A proposal to establish a new business tax break – amended in the Senate to also expand and extend an overly generous subsidy, the angel investor tax credit program – will result in significant lost funds for our schools, child welfare system, judicial system and other important needs without ensuring any benefit to Kentucky communities. This proposal, House Bill 6 (HB 6), is quickly progressing toward final passage in the 2018 Kentucky General Assembly.
The original provisions of HB 6 would create a mechanism for the establishment of rural investment funds by venture capital firms for the purpose of investing in rural Kentucky businesses. Investors would receive a 100 percent tax credit, with the program capped at $60 million over 4 years. The legislation also requires the rural investment funds to leverage an additional $40 million on top of the $60 million in public money diverted through tax breaks.
According to proponents of the bill, this should result in jobs, growth and prosperity for rural Kentucky. However, the proposed legislation does not include any provisions that will ensure the promised results, even while the venture capital firms, banks and insurance companies are guaranteed big winners.
The company that brought this proposal to Kentucky is Advantage Capital Partners – an investment firm based in Louisiana. According to reports published by the Pew Charitable Trusts, Advantage Capital Partners hired lobbyists in at least 10 states in 2017 to push legislation like House Bill 6. Advantage Capital Partners was also behind the establishment of New Markets Tax Credits in Kentucky in 2010. Companies like Advantage Capital Partners propose and lobby for passage of legislation like HB 6 and state New Markets Tax Credits because the programs are structured so that the investment funds and investors will earn money regardless of what happens in the states where the programs exist.
HB 6 contains a huge subsidy for the banks and insurance companies that invest in the program and creates even bigger advantages for the fund managers, who can use the risk-free investments to leverage even greater returns for themselves. Banks and insurance companies either purchase an equity interest in the fund or they purchase, at par value or at a premium, a debt instrument with a term at least five years out. This means that they have a stake in the fund that will allow the return of some or all of their initial contribution after five years. Depending on their agreement with the fund manager, they may also be entitled to a share of any profits or gains from their investments while the fund is still in existence.
In addition, these same investors receive a 100 percent tax credit for their investment. This means every dollar they put into the program will come back to them as they apply the credit awarded to reduce their state bank franchise or insurance premium taxes. Taking of the credit must be spread out over at least four years, but can be carried forward up to 10 years if not fully needed to reduce the tax liability in prior years.
Stated another way, under this proposal, Kentucky is guaranteeing that the banks and insurance companies that invest in the fund will not lose any money at all on the deal –and in fact, if the investments made by the fund simply break even, the banks and insurance companies could experience a return on investment of 100 percent or more.
What’s more, the legislation is problematic in terms of accountability:
- Although the act is called the “Kentucky Rural Jobs Tax Credit Act”, there are no requirements that investments result in new jobs, new businesses or economic improvement for rural counties. There is a weak requirement as part of the application process that the applicant provide an estimate of the number of jobs to be created or retained, as well as an analysis showing a positive revenue impact, using dynamic scoring, over ten years. Other than these requirements on the front end, there is no back end review or analysis to determine if these projections were met, and there are no claw backs of any tax breaks based on anything except the length of time the investor must leave the investment in the fund. In short, if nothing positive happens in the communities in which investments are made, investors will still receive their 100 percent tax credit, as well as their share of the principal and any returns on the investments. Fund managers will still have their principal investment, the portion of the bank and insurance company investments that aren’t returned to those investors, and any earnings and profits from the investments.
- There 3 requirements that must be fulfilled for investors to receive the 100 percent tax credit in no way relate to creating jobs or improving rural Kentucky economies. They are:
- An investment be made in the fund;
- The fund invests 100% of the money within two years in rural growth investments (which do not actually have to be in rural counties), with 20% invested in counties with labor force participation rates below the national average; and
- The original level of investment be maintained for at least five years.
- The bill includes reporting requirements that allow the General Assembly to evaluate the effectiveness of the program, however these requirements will not have a bearing on investments already made. Even if the General Assembly determines that the program is not fulfilling its stated goals and opts to close the program moving forward, they will be powerless to act on existing investments because the credits “earned” by investors vest immediately upon the contribution being made, which means the investors are legally entitled to the credits.
Given the generosity of the tax credits and the limited requirements to receive them, it is likely that this program will be 100 percent subscribed as soon as the application process opens, just like the angel investor tax break. And the process for awarding credits under this program requires that funds be approved on a first-come, first-served basis, with no review of the quality or content of the applications or the past performance or history of those applying.
The program proposed in HB 6 is very similar to the New Markets Tax Credit program and an older multilayer subsidized lending program referred to as CAPCO (certified capital companies). According to the Pew report, states that have evaluated these similar programs have found that they “failed to deliver the promised jobs and tax revenue.” Further, Pew notes that “the programs are so complex, and the promises so appealing, that states typically don’t take a close look at them until it’s too late.”
Total receipts from the bank franchise tax and insurance premium taxes in fiscal year 2017 were $253 million, and this bill would give away $60 million of those revenues in future years. With no quality review on the front end, no checks and balances on the back end, and no real ability to claw anything back, this proposal is a risky and costly way to accomplish a goal that could more easily and effectively be accomplished through direct, thoughtful investment by the General Assembly in the communities this proposal purports to benefit.
Updated March 29, 2018.