Tax Policy: New Markets Tax Credit Appears to Increase Investment by Investors in Low-Income Communities, but Opportunities Exist to Better Monitor Compliance
Published: 2007-01-31T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: 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.
section_title: What GAO Found
paragraphs: 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. 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.

section_title: Letter
paragraphs: Congress established the New Markets Tax Credit (NMTC) program in the  Community Renewal Tax Relief Act of 2000 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 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, 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.
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.
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.
subsections: section_title: Background
paragraphs: 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,  facilitate economic development in these communities, and encourage  investment in high-risk areas. 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.
subsections: section_title: The NMTC Investment Process
paragraphs: 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. 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. 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.
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. In turn, the CDE must invest “substantially all” 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.
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.
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.
section_title: Legislative Changes Created Targeted Populations
paragraphs: Two recent legislative changes have increased the number of areas where  NMTC investments can be made. First, the American Jobs Creation Act of  2004 added “targeted populations” to the eligibility criteria for NMTC  investments. Second, Congress also expanded the NMTC program in  2005, 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. 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.
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.
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.
section_title: Authorized Allocation Rounds End in 2008
paragraphs: Congress initially provided a schedule for allocating annual NMTC  authority to CDEs for calendar years 2001 through 2007. 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.
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, 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.
section_title: CDEs Are Using NMTC Allocations to Invest in Low-Income Communities, and the CDFI Fund Is Tracking Program Implementation
paragraphs: 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.
subsections: section_title: NMTC Allocations and Investments in CDEs and Low-Income Communities Have Increased in Number and Amount
paragraphs: 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.
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.
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.
The CDEs used this QEI to make investments in 583 qualified NMTC  projects totaling $3.1 billion through fiscal year 2005. 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.
section_title: The Ability of Investors to Use Tiered Investment Structures May Have Contributed to the Growth of the NMTC Program
paragraphs: 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.  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. 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, 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.
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 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.
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.
section_title: The CDFI Fund’s Data Collection Systems Are Operational
paragraphs: 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.
A brief description of these data collection systems follows.
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.
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.
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.
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.
section_title: Financial Institutions and Individuals Are the Primary NMTC Investors, and CDEs Most Often Use NMTC Investments to Make Loans to Qualified Businesses
paragraphs: Banks and individuals constitute the majority of NMTC claimants when  qualified equity investments are originally made. 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. 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.
subsections: section_title: NMTC Investors Tend to Be Financial Institutions with Larger Net Assets and Individuals with Higher Incomes
paragraphs: 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.
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 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). Similarly,  individual NMTC investors had larger adjusted gross incomes than other  individuals who filed tax returns in tax year 2003. 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.
In response to our survey, NMTC investors indicated that they decided to  participate in the NMTC program for a variety of reasons. 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.
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.
section_title: The Average Expected Return on NMTC Investment Has Declined
paragraphs: As NMTC investment structures have become increasingly complex in  recent years, the expected rate of return for NMTC investments  decreased. 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.
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.
section_title: CDEs Apply for More NMTC Allocations Than Are Available and Relatively Few CDEs Receive Allocations
paragraphs: 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.
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.
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.
section_title: Businesses Primarily Receive Loans from CDEs That They Use Chiefly for Investment in Commercial Real Estate
paragraphs: 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 and to provide working capital for businesses. 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.
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. According to CDFI Fund data, the most common types of loans  being made to qualifying business with better rates and terms 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.
section_title: The Communities Receiving the Investment Tend to Be More Highly Distressed
paragraphs: 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,” 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.
section_title: 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
paragraphs: 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.
subsections: section_title: NMTC Investors Reported That They Increased Their Investment in Low-Income Communities Because of the Credit, but Other Factors May Also Play a Role
paragraphs: 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.
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.
section_title: Statistical Analysis Suggests That Some NMTC Investment by Participating Investors May Be Investment Shifted from Other Assets and Some May Be New Investment
paragraphs: 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 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.
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. 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. 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.
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 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. 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.
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.
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.
section_title: 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
paragraphs: 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. 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.
section_title: IRS and the CDFI Fund Monitor NMTC Compliance, but Additional Opportunities Exist to Better Measure Noncompliance and Identify NMTC Investors
paragraphs: 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.
subsections: section_title: IRS’s Compliance Study Methodology Could Be Improved to Be More Representative of the Population of CDEs
paragraphs: 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. 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.
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). 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.
section_title: The CDFI Fund Has Systems and Procedures in Place to Monitor CDEs’ Compliance with Allocation Agreements
paragraphs: 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.
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.
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.
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.
section_title: IRS and the CDFI Fund Have an MOU for Compliance Monitoring, but Additional Opportunities Exist to Monitor Investor Compliance
paragraphs: IRS and the CDFI Fund have cooperated in their compliance efforts. As  part of their response to our initial NMTC report, 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.
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. 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. 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.
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.
section_title: Investors in CDEs Play a Role in Ensuring NMTC Compliance
paragraphs: 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.
section_title: Conclusions
paragraphs: 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.
section_title: Recommendations for Executive Action
paragraphs: 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.
section_title: Agency Comments
paragraphs: 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 brostekm@gao.gov.  Major contributors to this report are  acknowledged in appendix VI.
section_title: Appendix I: Objectives, Scope, and Methodology
paragraphs: 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. 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.
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.
section_title: Appendix II: Description of Data and Methodology for Statistical Analysis of the Effect of NMTC Participation on Investment
paragraphs: 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. 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.
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.
subsections: section_title: Description of Data
paragraphs: 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. 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. 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. 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) was used to adjust the year 2000 estimates  for earlier and later years.
section_title: Effects of NMTC Program Participation on Investment
paragraphs: 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. 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. Differences  in growth rates between NMTC investors and the comparison group do not  depend on differences in the level of assets.
Our baseline model for corporate investors is a fixed effects model of the  following form:  Yit = Xitβ + µit For corporate investors, Yit represents the log of total assets, total  liabilities, or net assets; Xit represents control variables which include the  lag of net assets, the NMTC participation dummy, year dummies, and  region dummies; and µit represents a random error term. 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. 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.
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 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:  yit = γNit + X1itβ + νit 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; γ and β are  coefficients; and νit is an error term.
However, unlike the analysis of corporate investors, we analyzed the effect  of NMTC on individuals by estimating an instrumental variables 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. These variables are likely to  be highly correlated with NMTC participation but not with levels of  household wealth.
To implement the instrumental variables model, we first estimated N as  follows:  Nit = X1it β+ X2itλ + νit where X 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. We then estimated the baseline fixed effects model with Yit as  the log of wealth and Xit as control variables, which include balance due,  an NMTC participation dummy (instrumented), year dummies, and region  dummies. In order to test the effect of NMTC participation on the  components of wealth, we also ran regressions with Yit 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.
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. 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 β)
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.
section_title: Literature Review and Credits
paragraphs: 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.
section_title: Appendix III: NMTC Investment Data by State, Fiscal Years 2003 through 2005
subsections: section_title: Total dollar amount of
section_title: Appendix IV: Comments from the Community Development Financial Institutions Fund
section_title: Appendix V: Comments from the Internal Revenue Service
section_title: Appendix VI: GAO Contact and Staff Acknowledgments
subsections: section_title: Acknowledgments
paragraphs: 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.