Community Development Financial Institution (cdfi) Tax Credit

C D F I (CDFI) T C OMMUNITY EVELOPMENT INANCIAL NSTITUTION AX REDIT Chapter 436 of 2011 (AB 624, J. Pérez), extended until January 1, 2017, provisions of the state’s personal income tax, corporation tax, and insurance tax laws that provide certain credits to individuals and businesses that make qualifi ed investments in CDFIs. According to prior fl oor analyses, the CDFI tax credits originally were created in 1996 “as an alternative to state legislation that would have required insurance companies to invest in low-income urban and rural communities” (just as the Federal Community Reinvestment Act requires for most banks). Chapter 608 of 2013 (AB 32, J. Pérez), increased the amount of tax credits available from $2 million to $10 million per year, added new reporting requirements, and modifi ed the process for allocating credits. Pursuant to Chapter 608, our offi ce is required to evaluate the effectiveness of the CDFI tax credits with a focus on employment in low-to-moderate income and rural areas. This report fulfi lls that reporting requirement. (Our offi ce previously evaluated the CDFI tax credits in a similar report dated April 14, 2011.) Background What Are CDFIs? According to the California Department of Insurance (CDI), CDFIs are “mission-driven community organizations, separate from government control, dedicated to providing fi nancial products and services to low-income communities underserved by traditional fi nancial markets.” This description covers a variety of private organizations that are certifi ed as CDFIs by the California Organized Investment Network (COIN)—an offi ce within CDI. The U.S. Treasury also certifi es CDFIs, but COIN does not require that California CDFIs be federally certifi ed—although many are. Most CDFIs are non-depository lenders and loan funds that lend money to affordable housing projects, businesses and non-profi t organizations, and various other community development projects. Some CDFIs instead take equity positions in community development projects. Often, CDFIs are organized as nonprofi ts, but they may be a for-profi t organization. Some CDFIs are depository institutions—such as a credit union. CDFI Tax Credit Program. The goal of this tax credit program is to provide incentives—through credits against the personal income tax, the corporate income tax, and the insurance gross premiums tax—to attract private capital investments that otherwise would not be available to CDFIs. Qualifi ed investments in state CDFIs eligible for the credits include (1) loans or deposits that do not earn interest, (2) equity investments, or (3) “equity-like debt instruments” meeting certain specifi cations. All qualifi ed investments must be equal to or greater than $50,000 and for a minimum term of fi ve years. The credit is equal to 20 percent of the qualifi ed amount invested in a state-certifi ed CDFI. The total for all credits for all recipients is capped at $10 million per year for the three taxes combined. Accordingly, each year, up to $50 million in eligible investments in CDFIs may qualify for up to $10 million in tax credits. If the aggregate amount of eligible investments made in any calendar year is less than $50 million, state law provides that the difference between $10 million and the actual amount of allocated CDFI tax credits may be carried over to the next year. When the total amount of eligible investments LEGISLATIVE ANALYST’S OFFICE 1 exceeds available tax credits, the COIN program has the authority to qualify a smaller portion of the eligible state CDFI investments for a tax credit. Tax Credit Investments. The CDFIs lend or invest their capital to various community development projects. It is as diffi cult to generalize the nature of these investments as it is to generalize the nature of the CDFIs. According to data provided by the COIN program, about three-fourths of eligible CDFI tax credit investments in 2014 and 2015 (by dollar amount) have been invested in affordable housing projects. As we show in Figure 1, state CDFI tax credit investments have also benefi ted other types of projects. We describe some examples of CDFIs and their investments in the box on the next page. Figure 1 Use of State CDFI Tax Credit Investments Percentage of Total Investments by Type of Usea Affordable Housing Small Business Community Facilities Education 2015 2014 Water Treatment & Efficiency Health Clinics 10 20 30 40 50 60 70 80 90 100% a Type of use classified by the California Organized Investment Network, California Department of Insurance. CDFI = community development financial institution. Program Has Signifi cantly Expanded Tax Credits Now Fully Utilized. We evaluated the CDFI tax credit program in 2011. At that time, we observed that the tax credit program had not been fully utilizing its capacity, and several million dollars in unclaimed CDFI tax credits had accumulated. In 2013, the Legislature expanded the program from $2 million to $10 million—as we LEGISLATIVE ANALYST’S OFFICE 2 Four Examples of State Certifi ed Community Development Financial Institutions (CDFIs) Self-Help. Self-Help is a family of fi ve affi liated nonprofi