projects are distributed across states. Activities reported
through fiscal year 2005 included 583 projects, located in 45
states, the District of Columbia, and Puerto Rico. Table 7 shows
the top 10 states organized by the total dollar amount of NMTC
investment and the total number of projects. Appendix III contains
the full list of the number of NMTC projects by state.
^34 For the purposes of the 2006 NMTC allocation round, the CDFI Fund
defined "areas of higher distress" as areas (1) with poverty rates greater
than 30 percent; (2) with median incomes of less than 60 percent of area
median income; (3) with unemployment rates at least 1.5 times the national
average; (4) that are designated Empowerment Zones, Enterprise
Communities, or Renewal Communities; (5) that are U.S. Small Business
Administration (SBA)-designated Historically Underutilized Business Zones
(HUB Zone), to the extent the investment will support businesses that
received HUB Zone certification from the SBA; (6) that are federally
designated brownfields redevelopment areas; (7) that are encompassed by a
HOPE VI redevelopment plan; (8) that are federally designated as Native
American or Alaskan Native areas, Hawaiian Homelands, or redevelopment
areas by the appropriate tribal or other authority; (9) that are
designated as distressed by the Appalachian Regional Commission or Delta
Regional Authority; (10) that are Colonias areas designated by the
Department of Housing and Urban Development; (11) that are federally
designated medically underserved areas, to the extent the investment will
result in the support of health-related services; (12) that are CDFI Fund
Hot Zones; (13) that are High Migration Rural counties; (14) that are
state or local tax increment finance districts, enterprise zone programs,
or other similar state/local programs targeted toward particularly
economically distressed communities; or (15) that are counties for which
FEMA has (a) issued a major disaster declaration since July 15, 2005 and
(b) made a determination that such county is eligible for both "individual
and public assistance."
Table 7: Top 10 States by NMTC Dollars through Fiscal Year 2005
Top 10 states by amount of dollars Total dollar amount of Number of NMTC
invested loans and investment projects
California $303,081,270 58
New York 239,178,566 25
Ohio 201,857,969 69
Maine 153,527,250 13
Wisconsin 149,131,108 26
Missouri 146,165,868 22
Massachusetts 145,059,237 34
Kentucky 135,117,406 44
North Carolina 126,420,590 14
Washington 125,703,680 19
Source: GAO analysis of CDFI Fund data.
NMTC Investors Report That the NMTC Increases Investment in
Low-Income Communities and Statistical Analysis Indicates That
These Investments May Be Financed by Shifting Assets from Other
Uses and Some New Investment
The results of our investor survey and statistical analysis
indicate that the NMTC may be increasing investment in eligible
low-income communities by participating investors, which is
consistent with the program's purpose. Increased investment in
low-income communities can occur when NMTC investors increase
their total funds available for investment or when they shift
funds from other uses. One limitation with our survey is that NMTC
investors responding to our survey, because they benefit from
claiming the credit, have an interest in ensuring that the NMTC
program continues to operate. Our survey indicated that most NMTC
investors increased the share of their investment budget for
low-income communities because of the credit. However, in many
cases the survey also indicated that the credit alone may not have
been sufficient to justify the investment and meeting other
government regulations may be an important incentive for making
NMTC investments. In addition, about two-thirds of investors also
indicate that NMTC investors have a track record of investing in
low-income communities, which may mean that some investment was
shifted from other low-income community investments. Our
statistical analysis suggests that corporations investing in the
NMTC are shifting investment funds while individuals who make NMTC
investments may be increasing their overall level of investment.
Neither our statistical analysis nor the results of our survey
allow us to determine definitively whether shifted investment
funds came from higher income communities or from other low-income
community investments.
A complete evaluation of the NMTC program's effectiveness requires
determining whether the program's economic and social benefits to
low-income communities offset its costs, which include costs such
as forgone tax revenue and economic distortions evidenced by
shifting investment funds. We did not conduct this complete
evaluation for this report because sufficient data were not
available. The CDFI Fund is currently working with a contractor to
develop plans for a comprehensive program evaluation, which may
include some aspects of program effectiveness.
NMTC Investors Reported That They Increased Their Investment in
Low-Income Communities Because of the Credit, but Other Factors May
Also Play a Role
In response to our survey, most NMTC investors said that they
would probably or definitely not have made the same investment
with the same terms if they had not been eligible to claim the
credit. An estimated 88 percent of investors said that they would
not have made the same investment without the NMTC. Of these
investors who would not have made the same investment without the
NMTC, 75 percent (66.6, 82.7) also indicated that in the absence
of the NMTC they would not have made a similar investment in the
same community. Moreover, 64 percent (54.9, 72.5) of investors
said that they increased the share of their investment budget that
is designated for low-income communities because of the NMTC.
Most NMTC investors have experience in low-income community
investment. Nearly two-thirds of investors have additional
investment in low-income communities that does not qualify for the
NMTC. Sixty-one percent (53.2, 69.4) of respondents currently had
additional investments in low-income communities that were not
eligible QEIs, and 29 percent of investors had made one or more
investments in other CDEs or similar organizations that mainly
serve low-income communities but cannot be used to claim the NMTC.
This interest in low-income community investment is also reflected
in survey responses where 90 percent of investors said the goal of
improving conditions in low-income communities influenced their
decision to invest in the NMTC from a moderate to very great
extent. Most investors also indicated that they plan to make
additional NMTC investments.
The survey responses indicate that in many cases, the credit alone
may not have been sufficient to justify the investment. The NMTC
can also be packaged with a number of other government incentives
to make the investment more attractive. About half of respondents
combine the NMTC with at least one other government incentive that
can provide additional tax benefits to the investor. As figure 9
shows, state and local tax abatements are the most popular type of
government incentive used. Some respondents that packaged the NMTC
with other government incentives indicated that their ability to
package the credit played an important role in their decision to
make the investments, which may indicate that in some cases, the
NMTC, in and of itself, is not a strong enough incentive to
encourage investment in low-income communities.
Figure 9: NMTC Investors Packaging the NMTC with Other Government
Incentives
Note: Confidence intervals for each of the categories in the
figure are as follows: Historic Rehabilitation Tax Credits (19.6,
35.5), Historic Rehabilitation Easement Deduction (.1, 5.8),
Brownfields tax incentive (7.2, 20.1), Empowerment Zone/Enterprise
Community funding (15.7, 31.8), and State/local tax abatements
(28.5, 46.1).
Meeting other government regulations may also be an important
incentive for making NMTC investments. Over 40 percent of the
investors reported that they use the NMTC to remain compliant with
the Community Reinvestment Act (CRA), which rates depository
institutions on their record of helping to meet the credit needs
of their entire community. Seventy-one percent (58.3, 80.8) of
investors that are required to comply with the CRA use their NMTC
investment to help meet their CRA obligations. For investors using
the NMTC to meet CRA requirements, 94 percent (83.4, 98.8) view it
as very or somewhat important in their decision to make the
investment.
Nearly half of NMTC investors also reported that they make
investments eligible for the Low-Income Housing Tax Credit, a tax
credit for investment in rental housing targeted to lower income
households. However, less than one-half of the investors that also
invest in the Low-Income Housing Tax Credit view it as an
alternative to the NMTC. One explanation for this is that these
investors may be making other low-income community investments as
a means for complying with government requirements such as the
CRA. For example, of the survey respondents that participated in
both the NMTC and the Low-Income Housing Tax Credit, nearly three
quarters of these investors are also required to comply with the
CRA.
Statistical Analysis Suggests That Some NMTC Investment by
Participating Investors May Be Investment Shifted from Other
Assets and Some May Be New Investment
Our statistical analysis of corporations and individuals that
claimed the NMTC indicates that some NMTC investment may be
shifted from other uses and some investment could be new
investment. Statistical analysis of corporations that claimed the
NMTC indicates that, in general, NMTC investment funds are not new
investment made from an increase in total funds available. When
combined with information from the survey, this statistical result
may indicate that corporations are shifting NMTC investment funds
from other uses. Statistical analysis of individuals who invested
in the NMTC indicates that in the aggregate, NMTC investment funds
represent, at least in part, an overall increase in investment
levels. Because corporate NMTC investment accounts for the
majority of QEIs, the increased investment associated with
participation in the program is likely to come primarily from
funds shifted from other uses.
Statistical analysis of corporations that claimed the NMTC
indicates that NMTC investment funds are not likely to represent
new overall investment. To assess whether NMTC investments
represent new funds, we compared the growth rate in net assets of
corporations that made NMTC investments to the growth in net
assets of a similar group of corporations that did not make NMTC
investments over time. We selected our comparison group using a
stratified random sample of taxpayers based on total assets at the
end of the tax period. We drew the comparison groups based on 2000
tax year data because this was the year before the credit could be
claimed and in that year we would not expect any changes in
behavior because of the credit. If NMTC investments represent new
investment funds^35 then we would expect the net assets of NMTC
participants to grow faster over time than the net assets of
corporations that did not make NMTC investments. Using multiple
specifications, our results suggest that corporate claimants' net
assets are not growing faster than similar corporations that did
not make NMTC investments.^36
Rather than new investment, NMTC investment could represent a
shift of investment by participating corporations from high- or
moderate-income communities to low-income communities. This
conclusion follows from combining evidence from the survey of
investors with evidence from the statistical analysis.^37 Because
our analysis does not show a faster growth rate for NMTC
investors, it is possible that the credit has no effect on
investor behavior, but instead rewards investors for investment in
low-income communities that would have been made in the absence of
the credit. However, the effect of the credit may also be to shift
investment from other low-income communities or from high- or
moderate-income communities. Although it contains some contrary
indicators about the effect of the credit, the survey of investors
that benefit from claiming the credit, indicated that most
investments would not have occurred in the absence of the credit
and that NMTC investors had increased their investments in
low-income communities because of the credit. Therefore, we infer
that the most likely effect of the credit is that it shifts
investment by participating investors into low-income communities
from higher income communities. Further analysis of the components
of net assets, total assets, and total liabilities, which are
discussed in appendix II, produced inconclusive results regarding
the source of the shifted funds.
