California’s First Film Tax Credit Program

California’s First Film Tax Credit Program MAC TAYLOR • L E G I S L A T I V E A N A L Y S T • SEPTEMBER 2016 AN LAO REPORT 2 Legislative Analyst’s Office www.lao.ca.gov AN LAO REPORT EXECUTIVE SUMMARY California provides tax incentives for qualified film and television productions to be made in the state. The first film tax credit program was adopted in 2009 and provided $800 million ($100 million per year over eight years) in credits to selected feature films and television projects. In 2014, the Legislature created a new film tax credit program that increased the available amount of tax credits to $330 million per year—beginning in the 2015-16 fiscal year—and modified the program in various ways. In this report, as required by law, we evaluate the economic effects and the administration of the first film tax credit program passed in 2009. We find that about one-third of the film and television projects receiving incentives under this program would probably have been made in California anyway. We suspect that this level of “windfall benefits” to some credit recipients may be low compared to other tax credits, which would suggest that the first film tax credit program targeted the types of production vulnerable to being filmed outside the state relatively well. The $800 million in credits under the first film tax credit program will eventually go to more than 350 projects. These projects generated or will generate billions of dollars of economic activity over the life of the program. The net amount of new economic activity is uncertain, however, with benefits offset somewhat by economic opportunity costs and other changes in the state’s economy. The direct fiscal cost of this program to the state of more than $800 million, including administrative costs, is likely offset by several hundred million dollars of additional state tax revenues related to the increased economic activity. Local tax revenues—mostly those of Los Angeles County—could also increase somewhat. As we have stated previously, the competition between states to provide public subsidies to specific individuals or companies is very problematic as a public policy. In general, we advise policy makers to reject such tax incentives. We have, however, acknowledged that California’s adoption of a film tax credit is understandable in light of the actions taken by other states to lure Hollywood productions away from California. If more jurisdictions back away from their film and television tax incentives, lawmakers should consider whether California’s incentive programs should be changed or eliminated as well. www.lao.ca.gov Legislative Analyst’s Office 3 AN LAO REPORT BACKGROUND California and the Motion Picture Industry. post-production employment cluster in the San The motion picture industry is one of California’s Francisco Bay Area. New York also has a large—and flagship industries. The U.S. motion picture industry growing—film and television production industry, is centered in Los Angeles County to such an extent with nearly 50,000 production and post-production that people all around the world refer to the entire jobs. A considerably smaller number of people industry as “Hollywood”—after a neighborhood work in the industry in other states. The states in Los Angeles where many film studios were with the next four largest motion picture industry historically located. Firms within this industry employment clusters—Florida, Georgia, Louisiana, make feature films, television programs, and other and Texas—each has roughly 5,000 film and products (such as commercials and music videos) for television production and post-production jobs. (Our distribution through various channels—including 2014 report, Overview of Motion Picture Industry movie theatres, television broadcast, on-demand and State Tax Credits, includes more detailed internet streaming services, and retailers. The information about the film and television production economic output of this industry in California totals industry.) roughly $50 billion annually (about 2 percent of the Motion Picture Production Is Mobile. A state’s $2.5 trillion economy). film or television episode can be made pretty Most U.S. Film and Television Jobs Are Here. much anywhere. Many U.S. states—and most The motion picture industry employs about 145,000 people Figure 1 in California. About 115,000 More Than Half of U.S. Motion Picture of these employees work in Production Employment Is in Californiaa film and television production and another 10,000 or so work 2015 in post-production. (The other Florida, Georgia, Louisiana, and Texas 20,000 employees work in motion picture exhibition— that is, in movie theatres.) As shown in Figure 1, more Other States than half of U.S. film and television production and Los Angeles post-production employment County is located in California. The industry is heavily concentrated in Southern California—with about New York 90 percent of these California Rest of jobs in Los Angeles County. In California addition, there is a significant a Includes production and post-production. 4 Legislative Analyst’s Office www.lao.ca.gov AN LAO REPORT developed countries, for that matter—now have region’s motion picture production industry and modern film and television production studio stimulate film-related tourism. Consequently, many facilities. Additionally, feature films are often made states now offer financial incentives—typically “on-location” in remote places. Cameras and other transferable or refundable tax credits—to encourage equipment can be easily moved. Key personnel and film and television production. Over time, cast can fly from one location to another. competition among states has escalated. Some states, Many States Offer Public Subsidies to such as New York, have recently expanded their Attract Motion Picture Production. Many policy incentive programs. On the other hand, states such makers would like producers to make large-budget as Michigan and New Jersey have discontinued their features and well-known television series in their programs. As of March 2016, 35 states, Puerto Rico, communities. As we noted in our 2014 report, policy and the District of Columbia offered some type makers hope that attracting several high-profile of state financial incentive for film and television motion picture productions will develop their production (see Figure 2). However, as noted in Figure 2 States Offering Financial Incentives for Motion Picture Production As of March 31, 2016 a b a b Without Incentive Incentive a Incentive program currently unfunded. b Incentive program sunsets June 2016. www.lao.ca.gov Legislative Analyst’s Office 5 AN LAO REPORT the figure, some states’ programs are currently Film and Television Production Tax Credit unfunded and others are expected to sunset this (film tax credit) program in 2009. This film tax year, such as Florida’s tax credit. credit program provided $100 million per year Governments in other countries also offer between fiscal years 2009-10 and 2016-17, for a total similar subsidies. A notable example is Canada, of up to $800 million in tax credits. In this report, where several provinces were among the first we refer to the tax credit program established in jurisdictions to offer financial incentives for motion 2009 as California’s “first” film tax credit program. picture production. As we discuss below, the first film tax credit Financial Incentives Likely Influence program has allocated all available funds and is no Production Location Decisions. Motion picture longer accepting applications. Chapter 413 of 2014 production incentive programs typically provide (AB 1839, Gatto) replaced the first film tax credit corporate tax and sales tax benefits. Some states, with a newly expanded film tax credit program. such as Tennessee and Colorado, provide a The new program allocates up to $330 million cash grant or a cash rebate to qualified film and annually through and including the 2019-20 fiscal television productions instead of a tax credit. year. A wider range of film and television projects In most states, the tax credit is transferable or are qualified to apply for tax credits under this new refundable because most production companies program. (or their parent corporations) would not have a LAO Required to Evaluate First Film Tax sufficiently large tax liability in the state to use Credit. Chapter 841 of 2012 (AB 