Tax credits

Ernst & Young estimates impact of dividend-tax proposal

by Donna Kimura

Washington, D.C.--Affordable housing production could fall by 40,000 apartments if President Bush’s plan to end the double taxation of dividends is enacted, estimates a new study by Ernst & Young.

Ever since Bush unveiled his tax plan in January, there’s been growing concern that the move would seriously harm the low-income housing tax credit (LIHTC) program, the nation’s main tool for producing affordable housing.

Now there are new estimates to support the fear. Housing credit investment could fall by $1.1 billion and production by 35% if the dividend exclusion were enacted as proposed, says the Ernst & Young study, which was prepared at the request of the National Council of State Housing Agencies (NCSHA). The loss would effect about 100,000 people each year.

The report, “The Impact of the Dividend Exclusion Proposal on the Production of Affordable Housing,” has been the talk of the industry since its February release.

While the study’s findings are dramatic, NCSHA officials say that the total impact may be even greater. The study did not factor in the impact of higher interest rates on tax-exempt housing bonds that would likely result from the dividend proposal.

“America cannot afford the loss of a single affordable apartment, let alone 40,000 housing credit apartments annually,” said Barbara Thompson, NCSHA’s executive director, in a letter sent to Treasury Secretary John W. Snow along with the report.

The recent findings will no doubt be cited as industry leaders try to minimize potential negative impacts of the tax plan on the LIHTC program.

The centerpiece of Bush’s economic stimulus package is a proposal to eliminate taxes on dividends. Currently, earnings that are taxed at the corporate level get taxed a second time when they are distributed as dividends to shareholders. Bush wants to end this “double taxation.” His proposal would allow corporations to pass along tax-exempt income to individuals if the income had been previously taxed.

The move, however, may harm the LIHTC program, which allows participants to claim tax credits in exchange for investing in the development of qualified affordable housing projects. Corporations would essentially have to decide whether to reduce corporate taxes and support affordable housing development by investing in LIHTCs or pass on more tax-free dividends to shareholders.

“It’s clear that by reducing the degree to which a corporation’s dividends would be tax-exempt, the dividend exclusion proposal would make credits less valuable for corporations and their shareholders,” said Marc Schnitzer, managing director of Related Capital Co. and an executive committee member of the Affordable Housing Tax Credit Coalition. “The Ernst & Young report is a good attempt to quantify the impact.”

Schnitzer added, “Low-income housing tax credits and other preference items are a permanent part of the tax code, with broad support. These preference items should not be impaired with a single brush stroke. Any proposed changes should address each item directly.”

Currently, the tax credit coalition is working with members of Congress on alternative tax proposals pertaining to LIHTCs.

The approach of many in the tax credit industry has been not to attack Bush’s proposal, but to find a way to protect the LIHTC program. NCSHA is recommending that housing credits be treated as taxes paid. This would be similar to how Bush’s proposal treats foreign tax credits. Not all of the adverse impact on the tax credit market would be mitigated, but it would be minimized.

At press time, several LIHTC investors reported that they were moving ahead with deals despite the uncertainties caused by the proposal. Several authorities said they didn’t think the impact would be as severe as estimated in the Ernst & Young report.

While passage of the plan is not guaranteed, some see the proposal gaining support.

The Mortgage Bankers Association of America (MBA) favors the proposal, saying its analysis shows that the plan could create one million jobs by the end of 2004. In addition, MBA says the plan could boost the nation’s gross domestic product by an additional 0.5% this year and 0.9% in 2004.

“While it appears that the relative benefits of LIHTC investments may decline for some investors under the administration’s proposal, it is unclear what the effect on LIHTC prices might be,” says a recent MBA report. “Given that the effect of the proposal on shareholder returns is limited to the changes in capital gains basis, the proposal may have limited effect. Indeed, not enacting the plan may have a greater effect on LIHTC pricing if the demand for LIHTC investments declines with lower corporate profits.

“In any event, any potential impact on LIHTCs is not a reason to oppose the growth plan but, if necessary, to seek changes to limit any negative effects. It appears that adjusting the capital gains basis to reflect LIHTC investments would be sufficient to offset the capital gains impacts on relative shareholder returns.”

The National Association of Home Builders (NAHB) has expressed its general support for the president’s plan while voicing concern about the effects on the tax credit program.

“On the whole, we believe the president’s economic proposal is good for the economy and good for housing,” said Jerry Howard, executive vice president and CEO of NAHB.

“As an organization that champions the broadest spectrum of the housing industry, NAHB looks forward to playing a leading role in representing all segments of the housing sector as the congressional debate on the administration’s economic package unfolds in the coming weeks.”

In a statement, Howard noted the strong concerns being raised by housing groups following the Ernst & Young findings. “… We believe it would be unwise to dismiss the entire Bush tax plan out of hand over this one study,” he said.

Effect on bonds

In its study, Ernst & Young used an analysis that compared the housing credit investment to a hypothetical equivalent taxable investment that provides the same after-tax yield. The firm also surveyed investors about whether their level of investment would change if the proposal were enacted. Results varied significantly, with about 40% indicating that they would decrease their investment activity, 20% indicating that they would maintain investment activity and another 40% saying that they were not yet certain.

In addition, tax-exempt bond financing is likely to become more expensive as a result of the dividend-tax proposal. “Since tax-exempt bonds have pretax yields below comparable taxable yields, investors pay an implicit marginal tax rate of 12% or more when investing in tax-exempt bonds,” explained the report. “By reducing the shareholders’ marginal tax rate to zero on corporate equity income, the proposal will result in a shift toward corporate equity and away from tax-exempt municipal securities.”

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