Shifted investment funds, in contrast to new investment funds,
indicate that investors are decreasing investment in another asset
or assets by some or all of the amount that they invest in the
NMTC program. Investors might choose to shift funds for a variety
of reasons, including a higher rate of return expected from the
NMTC investment, a need to make an investment eligible for meeting
CRA requirements, or the ability to establish new business
relationships. Regardless of the reason, if funds are shifted as
the result of a tax benefit, the shifting potentially creates
other economic costs, including the opportunity cost of other uses
of the funds, and benefits.^38 These costs and any benefits that
accrue to low-income communities should also be considered when
evaluating the overall effectiveness of the tax credit in addition
to the revenue costs of the program.
^35 For instance, new investments might be funded by a decrease in
dividend payouts for businesses.
^36 See app. II for a more thorough description of the steps we took to
verify the validity of these baseline statistical results.
^37 As described in app. I, the survey population and the statistical
analysis population of NMTC investors are not identical. We surveyed NMTC
investors that we identified using CDFI Fund data, and in a limited number
of cases we surveyed a point of contact at a pass-through entity rather
than all of the investors in the pass-through entity. Our statistical
analysis population of NMTC investors includes NMTC participants that we
identified as credit claimants using both IRS and CDFI Fund data.
When analyzing the effect of NMTC participation on the net assets
of corporations, our results consistently showed no effect.
Further, when we tested our results using different data
specifications, we were still not able to detect an effect.
However, our analysis of the NMTC's effect on net assets for
corporations had several limitations. For example, the amount of
NMTC investment might be small enough relative to a corporation's
total size that our statistical models could fail to detect a
positive effect of the NMTC investment on corporations' asset
levels. We attempted to mitigate this problem by basing our
analysis on firm-level data, the smallest unit of analysis
available, and growth in assets over time. In addition, we did not
have data for total liabilities. We calculated a corporation's
total liabilities by subtracting stockholders' equity and retained
earnings from the "total liabilities and shareholders' equity"
line-item on the tax return. Additionally, our data made it
difficult to identify which industry NMTC corporate investors
participated in, another variable that would have helped
strengthen our analysis.
Similar analysis of individuals who invested in the NMTC indicates
that at least some portion of their investment may represent an
overall increase in investment (or "new" investment) rather than
investment shifted from other uses. To assess whether NMTC
investments represent new funds, we compared the wealth of
individuals who made NMTC investments to the wealth of a similar
group of individuals who did not make NMTC investments over time.
If NMTC investments represent new investment funds^39 then we
would expect the wealth of NMTC claimants to grow faster over time
than the wealth of nonclaimants. As table 8 shows, the NMTC is
associated with a positive effect on the growth in NMTC investors'
wealth. This means that NMTC investors' wealth is growing at a
faster rate than similar investors who did not make NMTC
investments. ^40 Thus, according to our analysis for individual
NMTC claimants, the NMTC program investors appear to be increasing
their investment in low-income communities because their QEIs
represent investments that they would not have made otherwise and
these investments are placed into low-income communities according
to program rules.^41
^38 Potential economic costs are often referred to by economists as
efficiency costs or deadweight losses. Efficiency costs result when tax
provisions cause individuals or businesses to alter decisions like how
much to work, how much to save, what to consume, and where to invest. An
exception would be the case where the tax credit is offsetting a market
failure, such as a shortage of capital funds available in low-income
communities for reasons other than economic returns. Potential benefits
include the extent to which a community experiences reductions in poverty
and increases in employment opportunities as a result of the program;
possible "spillover" benefits to the community may include reductions in
crime and improvements in the health status of community residents.
^39 This conclusion follows from the statistical evidence alone and does
not depend on combining evidence from the survey as was the case for
shifted investment for businesses. New investment for individuals is
funded through a decrease in consumption (e.g., the amount spent on goods
and services).
^40 See app. II for more information on the methods we used to develop
these statistical models.
^41 Our analysis does not address the question of whether NMTC investment
by individuals would have taken place by different investors if these
particular investors did not make NMTC investments. Our analysis is
limited because it only allows us to say that the NMTC investment was new
investment by these particular investors.
The increase in wealth for individuals can be broken down into its
components, such as interest-bearing assets and business assets.
The NMTC can have indirect effects on these components of wealth
through its effect on after tax income. In addition to potentially
producing ordinary returns on investment (such as dividend
payments), part of the return on NMTC investments comes in the
form of reduced tax liabilities. Because they are paying less in
taxes, NMTC investors have more income available for investing in
other types of assets and for consumption. As table 8 shows, our
results are consistent with individuals placing at least a portion
of this income into interest-bearing assets, such as savings
accounts or certificates of deposit. As table 8 shows, these new
NMTC assets also appear to take the form of business assets,
including partnerships. Increases in business assets may be
consistent with typical NMTC investment structures where many
individuals are investing through pass-through entities.
Table 8: Effects of NMTC Individual Investor Participation on
Wealth
Measure Effect on growth of:^a
Wealth Positive^b
Interest-bearing assets Positive
Dividends None
Real estate None
Business Positive
Source: GAO analysis of IRS and CDFI Fund data.
aResults are based on comparisons of the 2000 to 2004 growth in
each category, comparing growth for NMTC investors and an
individual tax return representing the closest match among
non-NMTC claimants from our comparison group.
bFor categories where a positive effect is identified, our
analysis was statistically significant at the 5 percent level.
In our analysis, NMTC participation by individuals was associated
with greater growth in wealth, and most variables measuring this
association were highly statistically significant. In addition,
various checks that we performed were consistent with the results
we present above. However, as was also the case with our analysis
of corporate investors, several data limitations exist for our
analysis of individual investors. For instance, we did not have
direct data on asset holdings. Consequently, we estimated wealth
based on income streams reported on tax returns. In addition, some
assets are particularly difficult to measure. Business assets are
especially susceptible to measurement errors as income streams
from these assets may vary widely from year to year. This means
that assets not generating reportable returns, such as stock
holdings that do not generate dividends in a particular year, do
not appear in our estimates for that year. We have attempted to
mitigate this problem by conducting a series of tests, such as
using a 3-year average of wealth and asset variables, to confirm
the consistency of our results. These tests and data limitations
are discussed in more detail in appendix II.
Further Analysis Is Needed to Determine Whether the Economic
Costs of Shifting Investment Are Justified by Any Economic and
Social Benefits to Low-Income Communities
A complete evaluation of the program's effectiveness goes beyond
identifying whether the credit increases investment in low-income
communities by participating investors and also requires
determining both whether non-NMTC investors would have made the
same investments that the NMTC investors made if the NMTC
investors had not made the investment and whether the program's
benefits to low-income communities offset its costs, which include
costs such as forgone tax revenue and potential economic
inefficiencies created by shifting investment funds. Fully
examining the effectiveness of the NMTC requires addressing at
least two main issues: where do NMTC investment funds come from
and do NMTC investments generate economic benefits in low-income
communities? Because of data limitations, the relative youth of
the NMTC program, and the inherent difficulties of measuring
program costs and benefits, a full evaluation is beyond the scope
of this report. However, our finding that the NMTC program causes
claimants to shift their investment portfolios suggests that the
program might generate some additional economic costs, such as the
opportunity cost of redirecting investment resources from other,
potentially valuable uses.^42 Whether these economic costs are
justified depends on the economic benefits that are generated in
the low-income communities and the extent to which these benefits
accrue to the targeted population. This highlights the importance
of assessing the benefits of the program in eligible communities
so that one can assess whether the costs are justified by the
benefits of the program.
The CDFI Fund has hired a contractor to design a comprehensive
study to evaluate the NMTC program. The study design will be
completed by mid-2007, and the study will begin after the design
is complete. During the design phase, the contractor will complete
five case studies of NMTC investments. The study could potentially
evaluate the effect that the NMTC is having on factors such as job
creation and economic growth in areas that receive the credit.
These issues fell outside the scope of this report.
^42 To assess whether the funds would have been used in a more beneficial
way in the absence of the program, one would need information on both the
financial returns to the alternate use and any positive "spillover"
benefits created by NMTC investments such as creating a more skilled
workforce.
IRS and the CDFI Fund Monitor NMTC Compliance, but Additional
Opportunities Exist to Better Measure Noncompliance and Identify
NMTC Investors
IRS monitors CDEs' compliance with NMTC laws and regulations, and
IRS is conducting a compliance study but is not yet selecting CDEs
to audit in a manner that represents all types of CDEs. The CDFI
Fund monitors CDEs' compliance with their allocation agreements
through its data collection systems and, on a more limited basis,
by making site visits. The CDFI Fund has tested its data systems
and developed policies and procedures for site visits. IRS and the
CDFI Fund developed a memorandum of understanding (MOU) in an
attempt to clarify the roles and responsibilities of both agencies
in ensuring NMTC compliance, and IRS has access to CDFI Fund data.
However, additional efforts could help IRS receive information in
a more useful format. In addition to IRS and the CDFI Fund,
investors and CDEs play a role in ensuring that CDEs remain
compliant and the credit is not recaptured.
IRS�s Compliance Study Methodology Could Be Improved to Be More
Representative of the Population of CDEs
IRS is responsible for ensuring that CDEs and NMTC investors
adhere to NMTC laws and regulations. As part of its effort to
monitor CDEs' compliance, IRS is conducting a study to monitor
CDEs' compliance with NMTC legislative requirements, focusing on
CDEs' compliance with the "substantially all" requirement to
invest at least 85 percent of their QEIs within 1 year of
receiving the investment. IRS officials said that they chose to
focus on CDEs' compliance with the "substantially all" requirement
because they believed that this was the area where noncompliance
with NMTC provisions was most likely to occur. The current
compliance study will provide IRS with some information about
audited CDEs compliance with the "substantially all" requirement,
including information about whether funds were invested in a
timely manner and whether the investments were made to qualifying
businesses. However, IRS did not select first round NMTC
allocatees to audit in a manner that likely represents the full
range of CDEs.
IRS envisioned that its compliance study would focus on verifying
that CDEs were in compliance with statutory requirements through
examining CDEs' tax returns and auditing CDEs. IRS has taken steps
to develop and implement the compliance study, such as training
auditors to conduct NMTC examinations and developing a training
manual that provides examiners with background on the NMTC
program, key issues to consider when reviewing whether CDEs meet
the "substantially all" requirement, and information to
familiarize auditors with the investment structures that NMTC
investors use to make investments. IRS is currently auditing 20 of
the 66 first round allocatees.
