Imagine that you’re a tax or treasury manager working for one of New Jersey’s profitable corporate taxpayers. Imagine further that the state offers your company a risk-free investment that yields 17% to 38% with few conditions. If you think that sounds too good to be true, and that there is no way a state led by a former Wall Street wizard would ever use taxpayer dollars to hand private companies risk-free yields of that magnitude, think again.The Murphy administration recently announced the sale of $50 million in corporate tax credits at an average discount of 22% to begin funding its New Jersey Innovation Evergreen Fund (NJIEF), which is slated to invest up to $600 million in NJ-based startups in “innovative industries that disrupt current technologies or business models.”
No one disputes the desirability of growing innovative companies and high-paying jobs in New Jersey. And there is an argument to be made that a pool of public (that is, taxpayer-financed) capital can serve as a catalyst in promoting private capital investment. Yet it’s fair to ask whether the administration’s choice of financing in this case — using heavily discounted tax credits to fund a pool of investment capital — is an appropriate and efficient use of taxpayer dollars. It is not.
In its bid to jump on the politically fashionable “innovation economy” bandwagon, the administration faced a range of funding options. It could — and did — ask the Legislature to appropriate money directly to the NJIEF. But the state budget includes only $5 million in seed money, a nominal commitment that no doubt reflects the economic and political risks inherent in funding early-stage companies with taxpayer dollars. Alternatively, Murphy’s Economic Development Authority could have borrowed the money at market rates, currently around 6% for 20-year taxable debt backed by budget appropriations. But selling bonds is justifiably controversial in New Jersey and may require voter approval. Public borrowing to finance investments in private startups would certainly have generated strong pushback from rating agencies and the financial press.
Not-that-innovative financing
Instead, the administration opted to use a not-so-innovative mechanism for capitalizing its Innovation Fund: selling discounted corporate tax credits at auction. To enhance the politically fashionable optics of promoting the state’s “innovation economy,” the administration required that bidders “submit plans to support the state’s innovation economy along with their financial bids, including a commitment to serve on the NJIEF Advisory Board for one year.”
In a tax-credit auction, purchasers bid for the right to take a tax credit of a certain amount on a future tax return. Expressed as a percentage of the bid amount, the difference between the bid and the tax credit amount — the discount — represents effective yield to the bidder. For example, a bid of $90 for a $100 tax credit would reflect a discount of $10 and a yield of 11.1%. There is absolutely no risk to the successful bidder because companies only purchase tax credits they are certain they can use, generally within the next year. Not coincidentally, the political risk to our elected leaders is limited since no appropriation or borrowing is necessary, and few voters seem to care about foregoing future revenue. When the smoke clears, the state and its taxpayers will in substance have paid the cost of the discount to borrow against future tax receipts.
In theory, a tax-credit auction should result in discounts at rates that reflect the yields corporations would expect on their routine cash investments plus a modest premium added for compliance and administrative costs in claiming the credit down the line. Yet the recent NJIEF auction resulted in eye-popping discounts of 17% to over 38%.
Will the winning bidders’ nonfinancial commitments mitigate the cost to taxpayers? Not so much. Ignoring the unconscionable discounts, the administration’s press release proudly reports that the eight winners made “strategic commitments” valued at nearly $3.8 million “to bolster the innovation community” — including mentorship programs, free shared workspace, education and training to support STEM students from underserved districts and investor forums. All good stuff. Trouble is, these vague commitments will be hard to quantify and monitor over time, and in any event $3.8 million doesn’t change the math of a fundamentally bad deal. Besides, it would be shocking if big winners such as Comcast and Verizon aren’t already engaged in similar activities as part of their existing community engagement programs.
But there’s more. The recent auction’s huge discounts may also disrupt the existing market for transferrable corporate tax credits issued pursuant to the state’s economic development incentive programs. To reduce their state corporate tax bill, Verizon and a few other major New Jersey corporations routinely purchase as many transferrable credits as they can use, typically for 92 or 93 cents on the dollar. If Verizon and other buyers can purchase equally valuable NJIEF-related credits at auction for only 62 to 82 cents on the dollar, the demand for existing economic development credits will likely decline, raising the cost of the state’s incentive programs.
Even if you believe that it’s OK for government to invest in inherently risky startups, the Murphy administration’s use of heavily discounted tax credits is financially indefensible and smacks of naked political expedience. If the Legislature won’t wake up and ask the hard questions that need asking here, I have a question of my own: How do I participate in the next round of NJIEF tax credit auctions?