2026, Fuentes) the full tax credit. The value of the state financial requires the LAO to report on the economic effects incentive is usually based on a percentage of and administration of the first film tax credit production expenses. For example, the amount program. To produce this report, we reviewed the of the above-mentioned Colorado cash rebate is detailed project-level spending data that applicants calculated as 20 percent of qualified spending. As report to the state—both the actual spending we discussed in our 2014 report, this is typical. data provided by those that received a tax credit State incentive programs often qualify which and spending estimates by those that did not. As production expenses, such as local crew wages, are required by statute, we use this data and other used to calculate the amount of the incentive and sources to estimate the economic effects of the first those which are not, such as payments to out-of- program. We also discuss the administration of the state suppliers. These financial incentives are often first film tax credit. significant. While there are many considerations in Future Report Planned. Under the 2014 film choosing a filming location, for many productions tax credit law, our office is required to produce the availability of financial incentives appears to another report on California’s film tax credit influence the decision. programs by July 1, 2019. We expect to continue California Adopted First Film Tax Credit monitoring some of the same issues we have in 2009. In response to the increase in financial discussed here, as well as evaluate available data for incentives offered by other jurisdictions, the the expanded tax credit program passed in 2014. Legislature approved creation of the California (Little data was available on this new film tax credit program at the time we completed this research.) 6 Legislative Analyst’s Office www.lao.ca.gov AN LAO REPORT THE FIRST FILM TAX CREDIT PROGRAM Program Overview Tax Credits Provided Financial Incentives for Filming in California. Tax credits may be applied Tax Credit Program Administered by against state personal income, corporation, or sales State Film Commission. The California Film and use taxes. Independent production companies Commission (CFC) was established in 1985 to were allowed to transfer—sell—their tax credit to attract and retain motion picture production to another taxpayer. Non-independent projects could the state. The CFC provides production assistance not sell their tax credits but they were allowed to and information to filmmakers planning to shoot assign them to other companies within the same on-location in California. The CFC also coordinates corporate family. film permitting for most state-owned property, Annual Demand for Film Tax Credits such as for when a project wants to film at a state Exceeded $100 Million. The demand for film tax park or on a highway. In addition to these services, credits exceeded the $100 million available in every the CFC administers the state’s film tax credit year of the program’s existence. The CFC accepted programs. applications on a first-come, first-served basis. Tax Credit Based on Qualified Production However, after the first year of the program—when Costs. The first California film tax credit program production companies were still becoming familiar provided tax incentives to selected motion picture with it—most applications were submitted on the companies making an eligible film or television first day of each application period. The CFC used project. The amount of the tax credit was equal a random selection process—which we describe in to 20 percent of qualified expenditures for most the next section of the report—to determine the projects. Television series relocating to California order in which applications received on the same from other jurisdictions and projects that qualify date would be processed and allocated tax credits. as “independent” films were eligible for a tax credit of 25 percent of qualified expenditures. Tax Credit Allocation Only the production types described in Figure 3 Lottery Used to Randomly Allocate Film Tax (see next page) could apply for and receive a Credits. Given the high level of demand relative to film tax credit under the first film tax credit credits available under the first tax credit program, program. The program required that at least the CFC used a lottery process to randomly allocate 75 percent of all production spending occur in film tax credits. The final lottery to allocate tax California (expenses incurred outside the state credits available under the first film tax credit were not qualified). Only certain production and program was held on April 1, 2015. The lotteries post-production expenditures—such as crew determined the order in which the CFC opened wages and equipment—qualified for the tax credit. and processed applications received each fiscal year. Non-qualified expenditures included, among Once the CFC had allocated all of the tax credits other things, costs for securing the rights to the available for each year, the remaining projects were screenplay and cast compensation. Please see the moved to a waitlist. box on page 9 for the distinction between qualified Television Series Received Priority in and non-qualified motion picture production Subsequent Years. Any television series that spending. www.lao.ca.gov Legislative Analyst’s Office 7 AN LAO REPORT Figure 3 Types of Production Eligible for the First California Film Tax Credit Feature Film A feature, at least 75 minutes long, intended for commercial distribution. The total production budget had to be greater than $1 million but less than $75 million. Movie of the Week (MOW) A television MOW produced for initial broadcast on television and at least 75 minutes long. The total production budget had to be greater than $500,000. Miniseries A miniseries of two or more episodes produced for initial distribution on television. The total running time had to be at least 150 program minutes and the total production budget had to be greater than $500,000. New Basic Cable Series A new one-hour long television series licensed for original distribution on “basic cable.” Basic cable means non broadcast television programming transmitted to the viewer for a basic subscription fee. (Does not apply to “premium cable,” for which the viewer pays a separate per program or per channel fee.) Relocating Television Series A television series that filmed all of its prior seasons outside of California was eligible regardless of episode length or the television channel on which it was transmitted. Independent Feature A feature film, MOW, or miniseries was considered to be an independent feature if it was not produced by a publicly traded company or a company in which a publicly traded company owned more than 25 percent of the independent production company. Also, the total production budget could not exceed $10 million. 8 Legislative Analyst’s Office www.lao.ca.gov AN LAO REPORT Qualified Motion Picture Production Spending Under California’s First Film Tax Credit We describe below which motion picture production expenses qualified for the first California film tax credit and which did not. The tax credit allowed selected taxpayers to reduce their tax liability by 20 percent (25 percent in some cases) of qualified production expenses only. Non-qualified production expenses were not considered in calculating the amount of the tax credit. Wages for Most People Behind the Camera Are Qualified. Spending on goods and services in California used for film and television production and post-production were generally classified as qualified spending. These included the purchase and lease of equipment, spending on set construction, and many other expenses such as travel within the state. Wages and fringe benefits qualified for certain types of labor—primarily the crew working behind the camera. Qualified wages also included payments to some independent contractors and background actors that had no scripted lines. Non-Qualified Expenditures. Individuals whose wages (and other compensation) were not considered to be qualified expenditures included: • The writer or writers. • The director. • The producer, executive producer, line producer, visual effects producer, and associate producers. • The music director, composer, and music supervisors. • The cast and, with some exceptions, any other performer who appears