IRS officials said that they initially planned to conduct
examinations of early round CDEs using a sample of CDE tax returns
that would yield a valid 95 percent level of confidence for the
study's results. IRS expected that all CDEs that received early
round allocations would file income tax returns within a year or
two of the award date, and that shortly after all the CDEs' tax
returns were filed, IRS would have enough returns to select a
valid sample that would yield the desired confidence level.
However, IRS changed its selection process because it took more
time than expected for CDEs to file tax returns, and the volume of
returns filed was not sufficient for IRS to draw a valid sample in
a timely manner. IRS officials said that the delay for most CDEs
occurred because of the lapse of time between the date that the
CDE executed agreements with the CDFI Fund and when the CDE
actually collected equity investments and began operations.
As a result of the delay in acquiring tax returns for its study,
IRS modified its overall compliance strategy in two ways. First,
it decided to verify that each allocatee filed a tax return as a
way to monitor CDEs' filing compliance. IRS intends to continue to
monitor CDEs' filing compliance until they are confident that the
entities will file as required.^43 Second, IRS discontinued the
sample approach and decided to manually review every return that
it could identify. IRS initially requested over 80 tax returns
from tax years 2003 and 2004. Of the returns that IRS had received
by June 2006, it chose to facilitate audits of CDEs that filed
2004 tax year returns that had some indication of NMTC activity.
According to IRS, because of the delays in when CDEs were awarded
NMTC allocations and the time in which they began filing tax
returns, IRS did not develop specific criteria for deciding which
CDEs to audit. An IRS official said that IRS wanted to start its
compliance study as soon as possible and the filing time lags
created delays. IRS indicated that IRS will continue with this
selection process until it reaches a point where there are
sufficient returns placed in the examination stream to produce
meaningful results.^44
^43 As of November 2006 IRS was able to verify that 61 of the 66
allocatees that received NMTC awards in 2003 had filed tax returns. For
those instances where they were still unable to associate a filing, IRS is
making an effort to contact the CDE to determine why they have not yet
filed a tax return.
^44 IRS officials have not developed specific criteria for what
"meaningful results" include, but they indicated that they intend to
continue conducting NMTC audits until they are comfortable that they have
identified any key compliance issues that may arise.
IRS plans to use the results of the compliance study, which will
take several years to complete, to guide its future enforcement
efforts. While IRS's current compliance study will provide the
agency with information about CDEs' compliance with NMTC laws and
regulations, the compliance study will have limited value if the
audit selection process does not represent the full range of
transactions. We have previously reported that taxpayer compliance
studies should be representative of the population for which
compliance is being measured and reasonably designed for
developing compliance measures for the taxpayer population as a
whole and for subgroups of taxpayers (such as suballocatees in the
case of the NMTC program).^45 IRS's current plan for its
compliance study could be improved to adhere to these standards
more closely. Given IRS's intent to rely on the study to guide
enforcement efforts, the results of not having a study
representative of the population could be lost tax revenue and
increased cost through inefficient use of resources.
IRS could change its strategy to make its results more useful as
its compliance work progresses. IRS plans to audit 15 to 25 CDEs
from each allocation round until it feels that compliance levels
warrant a reduced number of audits. While it may be too resource
intensive to conduct a statistically valid study with fully
generalizable results, IRS could work with the CDFI Fund to
develop criteria for determining which CDEs to audit. For example,
IRS could use CDFI Fund data to categorize CDEs that invest in
different types of projects or CDEs that use different types of
investment structures for NMTC purposes. As the program expands
and more tax return data are available for future rounds, IRS
could use the audit results from its initial CDE audits, along
with developing these criteria for identifying which CDEs it will
audit, in order to produce compliance study results that will be
more representative of the entire population of NMTC allocatees.
The CDFI Fund Has Systems and Procedures in Place to Monitor
CDEs� Compliance with Allocation Agreements
The CDFI Fund is monitoring CDEs to ensure that they remain
compliant with their allocation agreements through the New Markets
Compliance Monitoring System (NCMS) and, on a more limited basis,
site visits. The CDFI Fund took steps to ensure that its data
collection and reporting systems are reliable and valid, such as
testing its data collection systems and the interaction between
these systems multiple times before using them to identify CDE
noncompliance. These steps help to reasonably ensure that the CDFI
Fund data are adequately maintained and properly disclosed in
reports. CDFI Fund databases rely on data that CDEs self-report to
the CDFI Fund. However, the CDFI Fund has several mechanisms in
place, such as providing written instructions to CDEs on how to
report data and providing a help desk for CDEs to call when they
have questions about reporting information to the CDFI Fund, that
help ensure that the data they collect are accurate and reliable.
In addition, data used to populate the NCMS are subject to several
validity checks to ensure accuracy. CDFI Fund officials have also
conducted a limited number of site visits to CDEs, one goal of
those site visits being to ensure that data are being accurately
reported.
^45 GAO, Tax Administration: New Compliance Research Effort Is on Track,
but Important Work Remains, [45]GAO-02-769 (Washington, D.C.: June 27,
2002).
Our review of the CDFI Fund's NCMS system and site visits
indicates that the CDFI Fund has instituted policies and
procedures that should allow it to collect the information that it
believes it needs to meet its compliance program's objectives of
identifying CDEs that are no longer compliant with their
allocation agreements. According to our Government Auditing
Standards, agencies should develop internal controls, including
controls that will ensure that programs operate effectively and
efficiently and that data collected are reliable and valid.^46
The CDFI Fund uses the NCMS to detect allocatees' noncompliance
with their allocation agreements relating to authorized uses of
NMTC allocations, restrictions on the use of NMTC allocations, and
other special provisions that are included in an allocation
agreement. If the NCMS identifies a CDE as being out of compliance
with its allocation agreement, the CDFI Fund contacts the
allocatee to let it know that the NCMS has identified it as
noncompliant. The CDFI Fund officials then attempt to determine
why the CDE is noncompliant and take steps necessary to bring the
CDE back into compliance with the terms of its allocation
agreement.
As of January 2007, the CDFI Fund had identified nine CDEs that
were not compliant with their allocation agreements and one CDE
that was not in compliance with the NMTC program's "substantially
all" requirement. For example, in one case the CDFI Fund
determined through data reported in the NCMS that the CDE was
serving communities that were outside its approved service area.
In this case, the areas that the CDE was investing in still
qualified for NMTC investment. In response, the CDFI Fund amended
the CDE's allocation agreement by expanding the CDE's service
area. Six of the noncompliance CDEs were first round allocatees
that had not, as required in their allocation agreements, issued
60 percent of their QEIs by the end of September 2006. The CDFI
Fund is working with most of these allocatees to correct the
problem; however, one first round allocatee has had its NMTC
allocation revoked and another CDE returned its allocation as a
result of not meeting this requirement. In the case where the CDFI
Fund used the NCMS to identify a CDE that was failing the
"substantially all" test, the CDFI Fund referred the problem to
the IRS. In this case, the CDE was able to correct the problem
within 6 months, the amount of time CDEs are given to correct
failing the "substantially all" test, and further action was not
required.
^46 GAO, Government Auditing Standards, 2003 Revision, [46]GAO-03-673G
(June 2003).
The CDFI Fund developed policies and procedures for conducting
site visits to CDEs where CDFI Fund officials check the validity
of data reported by CDEs' to the CDFI Fund and obtain additional
information about CDEs' efforts to remain compliant. These
policies and procedures include criteria for prioritizing which
allocatees warrant a site visit, the key information items to
collect on a site visit, and a plan for using the information
after the site visit is complete. As of November 2006, the CDFI
Fund had conducted four site visits, two in 2005 and two in 2006,
and indicated that it intends to conduct more visits in the
future. A CDFI Fund official indicated that the CDFI Fund has
plans to conduct three site visits in fiscal year 2007. So far,
the CDFI Fund has visited one multiyear allocatee, one CDE that
the NCMS had identified as noncompliant, a CDE that participates
in other CDFI Fund programs, and a bank that received an
allocation award.
The process of conducting a site visit goes through several steps.
A site visit can be triggered when a CDE meets one or more of the
seven criteria established by the CDFI Fund, which include whether
the NCMS identified the CDE as noncompliant and whether the
allocatee received awards in multiple allocation rounds. Once the
CDFI Fund contacts the allocatee it intends to visit, CDFI Fund
officials review the data that the CDE reported to the CDFI Fund
and identify any areas of concern that the CDFI Fund will
investigate during the site visit. During the visit, CDFI Fund
officials review other documents, such as board meeting minutes
and financial documents, and conduct interviews with key staff
members. CDFI Fund officials also review documentation that the
CDE maintains in order to ensure that the data the CDE reported to
the CDFI Fund are accurate and reliable. After the site visit is
complete, CDFI Fund officials prepare a site visit report using
information gathered before and during the site visit. If the CDFI
Fund does not find the CDE to be in default with its allocation
agreement, no further enforcement action is taken. However, if the
initial CDFI Fund report finds that the CDE is not compliant with
its allocation agreement, the report is passed on to CDFI Fund
senior management who then either approve or disapprove the
report's finding.
While these site visits do not yield generalizable results, they
do supplement the information that the CDFI Fund receives through
the NCMS. Unlike IRS, which must audit CDEs to determine if they
are compliant with the NMTC's laws and regulations, the CDFI Fund
is able to use data reported by CDEs as its primary mechanism for
reviewing CDEs' compliance with their allocation agreements. As a
result, the CDFI Fund is able to use data in the NCMS in
conjunction with site visits that do not yield generalizable
results in order to detect when a CDE is no longer compliant with
its allocation agreement.
If a CDE is determined to be noncompliant, the CDFI Fund can
restrict the CDE's access to the NMTC program. According to CDFI
Fund officials, if they find a "serious occurrence of
noncompliance," such as a CDE failing to perform any of the
transactions that it agreed to perform, the CDE would be found in
default. To the extent possible, the CDFI Fund would assist the
CDE in correcting the areas in which it was determined to be
noncompliant--this could include amending or modifying the CDE's
allocation agreement. If the CDE is not able to come back into
compliance, the CDFI Fund could potentially bar that CDE from
future allocation rounds, or if the CDE has not yet issued all its
QEIs, the CDFI Fund could revoke its ability to make additional
investments using its current allocation. Thus far, the CDFI Fund
has not had to take these actions against any CDE as a result of
the outcome of site visits.
IRS and the CDFI Fund Have an MOU for Compliance Monitoring, but
Additional Opportunities Exist to Monitor Investor Compliance
IRS and the CDFI Fund have cooperated in their compliance efforts.
