Tax Credits are like Carrots on a Stick for Companies

​“Tax Credits are like Carrots on a Stick for Companies” 

One of our Clinic’s projects deals specifically with the federal Low-Income Housing Tax Credit (LIHTC).  LIHTC incentivizes investors to provide capital to developers to help fund affordable housing projects.  Investors, in turn, receive substantial decreases in their tax liability through application of the tax credit, which is typically awarded for a span of 10 years.  As with most incentives, there follows a list of mandatory requirements.  

“Tax Credits are like Carrots on a Stick for Companies” 

 A fundamental premise of psychology is that most people, absent the altruistic few, behave in ways to improve their circumstances.  In the context of business, most often, that behavior involves making a decision to yield increases in one’s wealth.  This desire for self-gratification is a mere innate quality, but it makes the topic of tax incentives an interesting concept to study.  

Of course companies are interested in maximizing profit, so they are not eager to spend money on an unprofitable project.  So, how does one encourage a multimillion-dollar company to invest money into the development of affordable housing?  Well, what would one do to get an apathetic teenager to clean his room or an unrelenting toddler to eat her vegetables?  Simply put, provide them with an incentive.  To induce most individuals to perform a desired behavior, the targeted individual must know that the behavior will yield a favorable outcome for him or her.  Perhaps that inducement comes in the form of money for the teenager or a cookie for the toddler.  Tax incentives operate much the same way for businesses.  For example, to induce a business to invest into affordable housing (i.e., the desired behavior), the government will offer tax credits (i.e., the incentive).  Tax credits provide the company with the opportunity to substantially decrease the amount of tax liability it owes to the federal government.  And you would be hard pressed to find a company that does not want to limit its tax liability! 

One of our Clinic’s projects deals specifically with the federal Low-Income Housing Tax Credit (LIHTC).  LIHTC incentivizes investors to provide capital to developers to help fund affordable housing projects.  Investors, in turn, receive substantial decreases in their tax liability through application of the tax credit, which is typically awarded for a span of 10 years.  As with most incentives, there follows a list of mandatory requirements.  Under LIHTC, the developer is not granted the tax credit until he or she has sufficiently completed the affordable housing project to the satisfaction of the governing state agency in charge of administering the credits.  If the project fails to comply with the mandatory requirements, the developer does not receive the tax credit and the investor cannot decrease its tax liability.  With this particular scheme in place, both the investor and the developer will work diligently to deliver a satisfactory project; much like the teenager will clean his room better than a hired professional and the toddler will scrape her plate clean of any vegetables, all because the incentive is worth it! 

In a related discussion, Brazil demonstrates how it effectively uses tax incentives to generate economic development.  The Wall Street Journal recently reported that the Brazilian government increased taxes on imported foreign cars, but offered tax brakes to companies opting to manufacture their cars in Brazil under its program called “Inovar-Auto.”  BMW was the first company to take advantage of the lower tax bill and Audi is likely to follow suit in 2015.  These incentives offer financial benefits to the car manufacturers and they strategically provide mediums to stimulate Brazil’s economy by creating jobs.  In short, we learn that tax credits are financial carrots on a stick for businesses.  If the government presents a good enough tax incentive (i.e., carrot), the company will likely operate in the manner the government desires, whether it is investing in affordable housing or opening manufacturing plants on foreign soil. 

 

The author is a student in the DePaul Law Housing and Community Development Legal Clinic.