on screen. Other production expenditures that were clearly not qualified for the first film tax credit included the costs of acquiring the story, music rights and licenses, gifts and allowances to the cast and other non-qualified individuals, and certain payroll taxes. Some Confusion on What Expenditures Qualified. The California Film Commission (CFC) provided detailed descriptions of qualified and non-qualified expenditures on its website and in training sessions. Nonetheless, some applicants were reportedly confused about what kinds of spending qualified or not. We understand these applicants incorrectly estimated their qualified spending and estimated tax credit in their applications. Such mistakes were reportedly common enough that, after several years, CFC staff modified their application review process prior to allocating a film tax credit to one in which staff manually reviewed the budget of every application (instead of plainly accepting the provided estimates). This somewhat increased state costs, delayed the tax credit allocation process for all applicants, and may have delayed the start of principal photography for some projects. www.lao.ca.gov Legislative Analyst’s Office 9 AN LAO REPORT had been allocated a California film tax credit production had to begin filming within 180 days was automatically given priority in subsequent from the date the CFC allocated the tax credit. allocation periods. We understand that the purpose In several instances, projects began principal of this regulation was to give television series, photography prior to being allocated a film tax typically made over several years, a level of funding credit. In these cases, the project still qualified for certainty needed for production budgeting and the film tax credit under program rules at that that, without it, some productions might have time, but any production expenses incurred prior chosen to relocate to another state with greater to the allocation date could not qualify towards the certainty. Over time, recurring television series tax credit. received an increasing share of the tax credit Many Applicants Did Not Receive a Tax allocations each year—leaving less available Credit Certificate. Four out of five applicants for other projects. Less than $20 million of the to the first program never received a tax credit. $100 million was available for allocation in the Many applicants, especially in the later years of final lottery because about $80 million had been the program, were never allocated a tax credit reserved for television series already accepted into because there was not enough money available. the program. However, we found that about 35 percent of projects Application Materials Intended to Screen withdrew from the program and, therefore, never Applicants. Every production company submitting received a tax credit certificate even though they an application was required to provide certain had earlier been allocated a tax credit. Projects details about the production to calculate the withdrew for various reasons. For example, some estimated tax credit and to demonstrate that the may have had problems with licensing a script, a project was viable. This documentation included key member of the cast may have been working the script, production schedule, and proof that on another project, or a television series may not most of the project’s financing had been arranged. have been “green-lit.” Other projects withdrew CFC staff validated the amount of the estimated because they were otherwise unable to complete tax credit based on estimated qualified production production within the time allotted (see Figure 4 spending. for production milestone requirements). When Some Productions Began Filming Prior to production companies withdrew from the program Approval for Tax Credit. Once an application had without receiving a certificate, tax credits then been processed, the CFC allocated film tax credits became available for other projects on the waitlist to the project provided that a sufficient amount later in the fiscal year. However, by the time these of tax credits remained. At the conclusion of additional tax credits became available, many of the this review process, the CFC sent the production waitlisted projects had already begun production in company a credit allocation letter (CAL) notifying California or somewhere else. them (1) that their application for a film tax credit Tax Credit Certification had been approved and (2) of the amount of tax credits allocated to their project. The production Time Between Credit Allocation and company could begin principal photography Certification Varied by Project. Projects after they had been notified their application was must have completed production—including approved for a film tax credit. Under the first film post-production—within 30 months after receiving tax credit program, as we show in Figure 4, the the CAL. Once the project was completed, 10 Legislative Analyst’s Office www.lao.ca.gov AN LAO REPORT however, there was not a statutory deadline for these projects by project type in (see next page). requesting the CFC issue the tax credit certificate. Feature films were the most common type of We estimated that about 21 months passed, on production to receive a film tax credit—more average, between when a project was allocated a tax than half of the tax credits have gone to studio or credit and when it was issued a tax credit certificate. Some projects were completed Figure 4 rapidly and then quickly submitted the Film Tax Credit Process necessary documentation. Other projects Under the First California Film Tax Credit Program took much longer. We found that about 15 percent of projects waited for more 1 Production Company Submitted Application than a year after completing production If tax credits were available, the to request that the tax credit certificate be California Film Commission (CFC): • Processed application issued. We do not know why some projects 2 • Determined project eligibility • Estimated amount of tax credit allocation chose to wait for so long to submit their • Notified production company that: 1. Tax credit application approved documentation. 2. Application moved to a waitlist, or 3. Application ineligible Tax Credit Certificate Issued After Qualified Production Expenses Audited. Principal photography had to begin 3 within 180 days after the date on which Production companies were required the application was approved by the CFC to submit the copyright registration number of the finished project to prove it was actually completed. The CFC Principal photography could go on also required production companies to 4 hiatus after it began, but for no more provide documentation of all the qualified than a total of 100 days spending claimed for the tax credit. A certified public accountant—who had received specific training on the first film The project must have been completed— tax credit program—was also required to meaning that post-production had been 5 finished—within 30 months after the date audit the spending records. If the actual on which the application was approved by the CFC amount of qualified spending exceeded the initial estimate, then the amount of the tax credit was capped at the amount initially Production company submitted an audited allocated to the project. The CFC issued 6 expenditure summary report and other materials required by statute a tax credit certificate to the production company after staff had reviewed and verified this documentation. $447 Million in Film Tax Credits Have CFC verified: Been Issued to 229 Projects. The CFC has 7 • Compliance with required terms • Copyright of completed project • Qualified spending amounts issued $447 million in tax credits to 229 completed projects as of November 30, 2015. We summarize spending, including 8 CFC Issued Tax Credit Certificate estimates of non-qualified spending, for www.lao.ca.gov Legislative Analyst’s Office 11 AN LAO REPORT independent features. (However, as we discussed reduce corporation tax liabilities and 20 percent above, the proportion changed over time because has been used to reduce sales and use taxes. Only recurring television series received larger shares a very small portion of the film tax credits—about of the total available credits each year.) One-third $1 million—have been claimed against personal of the 229 completed projects were independent income tax liabilities. The Franchise