As part of their response to our initial NMTC report,^47 the CDFI
Fund and IRS developed an MOU in an effort to clarify the roles
and responsibilities of both with respect to monitoring NMTC
compliance. IRS and the CDFI Fund have had additional discussions
to identify ways for the CDFI Fund to streamline the data that it
provides to IRS. While IRS and the CDFI Fund have worked together
to monitor NMTC compliance, the two agencies could collect
additional information that would help the IRS monitor compliance
by NMTC investors, an area where neither the CDFI Fund nor IRS has
chosen to dedicate resources.
^47 [47]GAO-04-326 .
According to the MOU completed in 2004, the CDFI Fund is
responsible for carrying out the NMTC program's application and
allocation procedures. In addition, the MOU states that the CDFI
Fund will permit designated IRS staff to have access to CDFI Fund
databases, provide IRS with the relevant findings and assessments
of any site visits to NMTC allocatees conducted by CDFI Fund
staff, and notify IRS of any potential credit recaptures. Also, on
behalf of IRS, the CDFI Fund also includes compliance questions
that CDEs respond to in its database regarding recapture and
investments that CDEs have made in low-income communities. If the
CDFI Fund determines from the answers to these questions that the
CDE may be in danger of having the NMTC recaptured, it is to
forward the information to IRS.
According to the terms of the MOU, IRS is responsible for the
collection and determination of any tax as deemed appropriate. In
addition, the MOU notes that IRS is responsible for establishing
processes and procedures to ensure that taxpayers are in
compliance with the NMTC's tax provisions, and IRS will provide
the CDFI Fund with quarterly information, to the extent permitted
by law, regarding any CDEs that fail to meet the NMTC's legal
requirements.
IRS and the CDFI Fund have identified data sharing as an area
where their cooperation could be improved. While IRS has access to
CDFI Fund data, according to IRS officials, they have had
difficulty selectively obtaining the information that they are
most interested in from the CDFI Fund's data systems. According to
IRS officials, a more streamlined format for sharing data between
IRS and the CDFI Fund would allow IRS to better target
noncompliance. CDFI Fund officials said that they are working with
IRS to develop a streamlined compliance data report, and they
indicated that IRS has been cooperative in working with them. An
IRS official agreed that the two agencies are working together to
develop a more user-friendly data report specifically for IRS.
IRS is also taking steps to increase the amount of information
available about NMTC investors. IRS is in the process of
finalizing a new form that will require CDEs to report to IRS the
amount of QEI that NMTC investors made at the investment's
original issue. IRS currently does not have these data for all
claimants because the CDFI Fund data that IRS currently uses to
identify credit claimants does not track claimants in cases when
the underlying QEI is sold to another investor. In addition, IRS
is finalizing a second form that will require CDEs to notify the
original equity investor in an NMTC investment if the credit is
being recaptured. With these forms and the CDFI Fund data, IRS
will have a complete record of the initial NMTC investors in a CDE
and how much they invested.
However, further steps could be taken to identify NMTC investors
and ensure that only eligible taxpayers claim the credit and that
they claim the correct amounts. NMTC investors are allowed to sell
their equity share in a CDE, which determines their NMTC
eligibility, to other investors after the initial investment has
taken place, and neither the IRS nor the CDFI Fund tracks NMTC
investors after the original investment. IRS officials indicated
that the forms they are finalizing cannot be used to track the
selling of an investor's equity share in a CDE because they will
not be refiled if the investment is sold to another investor after
the original investment. As a result, IRS and the CDFI Fund will
not be able to identify all NMTC investors and the amount of QEI
that they made if an investor's equity share in a CDE is sold
after the original investment. When evaluating other tax credits,
we have noted that IRS is responsible for ensuring that taxpayers
claim those tax credits for which they are entitled.^48 If IRS and
the CDFI Fund developed ways to identify investors and the amounts
they invested, even when NMTC investors sell their equity shares
in a CDE, they would be better able to ensure that credits are
claimed correctly.
Our analysis of IRS and CDFI Fund data indicates that many NMTC
investments may be sold after the original QEI is made in the CDE,
making it difficult for IRS to identify all eligible NMTC
claimants and the amounts that they are eligible to claim. When we
compared potential tax credit claimants in IRS's databases to
claimants in the CDFI Fund's database, we noted that more
investors were identified as being eligible to claim the credit in
IRS's taxpayer data than in the CDFI Fund's data on claimants when
a QEI is originally issued.
According to IRS, requiring individual investors to report sales
of NMTC investments could place an undue burden on taxpayers.
However, IRS told us that this would be useful information for its
compliance monitoring efforts--both for identifying investors
eligible to claim the NMTC on their tax returns and for
identifying tax credit investors if IRS is forced to recapture the
credits from investors when a CDE is no longer compliant with the
"substantially all" requirement.^49 The CDFI Fund already collects
information from CDEs in its database identifying the initial
investors and how much NMTC eligible investment has been made by
investors that did not participate in tiered equity or leveraged
NMTC transactions. Further, a NMTC investor with prior experience
investing in CDEs and a representative of a CDE said that in their
experience, CDEs are already able to identify subsequent holders
of NMTC qualified equity investments when one NMTC investor sells
its equity share in a CDE to another investor, and CDEs could
potentially be able to report that information to the CDFI Fund or
IRS. In the case where investors in a partnership that has NMTC
investments sell their share in the partnership, it may be more
difficult for CDEs to identify who the correct tax credit
claimants would be, although the CDE would still know which
partnerships own QEI in the CDE.
^48 GAO, Tax Credits: Opportunities to Improve Oversight of the Low-Income
Housing Program, [48]GAO/GGD/RCED-97-55 (Washington, D.C.: Mar. 28, 1997).
Currently, neither IRS nor CDFI Fund data make it possible to
identify completely who is eligible to claim the tax credit and
how much they are entitled to claim. As more NMTC investments are
being resold and complicated investment structures are becoming
more common, limits on IRS's ability to monitor investor
compliance could make IRS vulnerable to a loss of tax revenues
caused by taxpayer noncompliance, fraud, and abuse, and it could
become increasingly difficult for IRS to identify tax credit
claimants if it is forced to recapture the credit. If CDEs
reported more complete information about initial NMTC investors
and subsequent sales of the equity shares in the CDE that are
linked to NMTC eligibility to the IRS or the CDFI Fund, IRS would
have better information to track investor compliance.
Investors in CDEs Play a Role in Ensuring NMTC Compliance
Investors that responded to GAO's NMTC survey indicated that they
are concerned about the possibility of the credit being recaptured
and that they play an active role in ensuring that CDEs remain
compliant with the laws and regulations that apply to the NMTC
program. An estimated 82 percent (74.0, 89.0) of our survey
respondents indicated that they are "moderately" to "very highly"
concerned about the possibility that the credit could be
recaptured. Nearly all investors, 97 percent, reported that they
make some effort to ensure that CDEs remain compliant so that the
investors avoid recapture. About 72 percent of the survey
respondents said that they have regular discussion with CDEs, and
84 percent said they receive regular reports from CDEs. Nearly
one-quarter of NMTC investors said that they audit the CDEs in
which they made NMTC investments. Figure 10 shows the activities
that NMTC investor survey respondents undertake to monitor CDE
compliance.
^49 If IRS finds a noncompliant CDE, it indicated that it will request an
investor list from the CDE to take appropriate action. If the investment
was sold after its original issuance, IRS plans to obtain information from
the known investors regarding the purchaser of the investments until the
total recapture amount is accounted for.
Figure 10: Activities Investor Survey Respondents Undertake to
Monitor CDE Compliance
Note: Confidence intervals for the data presented in this graphic
are as follows: receive regular reports from the CDE (75.8, 90.3),
receive independent audit reports about the CDE (74.4, 89.9), have
regular discussions with the CDE (62.8, 80.6), make regular site
visits to the CDE (33.8, 52.5), created the CDE and staff it
ourselves (25.3, 42.3), audit the CDE (16.1, 32.5).
Conclusions
The purpose of the NMTC program is to encourage investment and
development in low-income communities. Our analysis indicates that
the program may be accomplishing part of that objective. In our
investor survey, most participating investors said that they
increased investment in low-income communities because of the
credit. The statistical analysis also showed an increase in
investment, with individuals adding new investment and
corporations shifting funds from other uses. However, some of the
survey evidence may be less consistent with the credit increasing
investment (e.g., the prior experience of most NMTC investors with
low-income community investment) and, because of data limitations,
our statistical evidence may only establish an association between
the credit and increased investment, not that the program causes
the increase. In any case, the indication that the program
increases investment is not sufficient to support conclusions
about the program's effectiveness, nor is the fact that the credit
shifts investment an indicator of a lack of effectiveness. For
example, more information is needed about the economic and social
benefits that the low-income communities receive from the
investment. This information is only now likely to be available
given that the program's implementation was delayed.
IRS and the CDFI Fund are implementing a compliance monitoring
system in the context of a program that is growing and that is
attracting investors that use increasingly complex and
sophisticated investment structures. As IRS moves forward with its
NMTC compliance study, more rigorous development of criteria for
selecting which CDEs to audit could help it better identify the
most common compliance issues facing CDEs. Additionally, more
complete information on who is eligible to claim the tax credit
and the amounts that they are eligible to claim would be useful to
IRS in helping ensure that only eligible taxpayers claim the NMTC,
and a complete list of eligible NMTC claimants would assist IRS
should the IRS need to recapture NMTCs.
Recommendations for Executive Action
To ensure IRS is reviewing the full range of NMTC transactions and
that the conclusions of its compliance study are more
representative of all CDEs with NMTC allocations, we recommend
that IRS use CDFI Fund data and the results of its current NMTC
compliance study to develop criteria for selecting which CDEs to
audit as part of its future compliance monitoring efforts.
Additionally, to ensure that eligible taxpayers claim the correct
amount of NMTC on their tax returns and IRS is able to identify
all tax credit claimants in the event of the credit being
recaptured, we recommend that IRS work with the CDFI Fund to
further explore options for cost effectively monitoring investor
compliance and developing a way to identify NMTC claimants, even
in instances where the original investor sells its equity share in
a CDE, and the amount of QEI that each investor made.