t organizations— including a charitable nonprofi t, two credit unions, a loan fund, and a research and policy center. Self-Help’s stated mission is “to expand opportunities for underserved communities.” In addition to doing business in California, the Self-Help organization is active in North Carolina, Illinois, and Florida. Between 2011 and 2015, Self-Help received 48 state CDFI tax credit investments totaling $6 million for small business loans. Most of these investments were made by private individuals. Two insurance companies invested a total of $500,000 in Self-Help Federal Credit Union in 2012. Clearinghouse CDFI. Clearinghouse is a nonprofi t corporation that makes a wide range of housing and community development project loans. Its stated mission is “fi nancial lending for projects with measurable impacts.” Between 2011 and 2015, a number of banks made 20 state CDFI tax credit investments in Clearinghouse CDFI totaling $7 million. This capital allowed Clearinghouse to invest in projects such as a biomass electric facility in Madera County and a community center building in Vallejo. Genesis LA. This CDFI makes direct loans and investments to community and economic development projects in underserved areas of Los Angeles. Genesis LA received fi ve investments totaling $5.25 million in 2014 and 2015 from four banks and one insurance company. Some of the investments made by Genesis LA include loans to build an after school program for low-income students in Watts and an early child development center for low-income families in need of childcare in the Koreatown neighborhood of Los Angeles. Enterprise Community Partners. Enterprise Community Partners is a nationwide organization that lends funds, fi nances development, and manages and builds affordable housing. Its stated mission “is to create opportunity for low- and moderate-income people through affordable housing in diverse, thriving communities.” Two subsidiaries have received state CDFI tax credit investments. The Enterprise Community Loan Fund received fi ve investments totaling $10.5 million in 2015 from two insurance companies—MetLife and UnitedHealthcare. Some of these investments helped fund the purchase of a one-acre site in the Koreatown neighborhood of Los Angeles that will be the site of a fi ve story mixed-use multifamily building. Enterprise Community Investment received 24 investments from banks and insurance companies between 2012 and 2015 totaling $63.9 million. A project funded by some of these investments was the rehabilitation of a building in Oakland to create 137 units of affordable rental housing. LEGISLATIVE ANALYST’S OFFICE 3 show in Figure 2, the Figure 2 $8 million increase in Annual Utilization of CDFI Tax Credit Program tax credit capacity was rolled over to 2014. (In Millions) The COIN program Eligible Qualifi ed CDFI CDFI Tax Credits Investments Investments Tax Credits Tax Credits Available awarded $13.8 million Year In CDFIs In CDFIs Available Awarded Next Year in tax credits in 2014 and rolled over 2011a $23.6 $23.6 $4.7 $4.7 — 2012 10.0 10.0 2.0 2.0 — $4.2 million in tax 2013b 10.0 10.0 10.0 2.0 $8.0 credits to 2015. In 2014 69.0 69.0 18.0 13.8 4.2 2015, as we show in 2015 89.6 71.0 14.2 14.2 — Figure 2, taxpayers a $2.7 million in tax credits were carried over to 2011 from 2010. b invested $89.6 million CDFI tax credit program increased from $2 million to $10 million in 2013. CDFI = community development fi nancial institution. in CDFIs (eligible investments). Given that the credit is capped at only $10 million of new incentives each year, COIN could qualify only $71 million of the total amount of eligible investments. No credits were rolled over to 2016. A preliminary survey of CDFIs suggests that tax credit eligible investments in 2016 could exceed $150 million—up substantially from prior years. Credits Awarded Competitively. Until recently, the COIN program awarded state CDFI tax credits on a fi rst-come, fi rst-served basis. As we noted in 2011, this did not allow the state to prioritize CDFI investments to fi t desired policy objectives. Now that the demand for credits somewhat exceeds capacity, however, the COIN program has implemented an application scoring and weighting methodology to competitively award CDFI tax credits. This process aims to give priority to (1) investments that may generate higher economic, social, and environmental benefi ts; (2) CDFIs with the greatest fi nancial and operational capacity to deliver those benefi ts; and (3) investors that are insurance companies. Figure 3 shows the scoring questions used by COIN to evaluate and weigh the tax credit applications. In 2015, the COIN program qualifi ed for a tax credit only about one-fourth Figure 3 of the eligible CDFI investments made Tax Credit Application Scoring Questions by the lowest-scoring (cid:129) Direct benefi t to low-to-moderate income households? investors. (All other (cid:129) Direct benefi t to rural areas? eligible investments (cid:129) Green investment? in 2015 were fully (cid:129) Affordable rental housing? (cid:129) Community-based residential programs? qualifi ed for the tax (cid:129) Self-help housing? credit.) (cid:129) Veteran