[Createquity Reruns] The Bottom Line on Film Tax Credits

(Tax policy week at Createquity concludes with our most popular article thus far in 2014, John Carnwath’s investigation of the value of tax credits for film and television. Are they worth the hassle? Maybe, but probably not to the extent that lawmakers in New Jersey, California, and Austin think. -IDM)

Photo by vancouverfilmschool. Some rights reserved.

About a year ago the New York Times ran a series of articles on corporate tax breaks, complete with a web-accessible database of state tax incentives for businesses. All in all, the Times discovered 1,874 state and local incentive programs that give out a combined $80.4 billion to corporations each year. To put those figures in perspective, the tax breaks doled out by Oklahoma and West Virginia are worth about one third of those states’ entire budgets. Manufacturing is the most highly subsidized industry, receiving about $25.5 billion in tax breaks annually, followed by agriculture and oil, gas, and mining. Fourth on the list? Surprisingly, it’s the motion picture industry, which nets about $1.5 billion in state and local tax credits per year.

What’s behind this $1.5 billion tax rebate for filmmakers? While industries such as agriculture have been subsidized for decades, state and local tax credits for film productions are relatively new. Louisiana was the first state to introduce such an incentive in 1991, and other states were slow to follow suit. Only four states offered incentives to movie producers in 2002, but once the idea caught on it spread like wildfire, and by 2010 forty-four states offered some form of incentive to filmmakers. The specifics vary from state to state, but typically the financial incentives (for which TV productions, industrial videos, commercials and sometimes even video games are eligible) consist of some combination of tax credits, cash rebates, employment rebates, sales tax and lodging exemptions, and fee-free use of shooting locations. In order to qualify, productions must generally satisfy certain conditions, such as spending some percentage of their total budget locally, shooting a certain percentage of the footage in-state, employing a certain quota of local residents, or exceeding a minimum amount of in-state spending. In addition, some states require that the action of the films take place in a local setting or even demand that the film depict their state in a positive light in order to qualify for tax credits.

To be clear, the film industry isn’t supported out of any particular concern for cinematic art, nor are politicians incentivizing the production of films because they think we’d be better off as a society if we had more movies and TV shows to watch. As is the case with many other corporate tax breaks, the main reason for offering tax credits for filmmakers is simply jobs, jobs, jobs. State officials don’t particularly care if a company is making movies, auto parts, or toothpaste—if it has the potential to create a lot of jobs for local residents, officials want those jobs in their legislative district rather than someone else’s. They are willing to dangle tax breaks as bait on the assumption that the jobs created by the firm will bring more money into the local economy than the government will lose by providing the tax break.

So how effective are the tax incentives for film and TV productions in generating jobs and/or revenue? That depends on whom you ask. Or who funds the research you’re looking at.

The ROI of film tax credits

Reports funded by the Motion Picture Association of America (MPAA), the main lobbying arm for the movie industry, consistently show a positive return on investment for state treasuries. For example, a recent study of the New York State Film Production Tax Credit commissioned by MPAA found that “for every $1.00 of credit distributed, the State and City received a combined $2.23 in taxes.” In Florida, a research firm that was hired by MPAA found that $118.7 million in tax credits yielded $140.44 million in 2011/12, for a more modest return of $1.18 to the dollar.

By contrast, a recent report on Louisiana’s Motion Picture Tax Credit by the State Auditor found that the state supported the film industry with $196.8 million in tax credits and only received $27 million in additional taxes in return (about $0.14 for every dollar spent), and the Massachusetts Department of Revenue found its return to be only marginally higher at $0.16 per dollar spent. A 2011 article by the Tax Foundation lists several other studies by state agencies and a few that were funded by MPAA exhibiting the same discrepancies.

How do these studies arrive at such vastly different numbers? To get some insight into this question, we can take a look at two conflicting reports on Massachusetts’ Film Industry Tax Incentives that were published this year: one by the Massachusetts Department of Revenue (mentioned above) and the other by HR&A Advisors for MPAA.

* This is not explicitly reported as the number of jobs created, but is implied by the statement, “Massachusetts motion picture production employment increased 46.1 percent from 1,630 jobs in 2006 [the year the tax incentives were introduced] to 2,380 jobs in 2011.”