Agency Comments
We received written comments on a draft of this report from the
Acting Director of the CDFI Fund and the Commissioner of Internal
Revenue; their comments are reprinted in appendices IV and V. Both
the IRS and the CDFI Fund agreed with our recommendations. We also
incorporated technical corrections to the draft report that we
received from both IRS and the CDFI Fund where appropriate.
In its response to the draft report, the CDFI Fund characterized
GAO's study as indicating that the NMTC has been a highly
successful tool for increasing the flow of investments into
low-income communities. While our findings do suggest that the
NMTC appears to increase investment by participating investors in
low-income communities, we also note that further information is
needed to fully assess the effectiveness of the NMTC program.
We are sending copies of this report to the interested
congressional committees, the Commissioner of Internal Revenue,
the Director of the Community Development Financial Institutions
Fund, and other interested parties. We will make copies available
to others on request. In addition, the report will be available at
no charge on the GAO web site at http://www.gao.gov .
If you or your staff have any questions on matters discussed in
this report or would like additional information, please contact
me at (202) 512-9110 or at [email protected] . Major
contributors to this report are acknowledged in appendix VI.
Michael Brostek
Director, Tax Issues
List of Committees
The Honorable Max Baucus Chairman The Honorable Charles E.
Grassley Ranking Minority Member Committee on Finance United
States Senate
The Honorable John F. Kerry Chairman The Honorable Olympia J.
Snowe Ranking Minority Member Committee on Small Business and
Entrepreneurship United States Senate
The Honorable Christopher Dodd Chairman The Honorable Richard S.
Shelby Ranking Minority Member Committee on Banking, Housing, and
Urban Affairs United States Senate
The Honorable Charles B. Rangel Chairman The Honorable Jim McCrery
Ranking Minority Member Committee on Ways and Means House of
Representatives
The Honorable Nydia M. Velazquez Chair The Honorable Steve Chabot
Ranking Minority Member Committee on Small Business House of
Representatives
The Honorable Barney Frank Chairman The Honorable Spencer Bachus
Ranking Minority Member Committee on Financial Services House of
Representatives
Appendix I: Objectives, Scope, and Methodology
Based on consultations with staff at cognizant congressional
committees, the objectives of this report are to (1) describe the
status of the New Markets Tax Credit (NMTC) program; (2) profile
the characteristics of NMTC investors, the Community Development
Entities (CDE) that receive NMTC allocations, and the businesses
and communities that receive NMTC investments; (3) assess how
effective the NMTC has been in bringing new investment to
low-income communities by the investors that have participated in
the program; and (4) assess the steps that the Internal Revenue
Service (IRS) and Community Development Financial Institutions
(CDFI) Fund are taking to ensure CDEs and investors are complying
with the NMTC and evaluate how effective these steps have been.
In order to accomplish these objectives, we used a number of
methods of analysis. We met with officials from the CDFI Fund and
IRS. We collected documents on the program status and efforts to
monitor NMTC compliance. We also analyzed data from the CDFI Fund
on the CDEs and their investment in low-income communities and tax
return data from tax years 1997 through 2004 for investors in the
NMTC program. We used these data to report summary statistics that
profile the participants in the program and to conduct statistical
analysis that measures the effect of the NMTC on investment. We
also surveyed investors in the NMTC program in order to provide
additional information on the effect of the credit and
characteristics of the investors.
To evaluate investment in the CDEs by NMTC investors, we used data
from the CDFI Fund's Allocation Tracking System (ATS) on
investments reported through mid-December 2006. We used the ATS
data to report on the type and size of qualified equity investment
(QEI) made in the CDE and the CDE that received the investment. We
also used the ATS to analyze the equity investors in the NMTC
program. To report on qualified low-income community investments
(QLICI) from the CDE to the corresponding qualified active
low-income community business (QALICB) we analyzed data from the
Community Investment Impact System (CIIS). Specifically, we used
data from the CIIS Transaction Level Report (TLR) for fiscal years
2003 through 2005, which provides information on each transaction
made as part of a QLICI. To assess the reliability of the ATS and
the TLR data sources, we reviewed the CDFI Fund's data quality
control procedures and subsequently determined that the data were
sufficiently reliable for our purposes.
We also reviewed tax data on NMTC investors from IRS's Individual
Returns Transaction File (IRTF) and Business Returns Transaction
File (BRTF). We identified NMTC claimants using data on original
claimants (at the time the QEI was made) from the CDFI Fund's ATS
and used their tax return information to determine how NMTC
investors differ in size from all taxpayers. In cases where we
could not locate a corporation's tax return because the NMTC
investor was a subsidiary of a larger parent corporation, we used
IRS's National Account Profile to link the subsidiary to its
parent corporation. In these cases, the parent corporation's tax
return was used in our analysis. In addition, because original
claimants may sell their investment, and along with it their NMTC
credit, we identified further claimants as those individuals or
corporations that indicated they were eligible to claim the NMTC
on their tax returns. This information came from IRS's IRTF or
BRTF on the New Markets Tax Credit Form (Form 8874) or as part of
the General Business Credit (Form 3800). To assess the reliability
of the IRS data sources, we reviewed the IRS's data quality
control procedures and subsequently determined that the data were
sufficiently reliable for our purposes.
To obtain information from investors on the effectiveness of the
NMTC, we designed and implemented a Web-based survey to gather
information on the investors' motivations and methods. We used
CDFI Fund data and interviews with investors to determine the
proper points of contact for NMTC investors. Our survey population
consists of NMTC claimants and their proxies for cases in which
the individual claimant was not principally responsible for
deciding to make the NMTC investment. In some cases, one person
was designated as the contact point for a group of investors
responding to the survey.
The survey asked a combination of questions that allowed for
open-ended and close-ended responses. Because some investors
invested with more than one CDE and because not all investors
participated in tiered or leveraged investment structures, the
instrument was designed with skip patterns directing investors to
comment only on the prepopulated CDE and type of investment
structure that they utilized. Therefore, the number of survey
respondents for each question varied depending on the number of
CDEs in which the investor made a QEI and whether the investor had
used tiered or leveraged structures.
We pretested the content and format of the questionnaire with
knowledgeable investors. During the pretest, we asked the
investors questions to determine whether (1) the survey questions
were clear, (2) the terms used were precise, (3) the questionnaire
placed an undue burden on the respondents, and (4) the questions
were unbiased. We also assessed the usability of the Web-based
format. We received input on the survey from a CDFI Fund official
and made changes to the content and format of the final
questionnaire based on pretest results.
The survey was conducted using self-administered electronic
questionnaires posted on the World Wide Web. We sent e-mail
notifications to investors beginning on August 2, 2006.^1 We then
sent each potential respondent a unique password and user name by
e-mail to ensure that only members of the target population could
participate in the appropriate survey. To encourage respondents to
complete the questionnaire, we sent e-mail messages to prompt each
nonrespondent approximately 2 weeks and 3 weeks after the initial
e-mail message. We also arranged for contract callers to do phone
follow-ups from September 6 to September 8, 2006. We closed the
survey on October 3, 2006.
Because we attempted to collect data from every investor in the
population, there was no sampling error. However, the practical
difficulties of conducting any survey may introduce errors,
commonly referred to as nonsampling errors. For example,
differences in how a particular question is interpreted, the
sources of information available to respondents, how the responses
were processed and analyzed, or the types of people who do not
respond can influence the accuracy of the survey results. We took
steps in the development of the surveys, the data collection, and
the data analysis to minimize these nonsampling errors and help
ensure the accuracy of the answers that were obtained. A second,
independent analyst checked all the computer programs that
processed the data.
The response rate for this survey was 51 percent. We conducted a
nonresponse bias analysis by looking at the response rates for
eight cells defined by the four types of investors surveyed
(financial institutions, individuals, nonfinancial corporations,
and other) and the size of the investor's total assets (in the
case of corporations) or adjusted gross income (for individuals).
We collected this information primarily from the investor's most
recent tax return filed with IRS. In cases where we could not
identify a tax return (primarily because the corporation had
recently been acquired or merged with another corporation) we
relied on public information on the corporation's total assets
from its most recent annual report. Investors were placed in one
of two size categories, either less than the median or greater
than the median.
^1 Our survey only included tax credit claimants and, in a limited number
of cases, a point of contact at a pass-through entity as identified in
CDFI Fund data. It did not include lenders participating in NMTC leveraged
transactions, which accounts for just over one-quarter of the total amount
of QEI. Data are not available on lenders in leveraged transactions.
Individuals with adjusted gross income less than the median for
individuals using the NMTC had the highest response rate at 63
percent followed by financial institutions with a response rate of
56 percent for financial institutions with income above the median
and 53 percent for financial institutions with income below the
median. Individuals with incomes above the median had the lowest
response rate at 32 percent.
Differential response rates across analytic subgroups raise the
possibility of nonresponse bias. If the respondents provided
different responses than the nonrespondents, the survey estimates
would be biased. We have weighted the respondents by type and
income to reduce this source of nonresponse bias. Unfortunately,
there may be other sources of nonresponse bias that we are unaware
of and unable to adjust for.
A statistician used the data on size and type of investor to
create weights that allowed us to project the survey responses to
the entire population by assuming that the nonrespondents would
have answered the questions as the respondents did. We have
treated the respondents as a stratified, random sample and
calculated sampling errors as an estimate of the uncertainty
around the survey estimates. Ninety-five percent confidence
intervals are given in parentheses after the estimates. We are 95
percent confident that each of the confidence intervals in this
report will include the true values in the study population.
We also used IRS tax data to develop statistical analysis that
measures the effect of the NMTC on investment and addresses the
question of whether NMTC investments represent new or shifted
funds. Using the tax returns of NMTC investors as determined from
CDFI Fund and IRS data (see above) we used a multistage sampling
methodology to draw a comparison group of tax returns. These
methods are more fully described in appendix II. To develop our
statistical methodology, we relied on academic journal articles
and interviewed experts in the research fields of individual
savings and wealth and corporate taxation.
To study the effectiveness of the steps that IRS and the CDFI Fund
are taking to ensure CDEs and investors are complying with the
NMTC and the effectiveness of these measures, we met with
officials from the CDFI Fund and IRS. We also collected documents
on the program status and efforts to monitor NMTC compliance.
We performed our work at GAO Headquarters and the IRS office in
New Carrollton, Maryland, from July 2006 through December 2006 in
accordance with generally accepted government auditing standards.
