OIX: New Tax Credit Exchange Sheds Light in a Dark Economic Corner

NYSE tax creditsBrad Walker had a problem. Actually, he had three.

For starters, his Louisiana-based software company, InfiniEdge, was in a bind. As a U.S.-based firm, it could compete for contracts that foreign companies couldn't, but those short-term contracts made it difficult to control staffing. Walker wanted to keep his programmers on between contracts, instead of hiring them for each contract and then letting them go. But doing so would require more money in the coffers.

Secondly, as a high-tech outfit creating jobs in a state desperate to reduce its unemployment rate, InfiniEdge qualified for tax credits that could have spurred hiring. The trouble is, the company wasn't able to use them. Because Walker set up shop in a "GO Zone" -- an area that was devastated by Hurricane Katrina -- "we haven't owed taxes for a while," he explains. Tax credits are one of the major tools that state governments use to promote growth, but they can be a blunt instrument, and companies often qualify for more credits than they can use.

And even if he could take advantage of the tax credits, Walker needed money year-round, not just in April. Tax credits are great when tax time comes, but they aren't really all that helpful for most of the year.

Brad Walker (Photo: InfiniEdge)What it all added up to was that Walker had tax credits that he couldn't use, and needed extra cash that he couldn't find.

The Tax Credit Dilemma

Walker's problem is not uncommon. According to a recent report in The New York Times, state and local governments offer $80.4 billion in tax credits each year as an incentive to attract companies to create new private-sector jobs. But just because a company qualifies for a tax credit doesn't mean it will be able to use it. Whether because their tax bills are already covered, as in Walker's case, or because, their tax credits are larger than their tax liability, many companies find themselves tax credit rich, but cash poor.

On the bright side, many tax credits are transferable, which means that companies like Walker's can, conceivably, buy and sell them. As Tracy Gordon, a fellow in the Economic Studies program at the Brookings Institute, notes, governments are aware of many of the problems with tax credits and have designed the programs to be flexible.

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"The government wants to make it easier for these credits to be used for socially desirable purposes," she explains, pointing out that some credits, like Walker's, can be sold to other companies. "Credits can be bought and sold because the government knows that this is a good way to get things happening."

But while governments offer tax credits that can be bought and sold, they don't offer a place where buyers and sellers can meet. Some states will buy back certain types of credits, but these options tend to be limited, and the buyback rates are unattractive. Georgia, for example, buys back low-income housing credits for just 58 cents on the dollar.

As Walker discovered when he sold some of his credits, the market for tradeable credits consists of private brokers who buy the credits at a low price, then resell them at a steep profit. Initially, this worked out well for InfiniEdge, which was able to use the proceeds from its sales to help cover its staff's salaries. But soon, Walker says, "Our broker started getting greedy," and attempted to lowball the company. To make things worse, because the tax brokering market was entirely private, sellers like Walker had very little idea about the actual value of their credits.

A Dark, Mysterious Market

That's a common problem, notes Danny Bigel, a former member of the New York Stock Exchange and a movie producer who worked to help redevelop New Orleans' music district. "I would call tax brokers to find out about selling my incentives. I kept getting the same quotes from each of them, which suggests that they were working together, but there was no transparency, so I couldn't tell how they came up with their numbers."

To make things worse, Bigel points out, many brokers added in closing costs, legal fees, and other charges, which reduced the value of the incentives -- for both the states issuing them and the companies using them.

Currently, 45 states have tax credits that can be bought and sold. "These programs are worth billions," Bigel notes, "but some states have no idea what's going on in their market." Plus, the incomprehensibility of the tax code and confusion over which companies can use which incentives means that tax credits inordinately benefit large companies. "They're the ones who know about them," Bigel says. "And they have the accountants to help them figure out if they qualify for them."

A Transparent Market

In mid-November, Bigel launched the Online Incentives Exchange, a site where individuals and companies can directly buy and sell tax credits without going through a broker. Thus far, Louisiana is the only state listed on the OIX, but California and Georgia will also enter in December. Bigel has plans to ultimately include all 45 states that issue transferable credits.

"To put the OIX together, we started with state governments," Bigel says. "Tax credits aren't regulated, so we didn't really need their support, but we wanted our customers to have confidence in the exchange. With that in mind, we wanted to build supportive, cooperative relationships with state governments."

The key benefit for states, Bigel emphasizes, is that the OIX can help incentives to do what they are designed to do -- stimulate economic activity.

"In a transparent exchange, all sides win," he claims. "The buyer saves money, the seller gets more money for his credits, and the state, which hopes to generate economic activity, gets the best effect from its program."

Brad Walker has already seen a benefit from using the OIX. Selling to brokers, he generally got about 78 cents on the dollar for his tax credits. On the OIX, the credits he's sold have netted him 86 cents on the dollar. That can translate into a significant amount of operating income. "It takes longer than using a broker," he admits, pointing out that broker sales are instantaneous, while his OIX sales took about two weeks. "But the extra money will help us to grow, and will make it possible to hire employees."

In other words, with the help of the OIX, those tax credits will do exactly what they were designed to do.

Bruce Watson is a senior features writer for DailyFinance. You can reach him by e-mail at bruce.watson@teamaol.com, or follow him on Twitter at @bruce1971.

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