Tax Board feature films, eligible for the larger 25 percent tax (FTB) administers state corporation and personal credit. On average, studio films spent a total of income taxes. The State Board of Equalization about $35 million in qualified and non-qualified (BOE) administers sales and use taxes. expenditures. In comparison, independent feature Tax Credits May Be Carried Forward for Up films only spent an average of $6 million per film. to Five Years. If taxpayers do not have sufficient The average television series spent a total of about tax liability against which to use their credits, $30 million per season (the number of episodes per they are allowed to carry the credits forward for season varied among projects). The average movie up to five years. Consider a taxpayer that has a tax of the week (MOW) or miniseries spent less on credit certified in 2015 but has no tax liability in average—$3 million and $4 million respectively— the 2015 taxable year. That taxpayer may apply the than these other types. credit against their state taxes in taxable years 2016 through 2020. Depending on when the CFC issues Taxpayer Use of Film Tax Credits the final tax credit certificates under this program Most Credits Used to Reduce Corporation and other factors, FTB could still be processing Tax Liability. Of the $447 million in tax credits tax returns claiming film tax credits authorized issued by the CFC under the first film tax credit under the first film tax credit program through the program through November 30, 2015, taxpayers 2024-25 fiscal year. have claimed $232 million. Most of these claimed Tax Credits May Be Assigned to Affiliated tax credits—about 80 percent—have been used to Corporations. A majority of the credits (by dollar Figure 5 Completed Productions Received $447 Million in Tax Credits As of November 30, 2015 (Dollars in Millions) Number of Productions Spending in California Tax Credits Production Type Number Percent Qualified Total Amount Percent Feature Studio feature 51 22% $1,005 $1,785 $196 44% Independent feature 75 33 237 441 57 13 Miniseriesa 2 1 5 9 1 — Movie of the Week (MOW) Studio MOW 6 3 41 57 8 2 Independent MOW 51 22 66 99 16 4 Television series New basic cable series 37 16 663 1,096 130 29 Relocating TV series 7 3 153 215 38 8 Totals 229 100% $2,171 $3,702 $447 100% a One miniseries was an independent production. 12 Legislative Analyst’s Office www.lao.ca.gov AN LAO REPORT amount) have been allocated to companies that tax liabilities, most owners of independent film are owned by one of a handful of multinational production companies have sold their credits media corporations. Each of these corporate to another taxpayer. As of November 30, 2015, families control dozens of affiliated companies. FTB records show that independent production The individual production companies that receive companies sold at least 85 film tax credit the tax credits are unlikely to have a sufficient certificates worth a total of $53.9 million. The tax liability against which to apply them. State data that FTB provided to us for most records law allows the production companies to assign included the amount each seller received in the the credits to other affiliated companies within a transaction. As we show in Figure 6 the sellers of combined corporate reporting group. FTB requires film tax credits received 9 percent less than their companies to report certain information when they face value, on average, in 2011. The discount that elect to assign a tax credit. However, this is difficult buyers realized has fallen somewhat over time to to track in practice because, as we describe in the an average of 6.4 percent in 2015. We do not know box on the next page, we do not have very good how much was paid to the companies that brokered visibility into taxpayer data on the use of film tax these transactions because FTB does not request credits. that information. Also, as we discuss in the nearby Independent Productions Allowed to Sell Tax box, some taxpayers sold credits but do not appear Credits. Film tax credits allocated to independent to have reported the sale to FTB and so those productions may be transferred—sold—to another transactions are not included here. taxpayer. A film tax credit may only be sold once. Film Tax Credits That Reduce Sales Taxes. (Many of the film tax credits offered by other states Taxpayers may also use film tax credits to claim are also transferable under their own state tax a refund from BOE of sales and use taxes paid to laws.) We understand that businesses Figure 6 exist to broker these Film Tax Credits Purchased at Discount transactions between Average Percent Less Than Face Value an independent Received by Independent Producers That Sold Credits production company 10% and another taxpayer 9 for a fee. State law 8 requires taxpayers to 7 notify FTB prior to selling a tax credit and 6 for the seller to report 5 the amount it received 4 in the transaction. 3 Film Tax Credits 2 Sell for About 92 Cents 1 on the Dollar. Rather than claim the film 2011 2012 2013 2014 2015 tax credit against www.lao.ca.gov Legislative Analyst’s Office 13 AN LAO REPORT Available Data on Transfer, Assignment, and Use of Tax Credits Incomplete Taxpayer Filings on Film Tax Credits Difficult to Fully Capture. The Franchise Tax Board (FTB), which administers corporation and personal income taxes, is unable to easily track the transfer, assignment, and use of most film tax credits because many taxpayers do not file electronically. While there is reasonably good data on the aggregate amount of film tax credits claimed by each corporate combined reporting group, FTB does not routinely capture more detailed information about film tax credits from paper tax forms. In addition, some taxpayers appear to be providing incomplete or inaccurate information on their tax filings with respect to the film tax credits they report. FTB has explained to us that taxpayers often submit the supporting documentation that would include key details such as the certificate numbers—which may or may not be accurate and complete—as attachments within very complex tax filings. FTB scans and electronically stores all paper returns, but these processes do not allow them to easily, and automatically analyze the information about specific film tax credit certificates. Therefore, for many of the tax credits that have been issued, we do not know from available data how much of any given tax credit certificate has been used and how much has been carried forward. Comprehensive, Accurate Accounting of All Tax Credit Use Does Not Exist. FTB verifies taxpayer compliance in their auditing unit. However, there does not seem to be a way for FTB to easily share information on film tax credit use discovered during compliance activities with other entities, such as the State Board of Equalization (BOE) or the Legislature. Without comprehensive, accurate, and timely data, it is unclear to us how well the state can ascertain that credits are not being claimed more than once. There is no evidence that taxpayers have actually claimed a credit that had been previously used in a prior tax year or by another taxpayer. There seem to have been several isolated instances in which other taxpayers have mistakenly claimed film tax credits, but existing FTB and BOE tax compliance processes appear to have eventually identified these taxpayer errors. Improving Data on Film Tax Credit Use Would Be Costly. Given limited resources, FTB prioritizes staff resources on compliance activities that return the most revenue to the state. To date, FTB has collected comprehensive aggregate information on film tax credit use. Improving the data quality for tracking film tax credit transfers and use may require additional staffing and budgetary resources at FTB, but the benefit of this additional spending may not be viewed as worth the cost. the state. It has taken about a year, on average, for tax. Any sales tax refund over $100,000 takes more taxpayers to receive a refund after filing a claim. time to process than for smaller refunds because BOE must first check with FTB to make sure the additional approvals are required. Only 14 credits, taxpayer has not claimed the credit against income totaling $47.2 million, have been applied against the sales and use tax through November 30, 2015. 