housing? Technical (cid:129) Single-family owned housing? (cid:129) Is the investor an insurance company? Assistance and (cid:129) Estimated number of temporary jobs created? Underwriting. The (cid:129) Estimated number of permanent jobs created? COIN program works (cid:129) Estimated number of jobs in high unemployment areas? with CDFIs on an (cid:129) Is there any other statistical information that addresses the previous factors? LEGISLATIVE ANALYST’S OFFICE 4 on-going basis to evaluate their fi nancial and organizational capacity. For example, the program works with CDFIs before they submit tax credit applications to provide advice on their investment capacity and funding needs. Participating CDFIs provide COIN with quarterly updates on tax credit investments. In addition, the COIN program educates insurance companies about CDFIs. It is our understanding that many insurance companies may be unfamiliar with CDFIs and the types of investments they require. Moreover, many large institutional investors—such as insurance companies—typically prefer to make larger investments than most state-certifi ed CDFIs have the fi nancial capacity to use. To address these concerns, the COIN program reportedly helps to connect insurance companies with CDFIs that are seeking new investments. The program staff review eligible investments in CDFIs and may work with both parties to help structure the investment agreements. Tax Credit Effectiveness Appears to Have Increased CDFIs’ Access to Capital. Interest in the state CDFI tax credit program appears to have signifi cantly increased. According to preliminary estimates provided by the COIN program, tax credit eligible CDFI investments could exceed $150 million in 2016—more than double the $69 million in 2014. While this appears to be a signifi cant increase in investments in state-certifi ed CDFIs, it is also worth noting that CDFIs are capitalized in many ways and not only through investments facilitated by the COIN program. Our earlier comments regarding the wide variety of CDFIs are also relevant here. While this tax credit program has likely increased the amount of capital available to some small- and medium-sized state CDFIs, we think it has had a much less signifi cant effect on the largest CDFIs. Insurance Company Participation Has Declined. The legislative history of the CDFI credits—and the placement of its administration within CDI—suggest that a key goal of the program has been to encourage insurance company investments in CDFIs. In our earlier report, we observed that only a small number of insurance companies were participating in the program. By 2011, however, their participation increased signifi cantly, with eight insurance companies investing a total of $16.3 million in CDFIs—about 70 percent of the total eligible investments in state CDFIs that year. However, as shown in Figure 4 (see next page), the relative participation of insurance companies has been declining in recent years. In 2015, three insurance companies invested a total of $22.3 million in CDFIs—about a quarter of the eligible investments. Preliminary estimates provided by the COIN program suggest that insurance companies will make about one-third of all tax credit eligible CDFI investments in 2016. (The fi nal level of participation in the program could increase, however, because we understand that insurance companies tend to invest later in the year than other CDFI investors.) The COIN program gives insurers’ tax credit applications priority under existing regulations, so it is also possible that insurers may receive more than a third of the tax credits in 2016. COIN Estimates Some Economic Effects of Each Investment. The tax credit application requires that CDFIs provide various information and “impact” metrics about the investment—such as the percentage of the investment that will provide a direct benefi t LEGISLATIVE ANALYST’S OFFICE 5 to low-to- Figure 4 moderate income households Participation by Insurance Companies and estimates Insurance Company Investments in CDFIs as Percentage of All Investments of the number of jobs created. 100% In addition, the 90 COIN program 80 estimates the 70 total fi nal economic output 60 and employment 50 of each eligible 40 investment 30 using commonly 20 accepted 10 economic multipliers from 2011 2012 2013 2014 2015 the U.S. Bureau CDFI = community development financial institution. of Economic Analysis (RIMS II). Using this methodology, COIN estimates that a $1 million affordable housing investment, for example, would generate 16.8 direct, indirect, and induced jobs and $2.29 million in fi nal economic output. In comparison, COIN estimates that $1 million in loans to small businesses would generate 14 jobs and $2.28 million in fi nal economic output. While there are limitations to this methodology, the use of RIMS II multipliers allows for a consistent comparison of projects within a program such as this one. Tax Credits May Increase Employment in Low-to-Moderate Income Areas. Consistent with legislative intent, the tax credit appears to result in more resources to CDFIs, which invest that capital in low-to-moderate income areas of the state that may not have otherwise received