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

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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.
			  
			  IRSï¿½s 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
			  CDEsï¿½ 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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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

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  44. file:///home/webmaster/infomgt/d07296.htm#mailto:[email protected]
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  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/
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  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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