14 Legislative Analyst’s Office www.lao.ca.gov AN LAO REPORT ECONOMIC EFFECTS Spending by motion picture projects generally Non-qualified expenditures were not subject to benefits the economy through hiring of cast and the same rigorous reporting requirements as were crewmembers, leasing of studio space and filming qualified expenditures. (In some cases, the total equipment, and purchases of set materials and amount of production spending reported to the property. In evaluating the economic effects of a tax CFC was clearly inaccurate—such as when total credit (or other government policies), it is necessary spending was less than qualified spending. For this to distinguish between (1) “new spending” resulting reason, we estimated non-qualified spending for from the policy and (2) spending that would have 12 projects that reported mathematically impossible occurred in the economy regardless of whether or or statistically unlikely amounts of non-qualified not the policy existed. This new spending in the spending based on the other completed projects.) economy also causes various indirect and induced In Figure 7, we display our estimates of the total economic effects. It is difficult to identify and production spending of the projects that received quantify all of these effects, and many evaluations film tax credits, including our estimates of the of tax credits (and other governmental policies) fail non-qualified spending of these productions. to do so. In this part of the report, we try as best we Overall, we estimate that the first $447 million of can to quantify some of these economic effects for tax credits for completed projects was associated California’s first film tax credit. with total production spending of $3.7 billion in the state. Estimated Production Spending . . . And for Ongoing Projects That Had Not by Credit Recipients Reported Final Spending. The CFC allocated a total Total Production Spending Estimated for of $223 million in film tax credits to 80 projects in Completed Projects . . . All new spending in active production through November 30, 2015. In California affects the state’s economy regardless of addition, as of that date, another $130 million in tax whether or not it was qualified for the tax credit. credits was available and had not yet been allocated For the 229 projects completed under the first film to specific projects. We understand that CFC will tax credit program as of November 30, 2015, we allocate these credits to waitlisted projects and only have high-quality data on qualified spending. recurring television series. In Figure 7, we display Figure 7 Estimated California Spending by Film Tax Credit Recipients As of November 30, 2015 (In Millions) Qualified Spending Non-Qualified Total Production Tax Credits Wages Non-Wage Total Spending Spending Allocated Completed $1,264 $907 $2,171 $1,531 $3,702 $447 productions Active productions 661 402 1,064 594 1,657 223 Waitlisted 348 171 519 208 726 130 Productions Totals $2,273 $1,480 $3,753 $2,333 $6,086 $800 Note: A significant amount of these production expenditures were not new to California. www.lao.ca.gov Legislative Analyst’s Office 15 AN LAO REPORT our rough estimates of qualified and non-qualified specialized goods and services from California production spending for the film and television firms. Many film and television scriptwriters live projects that were still active and waitlisted at in California, and they rarely need to travel to that time. (The production companies estimate the same physical location as the production. In qualified and non-qualified spending in their addition, when a feature is shot on-location in tax credit applications. We observed that among another state, some or all of the post-production completed projects, actual spending was typically work may be done here in California. Based on lower than these initial estimates. We adjust the conversations with CFC staff, we understand information from the applications to account for that most scriptwriting and perhaps around half this.) In total, the $800 million of tax credits under of editing and other post-production may have the first film tax credit program will be associated occurred in California regardless of the physical with productions that collectively have spent or will location of principal photography. (We are told spend an estimated $6.1 billion in California over there may have been some exceptions to this. Many the entire life of the first film tax credit program. New York productions, for example, have writing Economic Effects of Tax Credit Must Account staff there.) In total, we make a rough estimate that for Other Factors. Deriving this number is the about $0.5 billion in total production spending by starting point for estimating the net amount of new projects that received a tax credit—about 8 percent spending in California as a result of the first film of total production spending—might have occurred tax credit. Our estimate of the net economic effects in California even had those projects filmed of the credits must also account for three additional elsewhere. As such, we do not consider this to be factors: new spending in the state’s economy resulting from the first film tax credit program. • Adjustments to the $6.1 billion estimate of Windfall Tax Benefits (Reduction of production spending. $1.5 Billion). Some projects that received a film • Indirect and induced economic effects. tax credit would have been made in California anyway. The film tax credit is essentially a windfall • Opportunity costs. benefit for these productions: that is, a benefit to the We discuss these further below. production company for doing something that they would have done even had they not received the tax Adjustments to Total Production credit. Windfall benefits occur with most—likely Spending Estimate all—tax credits, but it is difficult to quantify this We make several adjustments to the $6.1 billion impact. In the box on pages 18 and 19, we explain estimate of new film production spending to how we were able to make our rough estimates for roughly estimate how much is new spending the windfall benefits arising from the first film tax resulting from the tax credit and how much would credit program. Our model predicts that, overall, have occurred here regardless of whether or not the about a third of the projects receiving tax credits tax credit existed. would have been made in California even had they California Writing and Editing (Reduction of not been allocated a tax credit. The probability $0.5 Billion). Much of the motion picture industry that a project might have been made in California is concentrated in California. Film and television without the film tax credit varies depending on productions all over the world procure various the type of project—from under 15 percent for an 16 Legislative Analyst’s Office www.lao.ca.gov AN LAO REPORT independent MOW to nearly 50 percent for an Estimated Indirect and Induced independent feature film. Using these probabilities, Economic Effects we estimate that about $1.5 billion of the total In addition to new direct spending in the state’s estimated production spending by these projects economy, the first film tax credit program also represented windfall benefits and not new spending resulted in indirect and induced economic effects, on film production. as discussed below. While we estimate that about 30 percent of What Are Indirect and Induced Economic these projects received windfall benefits, only Effects? New film and television production 25 percent of total spending was a windfall. Projects spending supported additional economic activity such as studio features and television series—that throughout the state. Film industry workers hired on average have much larger budgets than on these productions, for example, spent some of independent features—appear more likely to select their income to buy more goods and services from a location based on the availability of production California businesses. Businesses that supplied the incentives. new film and television productions may have then Projects Receiving Tax Credits More Likely expanded their operations. The economic ripple to Be Made (Addition of $0.4 Billion). While effects from the initial increase in new production some projects that received an initial tax credit spending are called indirect economic effects. allocation withdrew from the program, it appears These indirect economic effects also subsequently that receiving a tax credit allocation could have induced additional effects