those investments. All of the eligible CDFI tax credit investments are in low-to-moderate income areas of California. Based on the information provided to us by COIN, the CDFI tax credit investments made between 2011 and 2015 could directly result in (the full-time equivalent of) roughly 1,400 jobs in low-to-moderate income areas. (We do not have any detailed information about these jobs. The estimate is based on the amounts of the investments in CDFIs and the types of projects identifi ed at the time of the application for the tax credit. The investments made by the CDFIs may ultimately differ from the projects identifi ed on the tax credit application.) Overall Net Effects on State Economy. As we discuss in the box on the next page, we would expect the total statewide net increase in employment due to the credit to be signifi cantly less than 1,400 jobs—and could be zero or even negative—because of other complex economic factors. While credits may benefi t the specifi c segment of the economy LEGISLATIVE ANALYST’S OFFICE 6 at which they are targeted, overall net effects for the state’s economy generally are much less positive. Investments in Rural Areas Growing. In 2012, only two state CDFI tax credit investments were in rural areas, about 12 percent of the total dollar amount. Chapter 608 specifi cally prioritized investments in rural areas and the number and dollar amounts of investments in rural areas increased considerably in 2014—to 26 investments and Estimating the Economic Effects of Tax Credits Our offi ce is often asked to evaluate the economic and employment effects of tax credits. In doing so, it is helpful to try to distinguish between (1) “new spending” resulting from the tax credit and (2) spending that would have occurred in the economy regardless of whether or not the tax credit existed. In addition to any direct effects of the spending in isolation, this new spending in the economy causes various indirect and induced economic effects—some positive and some negative. It is diffi cult to identify and quantify all of these effects, which may include “opportunity costs” and “windfall benefi ts.” Opportunity Costs. There are two major types of opportunity costs of tax credits, including the community development fi nancial institution (CDFI) tax credit: • A tax credit directly and indirectly changes the behavior of some businesses and individuals. Those businesses that invest in a CDFI in order to receive a tax credit would have otherwise invested their money in some other way. That other investment may have had similar economic effects. The tax credit subsidized investment also may have indirectly “crowded out” an investment that would have otherwise been made by a different business or individual. • A tax credit puts more money in the accounts of some businesses and individuals to spend and invest in the economy. However, it prevents the state government from using those funds for other public purposes—ranging from spending on other programs to broader tax reductions. Those alternative actions by government would have benefi ted a different set of businesses and individuals, potentially providing a similar benefi t to other parts of the economy as the CDFI tax credit. Windfall Benefi ts. Often, tax credits do not change the behavior of their recipients. In these cases, a tax credit is essentially a windfall benefi t to the taxpayer for doing something they would have done even had they not received the tax credit. Windfall benefi ts occur with most, if not all, tax credit programs but it can be very diffi cult to determine whether or not a tax credit has changed the behavior of any specifi c business or individual. LEGISLATIVE ANALYST’S OFFICE 7 22 percent of the total dollar amount. As we show in Figure 5, that trend has reversed somewhat in 2015, when 24 investments were made in CDFIs in rural areas representing 21 percent of the total dollar amount. Based on the information provided to us by COIN, the CDFI tax credit investments made between 2011 and 2015 could directly result in (the full-time equivalent of) roughly 250 jobs in rural low-to-moderate income areas of California. As noted in the discussion above and in the nearby box, the net effect on rural California’s economy is likely much less than this. Figure 5 Rural Investments Percentage of All CDFI Tax Credit Investments 30% 25 20 15 10 5 2011 2012 2013 2014 2015 CDFI = community development financial institution. Other Benefi ts. As CDFIs are community-development, mission-driven organizations, we understand that many of the projects they fund may likely achieve other policy objectives and benefi ts—beyond changes in employment and economic activity—that can be diffi cult to quantify. For example, some of the investments aim to improve energy effi ciency and others provide affordable rental housing to the mentally ill. Investments in community facilities and health clinics may be delivering social benefi ts. Other means of promoting these goals may be more or less costly for taxpayers than this program. For more information, contact Brian Weatherford at the Legislative Analyst’s Offi ce (Brian.Weatherford@lao.ca.gov). LEGISLATIVE ANALYST’S OFFICE 8