As far as I can tell, the disparity, most notably in the estimated economic impact, results primarily from the following differences in the models and their underlying assumptions:

• Opportunity costs: Since the state is required to maintain a balanced budget, the Department of Revenue assumes that any incentives that are provided to the film industry have to be paid for by saving money somewhere else in the budget. So instead of just calculating the positive effect that the tax credits have on creating jobs, their analysis factors in the number of jobs that will be lost in other areas of the state’s budget due to cuts. Of course, these cuts have negative ripple effects throughout the economy just as the newly created jobs have a positive impact. By contrast, the MPAA report only looks at the positive effects of the new jobs that are created.
• Wages paid to non-residents: Both reports acknowledge that some of the jobs that are created by film and television productions in Massachusetts will be held by people whose primary residence is in another state; however, the manner in which the studies correct for that varies considerably. The MPAA report merely exempts “individual employee salaries over $1 million, as it is assumed the majority of these employees are non-residents, so multiplier effects associated with this spending are not realized within the Commonwealth.” The Department of Revenue similarly excludes all payments to recipients earning more than $1 million per production, but in addition it excludes 95% of all other wages paid to non-residents. The rationale is that most of the lodging, food, and incidental expenses for non-resident employees are paid for by the production company, so that only a small portion (estimated at 5%) of the non-resident workers’ paychecks gets spent in-state.
• “New” spending vs. total spending: The Massachusetts Department of Revenue is careful to exclude the production of TV shows and commercials that would have been produced in-state even in the absence of the incentives. This wasn’t of great consequence in 2011 (the latest year included in the study), since $174.6 million of the $176 million spent on TV and movie productions was deemed to be “new” (i.e., induced by the tax credit). However, in 2010 41% of the total film production spending ($29.5 million out of $71.6 million) would have been expected to take place in Massachusetts even if no tax credit had existed. (The large difference between 2010 and 2011 was attributed to the discontinuation of some long-running TV programs that were produced locally). The MPAA study doesn’t factor pre-existing film production into the equation, preferring to attribute all of the current film production activity to the incentive.

Despite the considerable differences between the studies’ findings and their disagreement about whether the incentives produce a net benefit for the state treasury, everyone agrees that the tax credits have a positive impact on the economy. For example, the 2013 audit in Louisiana found that every dollar of film tax credits resulted in $5.40 in economic output. However, that’s not really saying much, since almost any form of government spending is likely to have a positive impact on the economy. The question is how the impact of the tax credits compares to other things the state could have done with the money.

What about those jobs?

As mentioned above, in most cases the objective of these tax incentives isn’t necessarily revenue generation but job creation. Are film tax credits efficient means of creating jobs? One way to consider that question is how many tax dollars are being spent for each job that is created. According to the Department of Revenue, Massachusetts’s taxpayers had to fork out $128,575 in tax credits for each job that was created in the film industry in 2011. Seeing as the median wage for jobs created by the film industry in Massachusetts was $70,657, that doesn’t seem like a very good deal. The state could have employed almost twice as many people at the same income level if it had simply hired those people directly, instead of subsidizing motion picture companies. The picture looks somewhat better if one uses MPAA’s numbers, but it’s still not great. Assuming (generously) that all of the jobs that were created by TV and film productions between 2006 and 2011 can be attributed to the tax incentives, 750 jobs were created in 2011 at a cost of $37.9 million. That comes out to $50,533 in state spending for each new job. So even using MPAA’s more favorable numbers, it seems that the state paid more than two thirds of the wages for the film industry’s new employees.

Film-induced tourism

One factor we haven’t considered yet is the effect that film and television may have on tourism and the public perception of the locations where they are produced. There are certainly a number of cases in which blockbuster films have led to significant increases in tourism, as The Lord of the Rings trilogy did for New Zealand. And once local residents get past the street closures, traffic delays, and general nuisance that come with a major movie shoot, I’m sure many would agree that there’s some excitement in spotting Hollywood celebrities at local restaurants. There’s also some satisfaction to be gained from recognizing familiar landmarks on the big screen when you see movies that were shot in your hometown. In that sense, local film productions may promote a sense of pride in and attachment to a location, so that tax credits could be justified on the basis that they improve the quality of life for local residents. If nothing else, they give them something to talk about.

Both the tourism and public opinion arguments are valid reasons to support tax incentives for movies. It therefore seems appropriate that MPAA includes film-induced tourism in its recent reports on state tax incentives (in Florida and Massachusetts); however, the measurement of this effect remains problematic. Having consulted twelve representatives of Florida’s tourist industry, MPAA figures (conservatively, it claims) that 5% of all tourism in the state can be considered film-induced tourism and can therefore be added to the economic impact of the film tax incentives. The MPAA-commissioned study of Massachusetts’s film tax incentives uses a different methodology that was employed to assess the value of New Zealand’s exposure in the Lord of the Rings and Stockholm’s exposure in the Millennium trilogy. This approach equates each recognizable shot of the location where the film is set with the publicity that is achieved by a 30-second paid advertisement for the destination on primetime television. The cost of purchasing enough airtime on television to reach an equivalent number of viewers is then assumed to be the value of the advertising that the film provides for the location.