in the state’s economy. had a small but measurable effect on whether or For example, when a new employee is hired by not a project was completed at all, as noted in a business that supports film productions, that the box on pages 18 and 19. We estimate that if individual will then spend some of his or her the CFC allocated a credit to a project during the income to buy more household goods and services initial allocation period of the first film tax credit than they would have otherwise. program, the project was about 5 percent more Estimating Indirect and Induced Economic likely to be completed—at all, anywhere—than Effects. The economy is complex, and it is always projects that were initially placed onto a waitlist. changing—growing in some areas, contracting in This increases the estimate of total spending in others. There is no way to directly observe how and California resulting from the first film tax credit by how much the economy has changed due to the an estimated $0.4 billion. film tax credit. A regional input-output model is Estimate: $4.5 Billion of New Production one commonly used method of estimating indirect Spending. In conclusion, we make a rough estimate and induced economic effects. This type of model that about $4.5 billion of the $6.1 billion in total uses statistics on the interconnections between production spending by tax credit recipients was different sectors of the economy to estimate how additional spending on film production in the state’s a change in circumstances (such as sustained economy that resulted from the first film tax credit new spending in the motion picture and video program. (This is the estimate of spending that industries sector due to a tax credit) changes the occurs over the entire multiyear life of the program. level of economic activity in a particular geographic The number is not adjusted for inflation over time.) area. The U.S. Bureau of Economic Analysis maintains such a model, the Regional Input-Output www.lao.ca.gov Legislative Analyst’s Office 17 AN LAO REPORT Modeling System (RIMS II). This model produces initial $1 million in net new direct spending, plus “multipliers” that are used to estimate how much a an additional $1 million in indirect and induced region’s economy might be expected to grow given economic output. This suggests that a net increase an increase in spending by a specified industry. in new motion picture production spending might The RIMS II final output multiplier for motion increase the state’s gross economic output by twice picture and video industries in California is that amount—the net new direct spending plus roughly 2. That means that for every $1 million in a roughly equal amount of additional indirect net new production spending, the RIMS II model and induced economic activity. However, as we estimates that total gross output of the California discuss in the box on page 20, regional input- economy will grow by a total of $2 million: the output models (like any other economic model) Estimating Windfall Benefits of California’s First Film Tax Credit Some of the motion picture projects under the first film tax credit program probably would have filmed in California even if they had not received a tax credit. We explain below how we were able to estimate these windfall benefits arising from the first film tax credit. Tax Credit Lottery Allows for Natural Experiment. It is impossible to identify with certainty which projects would have been made in California, which elsewhere, and which not at all, had they not received a film tax credit. Because of the way the first film tax credit was administered, however, we are able to roughly estimate the probability that any given film or television project might have been made in California without a tax credit. Beginning in 2011, the program was over-subscribed on the first day applications were accepted—with the demand for film tax credits far outstripping the available amount—and tax credits were mostly allocated to projects through a random process. This allowed for an imperfect natural experiment, as some projects were allocated a credit and other similarly situated projects were not. The California Film Commission (CFC) collected some information about projects that applied for and did not receive a tax credit from the program—whether they were made and, if so, where. (As noted elsewhere in this report, many projects were never allocated a tax credit because there was an insufficient amount of tax credits available. In other cases, some applicants received an allocation but withdrew from the program for various reasons—some of these were made eventually, but without a tax credit from California. When that happened, those tax credits became available for other projects that had been placed onto a waitlist. However, many of these began filming—in California or elsewhere—prior to being offered an allocation.) We supplemented this CFC data with publically available data sources, such as information from the Internet Movie Database and Variety. Looking just at the film tax credit applicants in 2011, 2012, and 2013—the three years for which we have the best data—we see that 199 projects applied for and did not receive a film tax credit but were eventually made. Of these, as we show in the figure, one-third—66 projects—filmed in California without receiving a tax credit. Dozens of other project applicants that did not receive a film tax credit from California were filmed in British Columbia, Georgia, Louisiana, New York, and elsewhere. 18 Legislative Analyst’s Office www.lao.ca.gov AN LAO REPORT simplify the economy for practical reasons and may alternative use of funds and other resources, such significantly over- or underestimate the changes in as workers and materials. In our evaluation of the a region’s economy. economic effects of the first film tax credit, we must account for two kinds of opportunity costs: Opportunity Costs • The $800 million in foregone state tax All actions have an opportunity cost. revenue the government would have used Opportunity cost is the economic value of the best for other purposes. Some Projects One-Third of Projects That Applied for and Did Not Would Have Been Receive a Film Tax Credit Made in California Anyway Made in California Location Number of Projects Precent of Total Anyways . . . We California 66 33% used the data on British Columbia 20 10 withdrawn projects Georgia 18 9 Louisiana 13 7 to fit a logistic New York 10 5 regression model Other states 33 17 to estimate the Other Canadian provinces 8 4 Other countries 13 7 statistical likelihood Unknown 18 9 of whether a Totals 199 100% production that received a film tax credit might have been made in California had it not received the incentive. Our model predicts that, on average, about a third of the projects receiving tax credits would have been made in California even had they not received a tax credit. The results depend significantly upon the type of production. For example, the model predicts that one out of every two independent feature films that applied for a film tax credit would have likely been made in California regardless of whether or not they received a credit. Meanwhile, our model predicts that only 13 percent of the independent movies of the week that applied for a film tax credit would have been made in California without one. . . . Others Not at All. We also estimated how receiving a film tax credit allocation might have affected whether or not a project was made at all. If a project was allocated a film tax credit during the initial allocation period, it was roughly 5 percent more likely to be made—at all, anywhere— than the projects that did not win the lottery and were initially placed onto a waitlist. (We caution that this result is not statistically significant at a 95 percent confidence level. This means that we cannot rule out negative, zero, or somewhat larger positive effects.) Production Budgets May Have Increased Somewhat. The tax credit could have somewhat increased the total amount of production spending, even for the projects that received windfall benefits, because it reduced the costs of qualified spending by 20 percent or 25 percent. We were unable to evaluate this potential effect given the available data. www.lao.ca.gov Legislative Analyst’s Office 19 AN LAO REPORT • The billions of dollars in new motion from using those funds for other public purposes, picture production