Is the Hollywood Tax Credit Under Attack?

In a year when severe budget cuts are on the table, states are rethinking film tax-credit programs.

Governors and legislators from Michigan to Georgia, Louisiana to New Mexico are rethinking their film tax-credit programs. In a year when cuts to K-12 education, Medicaid and pension benefits are on the table, it shouldn't be surprising that tax expenditures like film incentives are getting their "close-up."

In a cover story last spring, Governing's Senior Editor Zach Patton covered film-credit concerns in many states. Some elected officials in places like Massachusetts and Michigan were beginning to question if film incentives were going too far. Six months later, those questions are being raised loudly in legislative debates. In Michigan, home to one of the most generous film tax-credit programs, the governor is calling for a cap on the refundable credits. All this begs the question: If 40 states have such programs, where does incentive end and pay-to-play begin?

I caught up with Peter Enrich, a law professor at Northeastern University's School of Law in Boston, to get his take on film tax incentives. Before turning to academia, Enrich was general counsel to Massachusetts's Executive Office for Administration and Finance. Here are highlights from our conversation.

What don't you like about using tax incentives to attract a business to a state?

I'm not convinced they are cost effective. But film tax credits are a special case. They are the reductio ad absurdum of the location-incentive approach. It's almost a misnomer to call them tax credits at all. The "credits" are either refundable -- they can be turned in for cash -- or they're transferable and can be sold to someone else. When you get into a discussion of film tax credits with citizens and policymakers, there's a lot of confusion. They're inclined to think, "Oh, it's a tax credit -- we're just not collecting tax from people who otherwise wouldn't be doing business in the state." But that's not true. The Massachusetts Department of Revenue did a study recently and found that for the $100 million of tax credits issued in 2008, only $100,000 was actually used to reduce tax liabilities of film producers. The rest was paid out in cash or to reduce the taxes of insurance companies and banks that had purchased credits from film producers.

You don't like other location-incentive tax credits either. Why is that?

The job or investment tax-credit tools states have used to chase smokestack industries for decades aren't big enough to outweigh other factors that influence location decisions. All you're doing is reducing the taxes of businesses that would have located there anyway. With film credits, they are big enough to make a difference -- they do drive decisions. But they're so expensive that they are not cost effective.

You've suggested that film tax credits ought to be treated as appropriations rather than tax expenditures. What do you mean?

In the appropriation process, you know what the revenues are in a given year and you decide how much to spend on program A, which may mean less for programs B, C and D. You're making that decision for the coming year and the coming year alone. You'll revisit the decision the following year. With tax expenditures, that's not true. In the vast majority of cases, a tax expenditure is enacted permanently or for years with no budgetary competitive process. Often tax credits have a low cost in the first couple of years, and build up in out years. So it's easy to minimize the actual costs since you don't have to face them in the [budget process].

How do you think states should evaluate their tax expenditure programs?

The first thing is to determine what it is you're trying to achieve. In most states, it's to create good employment opportunities for people in the state. So then the question is: How much benefit are you getting? How many jobs are you creating? How well paid are those jobs and how long will they last? And what's the tradeoff against what you're spending to get those jobs? With film credits, if the Massachusetts numbers are typical, we are paying vastly more in state dollars for the jobs than the wages of those jobs. Maybe if you were spending $10,000 or $20,000 to create a job paying $60,000 or $80,000 that will be here for 10 years, that's not a bad deal. But here you're spending two to three times the wages of what the jobs are paying, for a job that won't be there next year. The film industry is very footloose.

Are their fixes for these drawbacks? Does capping the program or limiting the transferability of the subsidy help?

Capping reduces how much money you're throwing away but doesn't make the use of that money any more effective. Take Michigan: If you could reduce the refundable credit from 40 percent of the film's costs to 5 percent, then the cost-benefit analysis might look different. But if you're only offering 5 percent, you won't attract any productions. As to limiting transferability, the film producers look at this and say, "How much is it worth to me?" The way film production financing works, production companies tend not to have substantial state tax bills. So it's not a meaningful incentive if it can't be transferred.

How does that measure up to a tax incentive for biotech or other industries?

A generous investment tax incentive might be 5 percent of the cost of the tax investment -- not total operating cost of the enterprise. At least with a smokestack or biotech company, a plant will be there for a while. They're likely to continue to employ people for a while [because there is an] asset fixed in the state. The film industry tax credit is on steroids. Its scale completely dwarfs the scale of any other kind of tax incentive.

Do you think we'll see changes this year?

My sense is that enough states are in enough fiscal trouble that at least some -- a small number initially -- are seriously rethinking whether they can they afford these programs. A few states may cap their programs, and maybe a few will suspend them. When virtually every state is doing it, however, it's a little hard to be the first state to unilaterally disarm.

You've also argued that these location-based tax incentives are unconstitutional. How's that?

They violate the Constitution's commerce clause. There have been a number of court decisions that have recognized that. However, anything the courts decide is unconstitutional, Congress could turn around and authorize states to do it. Seven years ago, Ohio's investment tax credit was found unconstitutional by a federal appeals court. While an appeal to that ruling was pending, Congress moved quite rapidly to overrule that decision and allow the state to offer an investment tax credit.

Elizabeth Daigneau is GOVERNING's managing editor.