Appendix II: Description of Data and Methodology for Statistical
Analysis of the Effect of NMTC Participation on Investment
This appendix describes our data and methodology for assessing
whether participation in the NMTC program affects investment by
NMTC investors in low-income communities. The NMTC program may
affect investment by increasing the overall level of investment
(i.e., creating "new" investment) or by causing NMTC investors to
shift investment from other uses to investment eligible for the
credit. The methodology that we use to detect these changes in
investment follows the methodology used in the retirement savings
literature. This literature generally compares the wealth or
financial assets of participants in retirement savings plans to
that of nonparticipants to detect any effect of participation on
savings.^1 In our assessment of the NMTC program, we compare the
wealth or assets of NMTC program participants to that of a group
of similar nonparticipants to detect any effect on investment.
Our statistical analysis of the effectiveness of the NMTC program
in stimulating investment depends on the distinction between new
and shifted investment. If our analysis detects new investment,
this outcome is consistent with program goals because it may
indicate increased investment in low-income communities that would
not have occurred in the absence of the credit. If we do not
detect new investment, it is possible that the credit has created
no change in behavior and investors are just receiving a subsidy
for investments that they would have made anyway, which is not
consistent with the goals of the program. However, the investment
could also be shifted from other communities. The implications for
the effectiveness of the program in the case of shifted investment
are more ambiguous. It could mean that (1) the credit has induced
investors to shift investments from assets invested in other
low-income communities, which means that although the credit has
generated investments in projects that would not have occurred
otherwise, it has not increased investment in low-income
communities, or (2) NMTC investments represent funds shifted from
higher income communities. The first outcome is not consistent
with the NMTC's broader goal of increasing investment in
low-income communities as a whole. The second outcome is more
consistent with program goals because, as with new investment, it
may indicate increased investment funds available to low-income
communities. Finally, in the case of both new and shifted
investment, NMTC investment may reduce investment by non-NMTC
investors (called crowding out) which is also inconsistent with
the broader goal of the program. Our data and methodology do not
allow us to detect crowding out, and for this reason, we confine
our analysis to the effect of the credit on the investment
behavior of participants in the NMTC program.
^1 See the Literature Review and Credits section at the end of this
appendix for a list of references.
A limitation of our statistical analysis is that in the case of no
detected change in the overall level of investment, we cannot
distinguish between the possible types of shifting or between
shifting and the possibility that there has been no change in
investment behavior. However, if we combine evidence from our
survey of investors with evidence from our statistical analysis,
our analysis may provide some indication that the effect of the
program on investment in low-income communities by NMTC investors
is shifted investment. The survey of investors that benefit from
the tax credit indicated that most investments would not have
occurred in the absence of the credit (inconsistent with the
notion that the credit has no effect on investor behavior), and
that NMTC investors had increased their investments in low-income
communities because of the credit (inconsistent with the first
shifting outcome above). Therefore, we use the second shifting
outcome described above to interpret our statistical results in
cases where we detect no overall increase in the level of
investment by NMTC investors.
Description of Data
We identified NMTC investors using both CDFI Fund data and IRS
data. We collected data on original claimants (at the time the QEI
was made) from the CDFI Fund. We also identified investors from
IRS's Returns Transaction File data as those claiming a positive
amount for the credit on their tax returns in tax years 2001
through 2004. There were differences in the number of claimants
identified from the two different sources with the IRS data
resulting in more investors. The source of these differences is
unclear as they could indicate incomplete CDFI Fund data, missing
taxpayer identification numbers (TIN) in the CDFI Fund data, or a
large turnover in credits. In the latter case, investors may not
be responding to the incentives of the credit themselves but to
the terms constructed by the original investor. However, this is
not necessarily the case as some investors we spoke with that had
purchased the credit from the original investor indicated that
they intended to participate but that the original investor was
necessary due to timing issues. Because of the uncertainty over
which set of investors is the most relevant for our analysis, we
estimated results using both the full sample (IRS and CDFI Fund
claimants) and CDFI Fund claimants only. Our conclusions were the
same for both groups; however, we are only reporting results for
the full sample of NMTC investors identified in IRS and CDFI Fund
databases.
Our analysis of these data indicated that NMTC claimants were
generally higher income (individuals) or had higher total assets
(corporations) than the average taxpayer. This prompted us to
identify our basic comparison group using a stratified random
sample of taxpayers based on adjusted gross income for individuals
and total assets at the end of the tax period for corporations. We
oversampled high income and total asset taxpayers relative to an
unstratified random sample from the same populations. We used
quintiles to stratify our sample and drew a random sample of about
4,000 returns per quintile.^2 We chose our quintiles and drew the
comparison groups based on 2000 tax year data because this was the
year before the credit could be claimed and in that year we would
not expect any changes in behavior due to the credit.
For individuals, we collected all available data from Form 1040
and information from Schedules C and F to form a panel of
taxpayers for tax years 1997 through 2004. The data include more
than 24,000 individual tax filers and about 80 percent of filers
(including NMTC investors) are in the panel for all 8 years. For
corporations, we used income data from Form 1120 and balance sheet
data from Schedule L to form a panel of corporate taxpayers for
tax years 1997 through 2004. These data include more than 14,000
corporate tax filers and about 56 percent of corporate filers were
present in at least 7 years. (Forty-eight percent were present for
all 8 years and 57 percent of NMTC investors were in all years.)
Both individual and corporate NMTC investors were identified using
TINs contained in CDFI Fund data and the New Markets Tax Credit
Form (Form 8874) or as part of the General Business Credit (Form
3800) in the IRS data. The total number of NMTC claimants
identified from these sources was 753.
We also estimated asset values for individuals because, unlike IRS
balance sheet data for corporations, the IRS data for individuals
were limited to income streams and did not include asset levels.
We followed the methods used in the Survey of Consumer Finances
(SCF) to estimate asset holdings using income streams and rates of
return.^3 We also expanded on the SCF approach by using more
sophisticated modeling to develop estimates of home equity. Rather
than attribute to each household the median home value within its
income group (as the SCF does), we estimated home equity using the
November 1999 Wave (12) of the 1996 Survey of Income and Program
Participation. Our controls included total income, age, marital
status, and region.^4 We then applied these estimated coefficients
to tax return information on total income, age, filing status, and
region of residence to generate estimates of home equity for each
household using 2000 tax data. Negative values were set to zero,
and the consumer price index (CPI) (research series)^5 was used to
adjust the year 2000 estimates for earlier and later years.^6
^2 For corporate filers, the entire population of returns was drawn for
the top two quintiles because there were less than 4,000 total returns in
these quintiles. For individual filers, the bottom two quintiles were
divided into wage-only and other income groups. Most NMTC claimants had
some business income but a few had only wage income, making them harder to
distinguish from the "average taxpayer" for whom wage-only income is
common. Separating wage-only and other income groups allowed us to
minimize the number of returns drawn from the wage-only subset of filers
(who we determined to be, in general, less "like" the NMTC claimants).
^3 Note that we follow the SCF in excluding tax-preferred retirement
accounts, which may cause our wealth estimates to underestimate the wealth
of NMTC investors relative to noninvestors as NMTC investors tend to have
higher incomes than noninvestors. However, the exclusion's effect, if any,
on relative growth rates is not clear. This exclusion is primarily caused
by data limitations, as our income tax data only include information for
taxable distributions from these accounts (not applicable for most filers)
not contributions. For more information on SCF methods, see Arthur B.
Kennickell "The Good Shepherd: Sample Design and Control for Wealth
Measurement in the Survey of Consumer Finances" (SCF Working Paper,
Federal Reserve, Washington, D.C., 2005).
^4 Regions were chosen in accordance with U.S. Census Bureau divisions.
^5 See Kenneth J. Stewart and Stephen B. Reed, "CPI Research Series Using
Current Methods, 1978-98," Monthy Labor Review, vol. 122, no. 6 (1999),
for more information and access the data at:
http://www.bls.gov/cpi/cpiurstx.htm.
^6 We are likely to be understating wealth for households in markets that
grew at historically fast rates from 2001 through 2004. We predicted home
equity values based on 2000 tax return data and used inflation adjustments
to obtain values for 1997 through 1999 and 2001 through 2004. The most
likely affect is to bias our results downward because NMTC investors are
more likely to have more expensive homes (they are higher income on
average than noninvestors, and this factor is associated with higher
values of home equity) and experience a greater increase in wealth from
the increase in housing values. Consequently, wealth for investors would
be underestimated to a larger degree than that of noninvestors and our
analysis may underestimate the effect of the NMTC on the wealth of NMTC
investors.
Effects of NMTC Program Participation on Investment
We assessed the effects of NMTC participation by comparing the
level of assets and growth in assets of NMTC participants with the
level and growth in assets of corporations and individuals that
did not participate in the NMTC program.^7 We used regression
techniques to compare the level of assets of NMTC investors and
the relevant comparison group. The results of these models
indicate whether the assets of NMTC claimants are higher than
those of our comparison group controlling for other individual and
corporate characteristics. However, it is possible that this
approach is simply picking up the likelihood that NMTC claimants
systematically have higher assets than their counterparts (despite
our efforts to choose an appropriate comparison group using a
stratified random sample). Therefore, we used several methods,
including regression and propensity score techniques, to compare
the growth of assets over time.^8 Differences in growth rates
between NMTC investors and the comparison group do not depend on
differences in the level of assets.
^7 All dollar amount variables were adjusted using the CPI (research
series). The log transformation is used for all variables except for net
assets, which are transformed using the inverse hyperbolic sine (to better
address negative and zero values).
^8 The average treatment effect on the growth in assets for individuals
was from 2000 to 2004. For corporations, the period was 2000 to 2003 (we
choose 2003 for corporate filers because of the number of filers not in
our records for 2004).
Our baseline model for corporate investors is a fixed effects
model of the following form^9:
Y[it] = X[it]b + u[it
]For corporate investors, Y[it] represents the log of total
assets, total liabilities, or net assets; X[it] represents control
variables which include the lag of net assets, the NMTC
participation dummy, year dummies, and region dummies; and u[it]
represents a random error term.^10 Additional control variables
are not used because they are included in the fixed effect. These
variables include corporate-level characteristics, such as
industry, that do not change over time.