spending used some ranging from spending on other programs to workers and materials that other industries broad tax reductions. Those alternative actions by would have used otherwise. government would have benefited a different set of individuals and businesses—the economic benefit We discuss these below. of the alternative action is the opportunity cost of Reduced State Tax Revenue Has an the reduction in tax revenue from the use of the Opportunity Cost. The film tax credit puts more first film tax credits. These opportunity costs are money in the accounts of some businesses and unknown and reduce, perhaps significantly, the net individuals to spend and invest in the economy. economic effect of the first film tax credit program. In so doing, it prevents the state government Limitations of Regional Input-Output Modeling California’s first film tax credit increased motion picture production spending in the state. To estimate how much the state’s economy grew given that increased economic activity, we use economic multipliers calculated by a regional input-output model called the Regional Input-Output Modeling System (RIMS II). The RIMS II model—like similar models— has some well-documented limitations. (We have previously commented on these, http://www.lao.ca.gov/reports/2012/stadm/ letters/evaluate-film-tax-credit-061312.pdf and http://www.lao.ca.gov/reports/2016/3489/cdfi-tax- credit-063016.pdf, and have controlled for some in our approach.) We discuss these limitations below. Inputs Assumed to Be Unlimited, Prices Held Constant. Increased spending on motion picture production has increased demand in California for specialized labor and intermediate inputs, such as film cameras and specialized trailers used on film sets. This probably led to some supply shortages, with resulting increases in some prices and wages. However, the RIMS II model assumes the supply of these inputs is unlimited. As such, this model does not take into account any likely effects of price increases on motion picture production or on other industries that hire from the same workforce or use any of the same inputs. In addition, the model does not allow for input substitution, such as when a worker is replaced with a machine or when a physical set is replaced with a digital effect. Location of Suppliers and Consumption May Affect Economic Benefits. The RIMS II model estimates how much of a sector’s inputs were sourced from within the region and how much from elsewhere. Generally, an economic multiplier is higher if more inputs were sourced locally. The motion picture industry and its suppliers are very highly concentrated in Southern California. We suspect the RIMS II model may underestimate the amount of inputs sourced locally. If this is true, the final output multiplier could be somewhat larger than we assume. On the other hand, if productions acquired more goods and services from out of state than the model has assumed, the economic benefit for California from new spending may be overestimated. The model may also overstate the economic benefit from new spending if higher household incomes were used to buy more goods and services from out of state than assumed by the model. 20 Legislative Analyst’s Office www.lao.ca.gov AN LAO REPORT New Film Production “Crowds Out” Other Indirect and induced economic effects further Economic Activity. Under some conditions, new increased economic activity here by an additional motion picture production spending uses resources amount, perhaps roughly equal to the new direct that would have been put to some other use had motion picture production spending. However, there not been a tax credit program. For example, economic opportunity costs likely offset the workers and resources (such as sound stage space increased economic activity significantly. and trailers) used to make a new film subsidized It is important that we emphasize that it is with a tax credit might have instead been used to impossible to precisely measure the net change in make a different film that will now not be made. an economy caused by a tax credit or any other In another example, electricians and construction policy change because many other economic workers on a film crew might have instead worked changes are occurring simultaneously. It is not in some other industry. In addition, as we discuss possible to know what the economy would have in the nearby box, the indirect and induced done had the policy not been adopted in the first economic effects are based on a model that assumes place. We note that there is some uncertainty in unlimited inputs to production. In reality, there the underlying data we use in this evaluation and, is always some slack in some parts of an economy as we discussed in the nearby box, limitations to and scarcity in many parts of an economy. The the methods that are used to estimate indirect and economic benefits of the new motion picture induced economic effects. Finally, any assessment production spending are reduced to some extent by of the full economic value of the opportunity costs the opportunity cost of whatever economic activity is inherently subjective, as we cannot know how was superseded. foregone revenue might have otherwise been used. Overall, we think that the first film tax credit Bottom Line: Billions in Net Added program probably increased the economic output State Economic Output of California by between $6 billion and $10 billion Film Tax Credit Likely Increased Economic on net. This is a total amount over a period of Output. As we discussed above, we believe that the more than a decade. The annual increase in likely first film tax credit program increased spending on economic activity—typically under $1 billion per motion picture production by roughly $4.5 billion. year—boosts California’s economic output by no more than a few hundredths of a percentage point. STATE AND LOCAL FISCAL EFFECTS The first film tax credit program affected state Tax Credits Reduced State Revenue. The and local finances both directly and indirectly. For first film tax credit will reduce total General Fund state finances, the direct effects were the reduction revenue by up to $800 million over the life of the in tax revenue as taxpayers used the credits and program. (Only $232 million in tax credits had the costs to administer the program. Indirectly, the been claimed as of November 30, 2015.) The state’s credit affects state and local finances by causing new corporation tax was most significantly affected—we spending and employment in the economy. In this estimate that nearly $700 million in tax credits, section, we discuss both of these direct and indirect 87 percent of the total, will be applied against fiscal effects for the state and local governments. corporation tax liabilities. Just over $100 million www.lao.ca.gov Legislative Analyst’s Office 21 AN LAO REPORT in film tax credits will be used to request refunds Taxpayers claimed nearly $100 million in tax of sales and use tax. Relatively minor amounts credits in 2014-15. We expect the General Fund will be applied to reduce personal income tax revenue reductions will peak in 2018-19 at just liabilities. Under Proposition 98, decreases in under $110 million, as we show in Figure 8, before revenues generally reduce overall school funding tapering off in later years. Tax credits could continue requirements. (In addition, other variables, such as to be claimed until as late as fiscal year 2024-25, as school enrollment, and certain long-term economic taxpayers can carry credits forward for up to five trends also have an effect such that it would be years if they have insufficient tax liability to use them impossible to provide a meaningful estimate of earlier. how the film tax credit affects school funding Administration Costs. In addition to the requirements in each fiscal year over the period.) tax credits reducing General Fund revenues, The actual reduction in state revenues could be the program itself had one-time and ongoing somewhat lower than $800 million in the event some administration costs. Annual salary for staff and tax credits are never claimed. other operating costs are about $230,000 per year. Tax Credit Usage Spread Over Many Years. There were also some one-time program costs, In, we show when the credits under the first film totaling less than $100,000, in prior years. Over the tax credit program have been used and when we life of the first film tax credit