However, if tourism is the objective, the tax credits shouldn’t be granted to all movies indiscriminately. Only those that showcase the location prominently and identifiably should be eligible. I wouldn’t doubt that ABC’s Nashville is having a positive effect on the psyche of that city’s residents as well as on tourism and the local economy. As the assistant commissioner of communications and creative services for the Tennessee Department of Economic and Community Development noted, “You’re not only getting the 20-plus episodes per season”: every advertisement and preview for the TV show is essentially advertising Nashville. By contrast, it’s hard to imagine how shooting Homeland in Charlotte, NC, would do much to increase public awareness of North Carolina’s attractions, given that the show is supposed to be taking place in Washington, DC. Incentive programs that require films to be set in-state and/or depict the location in a positive light make a lot of sense from this perspective (though the latter condition may seem dangerously close to censorship).

So where does that leave us?

In December, the Bureau of Economic Analysis, which among other things is responsible for determining our nation’s Gross Domestic Product, for the first time released a calculation of the economic value of the arts and cultural production in the United States. According to the BEA, arts and culture contributed $504 billion to our GDP in 2011. To put that in perspective, that’s almost twice the $289.9 billion generated by mining (which includes all oil and gas extraction). The motion picture industry alone added $83.2 billion to the US economy, which, believe it or not, is more than the total value added by automobile manufacturing. The motion picture industry has long been touting its economic significance to argue for more favorable tax treatment, and these latest numbers will only bolster its case.

Yet critics of film tax credits claim that these policies do nothing to stimulate the economy and merely pit states against each other in a race to the bottom. Even some people within the movie industry acknowledge that if the tax credits are the only thing that a certain location has going for it, business will likely move somewhere else as soon as the financial incentives are rolled back or some other state offers even bigger tax breaks. Once the states have foregone all tax revenue from movie producers in the rush to compete with other locations, the playing field will once again be even and the industry will settle where it was to begin with—the only difference being that the production companies no longer pay taxes and state budgets are even tighter than before.

I haven’t found any data to indicate whether or not the incentives are increasing due to competition between states, but from a theoretical perspective the race-to-the-bottom argument is compelling. Even if one believes the MPAA studies that show a positive return on the states’ investment, if the states keep raising their tax incentives to compete with their neighbors, the public benefits of attracting motion picture productions will eventually approach zero.

In the material I’ve reviewed for this article, there is little to suggest that the current incentives offered by state and local governments are optimal in any sense. I have yet to come across calculations that show that a certain level of tax incentives creates the greatest number of jobs per tax dollar forgone. So why do some states offer 15% tax rebates while others offer 20%? Are the expected returns really higher in some states than others, justifying the additional investment? Or are the higher tax incentives necessary in states where the conditions for filmmaking are otherwise so poor that no producers would go there if the rates were any lower? Since I haven’t been able to find a convincing rationale for the levels of the tax credits, I assume the levels are indeed set according to inter-state competition, which is consistent with the race to the bottom scenario. If that’s the case, I’d say it’s a poor justification for public spending. (This situation isn’t unique to the motion picture industry, by the way. The same doubts about inter-state competition and the race to the bottom hold true for all sorts of corporate tax breaks that try to bribe corporations into setting up shop – or keeping current plants open – in particular locations.)

So how might we improve the current system of incentivizing film and TV productions? Even if the economic argument offered up by MPAA doesn’t hold—and, personally, I’m inclined to believe the governments’ internal audits that show a net loss for the states—I don’t think one must abandon the idea of incentivizing motion pictures entirely. The system might just need to be improved to target those productions that are likely to generate the greatest public benefits.

The fact is, the current tax credits already target specific types of motion picture productions. Minimum requirements for the production budget and/or the amount of money that is spent in-state are presumably designed to ensure that the tax breaks go to big-budget productions that will employ a lot of people. The large corporations behind those productions are the ones most likely to respond to incentives, moving their operations to whichever state offers the lowest costs, whereas a small film production company in Massachusetts is likely to work in Massachusetts whether or not the state offers any incentive. However, for that same reason one might argue that the large corporations are precisely the wrong place to invest public money: they operate nationally (or internationally) and will fly in people from around the world to work on the production, so relatively few of the jobs created will go to local residents. Furthermore, as soon as another state offers bigger tax rebates, they’ll pack up shop and move there. Any spike in economic activity from a big-budget production coming to town is therefore likely to be short-lived. Wouldn’t it be better to give the tax breaks to smaller firms whose production budgets are too modest to fly in talent from out of state? Those productions might not hire a whole lot of people, but at least the paychecks will be going to local residents, and if the production does well and the company grows, that growth will happen in-state.

The one argument that does work in favor of giving tax breaks to big budget productions is their ability to reach a wide audience and potentially increase tourism or improve public opinion of a certain location. In order to fully endorse this approach, I’d need to see more credible research on the economic value of the exposure that shooting locations receive, preferably coupled with a greater capacity to predict which films are going to have a significant impact in that regard. As tempting as it is to reduce the conversation about film tax credits to a simple thumbs-up or thumbs-down, it would be smarter to consider how to determine which productions to incentivize with tax credits and where such tax expenditures would be wasted. That’s speaking from the perspective of job creation, of course. If the objective were to improve the quality of cinematic art, an entirely different set of selection criteria would be necessary.