Statistical analysis of this baseline model indicates that
corporate NMTC investment funds are more likely to represent
investment funds shifted from other uses. Although there was some
evidence that NMTC investors have higher levels of net assets than
those in our comparison group, this result was not robust over
different specifications of the model. On the other hand, our
analysis of growth rates showed no statistically significant
effect of NMTC investment status on the growth of net assets. This
result means that NMTC investors are not investing at rates
different from non-NMTC investors. Unlike the case of asset
levels, this result was robust across several specifications
involving regression and propensity score methods, as indicated in
table 9.^11 In addition, the result was qualitatively the same for
each quintile, when we used only years 2001 through 2004 in the
analysis, when we used median regression, and when our analysis
included only banks.
^9 Initial Hausman tests indicated that fixed effects estimation was more
appropriate than random effects estimation.
^10 The Y, X and u variables are time-demeaned data. The inverse
hyperbolic sine transformation is used for net assets.
^11 Our regression techniques included using the change in the inverse
hyperbolic sine of net assets as a dependent variable and median
regressions of inverse hyperbolic sine and the change in inverse
hyperbolic sine. Our propensity scoring approach was to compare the change
in inverse hyperbolic sine of NMTC claimants to their nearest neighbor
(closest match) based upon their propensity score using differences in
2000 and 2003 data.
Table 9: Growth in Net Assets Using Fixed Effects Regression and
Comparisons Based on Nearest Neighbor Propensity Score Matching
Specification^a Average effect Coefficient Standard error
Nearest neighbor matching -2,883.972 6,740.992
Matching - CDFI Fund indentified -19,000.000 41,265.206
investors
Baseline regression - full 0.009 0.091
sample
Quintile one 0.002 0.012
Quintile two 0.020 0.090
Quintile three -0.065 0.614
Quintile four -0.065 0.306
Quintile five 0.662 1.134
Banks only 0.082 0.061
Tax years 2001 through 2004 -0.100 0.133
Median regression 0.000 0.003
Source: GAO analysis of IRS and CDFI Fund data.
Note: No coeffiecients were significant at the 10 percent or
better level.
aUnless otherwise noted the dependent variable is the difference
in the inverse hyperbolic sine of net assets. This transformation
was used instead of the related log transformation to better
address zero and negative values.
Further analysis included using instrumental variables for
predicting participation in the NMTC. However, we did not find
important differences between participants and nonparticipants
based on location and participation in other general business
credits. We concluded that the problem of endogeneity^12 may not
be a significant issue for corporations because corporate
participants are likely to be exposed to a similar set of
investment options as nonparticipants and individual corporate
characteristics that affect participation are captured in the
fixed effect. We also attempted to identify the source of the
shifted investment funds by dividing net assets into components,
total assets and total liabilities. However, these results were
inconclusive as they were not consistent enough to reach any
strong conclusions.
A limitation of our analysis of corporations is that the amount of
NMTC investment might be small relative to a corporation's total
size. This means that our statistical models could fail to detect
a positive effect of the NMTC investment on corporations' asset
levels even if such an effect exists. We attempted to mitigate
this problem by analyzing firm-level data, the smallest unit of
analysis available, and growth in assets over time.
We assessed the effect of NMTC participation on level and growth
of assets for individuals in a manner similar to the analysis for
corporations. Our baseline model for individual investors is a
fixed effects model of the following form:
y[it] = gN[it] + X[1it]b + n[it
]where y is the dependent variable, wealth, for household i at
time t; N is an indicator for NMTC investment (which is
endogenous, i.e., correlated with the error term); X is a set of
exogenous control variables; g and b are coefficients; and n[it]
is an error term.^13
However, unlike the analysis of corporate investors, we analyzed
the effect of NMTC on individuals by estimating an instrumental
variables^14 version of the baseline model to account for possible
endogeneity of the NMTC participation variable. We concluded that
this problem is likely to be worse for individuals than for
corporations because individuals are less likely to have the same
information about the various business tax incentives so that the
decision to participate is not random and likely to be correlated
with other explanatory variables. We chose as our instrumental
variables the dollar amount of allocation in the state of
residence and the presence of other general business credits.^15
These variables are likely to be highly correlated with NMTC
participation but not with levels of household wealth.
^12 A regression model suffers from endogeneity if one or more of the
explanatory variables is correlated with the error term (the unexplained
portion of the variance in the dependent variable).
^13 The household specific effect (u[i]) is fixed over time and
differenced out of the equation.
^14 An instrumental variables estimator is a method in which another
variable that is not correlated with the error term and is (partially)
correlated with the endogenous explanatory variable (NMTC participation)
is used to predict the endogenous variable in a separate equation.
^15 Our analysis of correlations indicated that the presence of the
general business credit is not strongly correlated with wealth, as one
might expect. This is likely because claiming these credits is relatively
rare for individual filers and presence of the credit might be more
indicative of a preference for certain types of tax planning or awareness
of tax incentives.
To implement the instrumental variables model, we first estimated
N as follows:
N[it] = X[1it] b+ X[2it]l + n[it
]where X[2] contains our instrumental variables and the other
variables are defined as in the baseline model. This regression is
used to predict NMTC participation using presence of a general
business credit deduction and the cumulative NMTC allocation in
state of residence as instrumental variables.^16 We then estimated
the baseline fixed effects model with Y[it] as the log of wealth
and X[it] as control variables, which include balance due, an NMTC
participation dummy (instrumented), year dummies, and region
dummies.^17 In order to test the effect of NMTC participation on
the components of wealth, we also ran regressions with Y[it] as
the log of business assets, real estate assets, dividend assets,
and interest bearing assets. Like wealth, these asset levels were
measured in thousands of dollars and adjusted into constant
dollars using the CPI research series. The results of this
analysis for asset levels of individuals are presented in table
10. The coefficient for NMTC investor in the wealth column
indicates that the log of wealth (in thousands of dollars) is
significantly higher than for noninvestors.
^16 STATA's panel IV regression models do not include a categorical
variable option for the first-stage regression so we are running a linear
probability model for the first stage.
^17 Demographic information was not included as those variables are
constant over the panel.
Table 10: Baseline Analysis: Instrumental Variables Fixed Effects
Regressions on the Full Sample
Wealth Interest assets Business assets
Standard Standard Standard
Variable Coefficient error Coefficient error Coefficient error
NMTC 2.346 0.331 2.719 0.665 17.287 0.950
investor
Total income 0.245 0.006 0.587 0.011 0.360 0.016
(log)
Balance due 0.038 0.002 -0.031 0.005 0.070 0.006
New England -0.071 0.084 0.269 0.169 0.324 0.242
East North -0.242 0.078 0.028 0.156 0.517 0.223
Central
West North 0.003 0.097 -0.315 0.196 0.363 0.279
Central
South -0.134 0.063 -0.170 0.127 0.155 0.181
Atlantic
East South -0.232 0.101 -0.319 0.203 0.437 0.289
Central
West South 0.135 0.086 0.301 0.172 0.630 0.246
Central
Mountain -0.125 0.081 -0.062 0.162 0.236 0.232
Pacific -0.227 0.075 -0.008 0.150 0.103 0.214
Year 1998 0.097 0.016 0.061 0.032 0.068 0.046
Year 1999 0.158 0.016 -0.025 0.032 0.099 0.046
Year 2000 0.372 0.016 0.338 0.032 0.259 0.046
Year 2001 0.211 0.016 0.210 0.032 0.270 0.046
Year 2002 0.061 0.016 -0.267 0.033 0.405 0.046
Year 2003 0.069 0.017 -0.687 0.033 0.569 0.047
Year 2004 0.072 0.017 -0.920 0.035 0.506 0.050
Constant 3.383 0.055 -3.022 0.110 -8.314 0.156
Number of 186,241 186,241 186,241
observations
Number of 24,933 24,933 24,933
groups
Overall 0.157 0.190 0.038
R-squared
Source: GAO analysis of CDFI Fund and IRS data.
Notes: The dependent variables are in log form and all bold type indicates
significance at the 5 percent level. Further, "NMTC investor" is
instrumented using total income (log), balance due, allocations in state
of residence (log), presence of another general business credit (log),
region, and year. The Middle Atlantic is the omitted region and 1997 is
the omitted year.
The coefficients of these regressions should not be used to generate
numeric estimates of the magnitude of the effect that the NMTC has on
asset levels. In some cases, the fit of our models is poor and it is
difficult to estimate the value of some types of assets, in particular
business assets. Our results for both the baseline analysis and propensity
scoring are intended to illustrate the direction of the effect that the
NMTC has on participating individuals' investments.
Nonetheless, these results show that NMTC participants have higher levels
of wealth and business assets than those in the comparison group after
controlling for individual fixed effects, year, region, and tax balance
due--a proxy for risk attitudes. These results are consistent across four
of five quintiles, using data for years 2001 through 2004 only, and using
3-year averages for the dependent variable. However, it may be that these
differences in asset levels are simply picking up the likelihood that NMTC
claimants systematically have higher assets that their counterparts. (The
summary statistics show that individual NMTC investors have higher asset
levels on average than the comparison group despite our use of a
stratified random sample where comparison households were chosen based on
levels of adjusted gross income in tax year 2000.) Therefore, as an
alternative measure of the effect of NMTC participation, we compare the
growth in assets between the two groups using closest neighbor propensity
score matching to further narrow the comparison group and estimate the
effect of NMTC participation on asset growth.^18 We used year 2000 data to
estimate propensity scores for future participation in the NMTC. The
specification for our propensity scoring is as follows:
Prob(N=1) = G(X[i] b)
Where N represents any NMTC participation from 2001 through 2004; X
includes age, balance due, total income, presence of another general
business credit, wage earnings, and dividend earnings; and G( . ) is the
cumulative standard normal distribution.
We then estimated the effect of NMTC participation on the change in the
log of wealth asset levels from 2000 through 2004. Our results show that
individuals who participate in the NMTC have higher growth in interest
bearing assets, business assets, and wealth which is consistent with the
results we obtained for our instrumental variables regressions. For
example, the first column in table 11 indicates that the growth in wealth
for NMTC investors was significantly higher than that of noninvestors.
^18 We experimented with difference-in-log specifications to measure
growth in our fixed effects models, but the fit of the models was not
sufficient to interpret the results.