program, we estimate estimate such credits will be used in future years. the state will spend a total of about $2 million in administration costs. Figure 8 Estimated Annual Use of Tax Credits Under First Film Tax Credit Program (In Millions) $120 Personal Income Tax Corporation Tax 100 Sales & Use Tax 80 60 40 20 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 2018-19 2019-20 2020-21 2021-22 2022-23 2023-24 2024-25 22 Legislative Analyst’s Office www.lao.ca.gov AN LAO REPORT Increased Revenues Indirectly Caused by Tax Net State Revenue and Administrative Cost Credit. The new spending in the economy resulting Effects by Fiscal Year. The first film tax credit from the first film tax credit has also affected state generated new spending in the economy several tax revenues indirectly. For example, a worker who years before state tax revenues were reduced by earned more income because of the film tax credit the usage of the credit. Accordingly, as shown in also paid more state income, and sales and use Figure 9, the first film tax credit program can be taxes. All state taxes have likely been affected to viewed as having provided a net benefit to the state some degree by these economic changes. Over the General Fund for the first few years of the program. life of the first film tax credit program, we estimate Thereafter, as taxpayers claim more and more credits that new spending in the economy resulting from under the program, the first film tax credit program the credit has increased and will increase General will likely reduce General Fund resources on net Fund revenues by $300 million to $500 million through 2024-25. Using some rough assumptions, (not adjusted for inflation). This estimate is based Figure 9 shows that the effect on the General Fund on our rough estimate of the increase in economic could peak at around $100 million per year in activity related to the film tax credit. The bulk of reduced resources around fiscal year 2018-19. this increased revenue has likely come via the state’s Fiscal Effects on Local Governments. The first personal income tax. Furthermore, these increases film tax credit program and the related increase in in state tax revenue boost overall school funding economic output will also increase local government requirements under Proposition 98 in most years, tax revenue and demands for public services at the offsetting the negative effects discussed earlier. local level. We estimate that local tax revenues will increase by roughly $200 million over the entire, Figure 9 Net Estimated Annual Effect of Film Tax Credits on State General Fund Under First Film Tax Credit Program (In Millions) $80 60 40 20 -20 -40 -60 -80 -100 -120 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 2018-19 2019-20 2020-21 2021-22 2022-23 2023-24 2024-25 www.lao.ca.gov Legislative Analyst’s Office 23 AN LAO REPORT multiyear life of the first film tax credit program. Among the local government revenues affected The total increase could be somewhat higher because will be property taxes. (A portion of local property most new economic activity will occur in and taxes go to schools and community colleges, and around Los Angeles County, where local sales tax in some years, this share will reduce somewhat the rates often are higher than the statewide average. state’s share of required school funding costs under Proposition 98.) LAO COMMENTS Below, we summarize our findings and New Program Addresses Perceived Issues observations concerning California’s first film tax of the First. We do not evaluate the new film tax credit program. credit adopted in 2014 in this report. However, we observe that the new program was designed in part California Film Tax Credits to address several perceived issues concerning the Program Appears Relatively Well Targeted. first program. In particular, under the first film tax Most—likely all—tax credits provide windfall credit program (1) most tax credits were allocated benefits to some taxpayers in exchange for doing randomly instead of based upon some objective something (like filming in California) that they criteria, and (2) credits reserved for recurring were going to do anyway. We find that the first film television series in later years of the program left tax credit program was a windfall benefit for about little for other types of production. Instead of one-third of the projects that received a credit. We allocating projects on a first-come, first-served suspect that this level of windfall benefits may be low basis, the new program involves a “jobs ratio” score compared to some other tax credits. In fact, there and allocates tax credits to the highest scoring is evidence in our analysis that much of the first applications. In addition, the new program reserves film tax credit program was relatively well targeted. fixed portions of tax credits for each category of First, the tax credit was developed with the input of eligible production type. For example, 35 percent of stakeholders to target those types of productions— the available credits are reserved for feature films. such as independent MOWs and basic-cable We expect to discuss the effectiveness of these television series—that were vulnerable to being lured changes in our 2019 report. to other locations for economic considerations. Our State Tax Competition research shows that, indeed, those types of projects often film outside the state if they do not receive a In General, Problematic Public Policy . . . film tax credit from California. In addition, while As we noted in our April 2014 report on the film the credit may be a windfall for about one-third of and television industry, states ideally would not the projects, those projects only account for about use subsidies to compete for film and television 25 percent of total estimated spending. The tax productions—or for any other specific industry. credit appears more likely to influence the location We generally view company-specific or industry- decisions of studio features and television series— specific tax expenditures—such as film tax that on average have the largest budgets—than, for credits—to be inappropriate public policy because example, lower-budget independent features. they (1) give some businesses an unequal advantage 24 Legislative Analyst’s Office www.lao.ca.gov AN LAO REPORT at the expense of others and (2) promote unhealthy have provided significant subsidies for film and competition among states in a way that does not television production. These subsidies have clearly benefit the nation as a whole. We harbor deep resulted in some productions, which would have concerns about the ability of officials in any state otherwise been filmed here, relocating away from to make objective, well-informed decisions about California to those places. California’s first film allocating tax credits to specific individuals and tax credit program, and the expanded program companies in a way that better allocates resources passed in 2014, can be viewed as ways to “level the across the entire economy. For these reasons, we playing field” and counter financial incentives to generally advise policy makers to reject such tax locate productions outside of California unrelated expenditure programs. to creative considerations. In evaluating this tax . . . But Understandable to Defend a Flagship credit in the future, the state’s leaders may want Industry Targeted by Other States. As we to consider trends in other states. For instance, noted in our April 2014 report, it is nevertheless if other states keep scaling back their film tax understandable that the Legislature has taken incentive programs, it might allow California to action in this area. Other states and countries scale back or eliminate its own. www.lao.ca.gov Legislative Analyst’s Office 25 AN LAO REPORT 26 Legislative Analyst’s Office www.lao.ca.gov AN LAO REPORT www.lao.ca.gov Legislative Analyst’s Office 27 AN LAO REPORT LAO Publications This report was prepared by Brian Weatherford and reviewed by Jason Sisney. The Legislative Analyst’s Office (LAO) is a nonpartisan office that provides fiscal and policy information and advice to the Legislature. To request publications call (916) 445-4656. This report and others, as well as an e-mail subscription service, are available on the LAO’s website at www.lao.ca.gov. The LAO is located at 925 L Street, Suite 1000, Sacramento, CA 95814. 28 Legislative Analyst’s Office www.lao.ca.gov