Table 11: Growth in Assets: Comparisons Based on Nearest Neighbor
Propensity Score Matching
Interest-bearing Real Estate
Wealth assets Business assets assets Dividend assets
Average Average Average Average Average
NMTC Standard NMTC Standard NMTC Standard NMTC Standard NMTC Standard
effect error effect error effect error effect error effect error
0.881 0.152 1.554 0.351 3.112 0.527 0.385 0.441 0.650 0.431
Source: GAO analysis of IRS and CDFI Fund data.
Notes: Average effects are on the difference in the log of the asset from
2000 to 2004 and bold type denotes significance at the 1 percent level.
Literature Review and Credits
To develop our methodology, we relied heavily on savings literature, which
generally compares the wealth or financial assets of participants in
retirement savings plans to those of nonparticipants to detect any effect
of participation on savings. The following list of publications provided
us with important information in developing our methodological approach.
1. Engen, Eric M., and William G. Gale. "The Effects of 401(k)
Plans on Household Wealth: Differences Across Earnings Groups."
NBER Working Paper No. 8032, 2000.
2. Engen, Eric M., William G. Gale, and John Karl Scholz. "Do
Saving Incentives Work?" Brookings Papers on Economic Activity,
vol., no.1 (1994).
3. Engen, Eric M., William G. Gale, and John Karl Scholz. "The
Illusory Effects of Saving Incentives on Saving." Journal of
Economic Perspectives, vol. 10, no. 4 (1996).
4. Hubbard, R. Glenn, and Jonathan S. Skinner. "Assessing the
Effectiveness of Saving Incentives." Journal of Economic
Perspectives, vol. 10, no. 4 (1996).
5. Pence, Karen M. "401(k)s and Household Saving: New Evidence
from the Survey of Consumer Finances." Finance and Economics
Discussion Series 2002-6. Washington, D.C.: Board of Governors of
the Federal Reserve System, 2002.
6. Poterba, James M., Steven F. Venti, and David A. Wise. "Do
401(k) Contributions Crowd Out Other Personal Saving?" Journal of
Public Economics, vol. 58 (1995).
7. Poterba, James M., Steven F. Venti, and David A. Wise. "How
Retirement Saving Programs Increase Saving." Journal of Economic
Perspectives, vol. 10, no. 4 (1996).
8. Poterba, James M., Steven F. Venti, and David A. Wise.
"Personal Retirement Saving Programs and Asset Accumulation:
Reconciling the Evidence." NBER Working Paper No. 5599, 1996.
We also consulted several experts in the course of our work, including
Arthur Kennickel, Karen Pence, James Poterba, and Paul Smith, to discuss
the methodology for our statistical analysis. They provided comments that
we incorporated into our statistical models.
Appendix III: NMTC Investment Data by State, Fiscal Years 2003 through
2005
Percentage of Number of Percentage
Total dollar amount of all loans and NMTC of NMTC
State loans and investment investment projects projects
California $303,081,270 9.74 58 9.95
New York 239,178,566 7.68 25 4.29
Ohio 201,857,969 6.49 69 11.84
Maine 153,527,250 4.93 13 2.23
Wisconsin 149,131,108 4.79 26 4.46
Missouri 146,165,868 4.70 22 3.77
Massachusetts 145,059,237 4.66 34 5.83
Kentucky 135,117,406 4.34 44 7.55
North Carolina 126,420,590 4.06 14 2.40
Washington 125,703,680 4.04 19 3.26
Minnesota 122,587,357 3.94 13 2.23
Oklahoma 112,092,186 3.60 24 4.12
Oregon 111,464,317 3.58 14 2.40
Maryland 106,171,382 3.41 14 2.40
New Jersey 83,439,000 2.68 7 1.20
Pennsylvania 77,111,177 2.48 21 3.60
Arizona 68,476,055 2.20 8 1.37
District of 67,715,807 2.18 10 1.72
Columbia
Texas 65,644,265 2.11 11 1.89
Michigan 57,541,869 1.85 10 1.72
Virginia 55,898,873 1.80 8 1.37
Rhode Island 55,235,675 1.77 3 0.51
Utah 53,884,716 1.73 14 2.40
Georgia 38,516,906 1.24 4 0.69
Florida 38,261,093 1.23 8 1.37
Louisiana 36,162,671 1.16 4 0.69
Connecticut 34,819,477 1.12 3 0.51
Indiana 26,098,460 0.84 3 0.51
Tennessee 22,249,867 0.71 21 3.60
Iowa 20,229,952 0.65 5 0.86
Nebraska 18,778,563 0.60 2 0.34
Delaware 17,000,000 0.55 1 0.17
Mississippi 16,310,758 0.52 2 0.34
Colorado 15,942,664 0.51 7 1.20
Idaho 12,890,000 0.41 10 1.72
Illinois 12,503,895 0.40 8 1.37
Arkansas 10,616,786 0.34 4 0.69
West Virginia 7,398,340 0.24 8 1.37
New Mexico 6,050,000 0.19 1 0.17
Alabama 5,000,000 0.16 1 0.17
South Carolina 3,607,755 0.12 2 0.34
Alaska 3,138,132 0.10 2 0.34
Puerto Rico 1,474,956 0.05 1 0.17
Wyoming 1,461,532 0.05 1 0.17
Nevada 588,750 0.02 1 0.17
Montana 457,200 0.01 1 0.17
Hawaii 250,000 0.01 2 0.34
Totals $3,112,313,380 100.00 583 100.00
Source: GAO analysis of CDFI Fund data.
Appendix IV: Comments from the Community Development Financial
Institutions Fund
Appendix V: Comments from the Internal Revenue Service
Appendix VI: GAO Contact and Staff Acknowledgments
GAO Contact
Michael Brostek, (202) 512-9110 or [email protected]
Acknowledgments
In addition to the contact named above, Kevin Daly, Assistant Director;
Thomas Gilbert; Evan Gilman; Tami Gurley-Calvez; Katherine Harper; Stuart
Kaufman; Summer Lingard; Don Marples; Donna Miller; Ed Nannenhorn; Karen
O'Conor; and Cheryl Peterson made key contributions to this report.
(450436)
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www.gao.gov/cgi-bin/getrpt?GAO-07-296 .
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and methodology, click on the link above.
For more information, contact Michael Brostek at (202) 512-9110 or
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Highlights of [57]GAO-07-296 , a report to congressional committees
January 2007
TAX POLICY
New Markets Tax Credit Appears to Increase Investment by Investors in
Low-Income Communities, but Opportunities Exist to Better Monitor
Compliance
The Community Renewal Tax Relief Act of 2000 authorized up to $15 billion
of allocation authority under the New Markets Tax Credit (NMTC) to
stimulate investment in low-income communities. The act mandated that GAO
report on the program to Congress by January 31, 2004, 2007, and 2010. Two
subsequent laws authorized an additional $1 billion in NMTC authority for
certain qualified investments and extended the program for 1 year with an
additional $3.5 billion of authority.
This report (1) describes the status of the NMTC program, (2) profiles
NMTC program participants, (3) assesses the credit's effectiveness in
attracting investment by participating investors, and (4) assesses IRS and
the Community Development Financial Institutions (CDFI) Fund compliance
monitoring efforts. To conduct the analysis, GAO surveyed NMTC investors,
conducted statistical analysis, and interviewed IRS and CDFI Fund
officials.
[58]What GAO Recommends
To ensure that it is reviewing the full range of NMTC transactions, IRS
should develop information for selecting which CDEs to audit as part of
its compliance study. In addition, IRS should work with the CDFI Fund to
further explore options for cost effectively monitoring investor
compliance.
IRS and the CDFI Fund agreed with our recommendations.
As of January 2007, the CDFI Fund had awarded $12.1 billion of NMTC
authority to 179 Community Development Entities (CDE). CDEs that received
allocations began making NMTC investments in 2003, and the program has
continued to grow since then. Investors use two main investment structures
to make NMTC investments: direct investments to CDEs and tiered
investments, which include equity investments and leveraged investments,
where a portion of the investment amount originates from debt and a
portion from equity.
Banks and individuals constitute the largest proportion of NMTC investors,
though banks and other corporations have made the largest share of NMTC
investment. CDEs that received allocations applied for allocations in a
competitive selection process and, through fiscal year 2005, most
investment from CDEs to low-income communities had been used for either
commercial real estate rehabilitation or new commercial real estate
construction.
NMTC Loans and Investment by Type of Activity for Fiscal Years 2003
through 2005
The results of GAO's survey and statistical analysis indicate that the
NMTC may be increasing investment in low-income communities by
participating investors. Investors indicated that they have increased
their investment budgets in low-income communities as a result of the
credit, and GAO's analysis indicates that businesses may be shifting
investment funds from other types of assets to invest in the NMTC, while
individual investors may be using at least some new funds to invest in the
NMTC.
The CDFI Fund and IRS developed processes to monitor CDEs' compliance with
their allocation agreements and the tax code. However, IRS's study of CDE
compliance does not cover the full range of NMTC transactions, focusing
instead on transactions that were readily available, and may not support
the best decisions about enforcement in the future. Moreover, IRS and the
CDFI Fund are not collecting data that would allow IRS to identify credit
claimants and amounts to be claimed.
References
Visible links
40. http://www.gao.gov/cgi-bin/getrpt?GAO-04-326
41. http://www.gao.gov/cgi-bin/getrpt?GAO-04-326
42. http://www.gao.gov/cgi-bin/getrpt?GAO-04-326
43. http://www.gao.gov/
44. file:///home/webmaster/infomgt/d07296.htm#mailto:[email protected]
45. http://www.gao.gov/cgi-bin/getrpt?GAO-02-769
46. http://www.gao.gov/cgi-bin/getrpt?GAO-03-673G
47. http://www.gao.gov/cgi-bin/getrpt?GAO-04-326
48. http://www.gao.gov/cgi-bin/getrpt?GAO/GGD/RCED-97-55
49. file:///home/webmaster/infomgt/d07296.htm#mailto:[email protected]
50. http://www.gao.gov/
51. http://www.gao.gov/
52. http://www.gao.gov/fraudnet/fraudnet.htm
53. file:///home/webmaster/infomgt/d07296.htm#mailto:[email protected]
54. file:///home/webmaster/infomgt/d07296.htm#mailto:[email protected]
55. file:///home/webmaster/infomgt/d07296.htm#mailto:[email protected]
56. http://www.gao.gov/cgi-bin/getrpt?GAO-07-296
57. http://www.gao.gov/cgi-bin/getrpt?GAO-07-296
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