Testimony: Calculating Tax Savings for Public Subsidies
Thank you, Commissioner Reardon and distinguished members of the board, for this opportunity to testify. My name is Debipriya Chatterjee, and I am a Senior Economist with the Community Service Society of New York—a non-profit that has worked with, and for New Yorkers since 1843 to promote economic opportunity and champion an equitable city and state. We use rigorous research, provision of direct services, and advocacy to make New York a more prosperous and equitable place. For over a decade I have been working on issues of economic security with special focus on tax and fiscal policies and the impact of such policies on low-income workers.
Today’s topic of how future tax savings should be treated in estimating the total public cost of a project is an important one because of the layers of uncertainty involved, from a practical standpoint. However, my testimony today will focus on the theoretical framework that should inform this policy. Typically, from an investor or a developer’s perspective, future tax savings are factored in as increasing future after-tax cash flow and thus improving profitability, when discounted to the present.
For any public entity subsidizing the project by promising future tax savings, the overall cost of the project is the discounted sum of the foregone revenue over the period mandated for tax savings. Revenue that could have been put to alternate uses.
In both instances, the crucial factor is the discount rate, which captures the opportunity cost of allocating funds to a particular project while they could have been invested elsewhere. Another way to put it is to say that the discount factor is used to express the time value of money. The further in future that savings are accrued, the less they are worth in the calculation at present. This is important because it helps us see that the uncertainties in future estimates should matter less as we make the decision today.
By limiting the purview of public funds to the value of the current subsidy amount would not be capturing the core rationale behind the spirit of the law for any long-term tax incentive program. As board member LaBarbera pointed out earlier, if an entity is submitting an estimate for financing, it should be able to provide one that incorporates the public subsidy, even if it is an estimate under a long set of assumptions.
However, to ensure that we have an accurate estimate of the total subsidy involved, we need to accurately estimate future subsidy amounts, often on a case-by-case basis.
In the case of real estate projects, public subsidy is often granted as tax exemptions and abatements on property taxes and as PILOTs as we have heard this morning. For instance, this year’s Executive Budget includes the Affordable Housing from Commercial Conversion (AHCC) which provides developers with up to 90 percent reduction in their tax bills for a maximum of 35 years, if they meet all requisite criteria.
Thus, for a potential project that is approved under AHCC, in any given year, the developer or the owner calculates the net operating income and deducts depreciation and any other exemptions to arrive at their tax liability.
Thus, in any given year, public subsidy provided would equal the real property tax amount exempted for each qualifying project. And we can sum the discounted value of these exemptions to arrive at the present value of total subsidy for the project.
This overall framework is amenable to handling variations in several underlying parameters, including inflation, tax increases, and depreciation. Assuming a 3 percent annual inflation, we can adjust the future tax savings to reflect their purchasing power of the present. Similarly, if the tax rate increases, and assuming the assessed value of the property has not declined, the dollar value of the exemption would increase, effectively increasing the total public subsidy.
Finally, to calculate total public subsidy, we should consider the entire horizon for which the exemption would be effective. For some properties, the exemption phases-out at 40 percent, at others, it phases out at 10 percent, requiring that the calculation of public subsidy include this final exemption rate in its calculation.
And just to add a note on the prevailing wage, I would state that construction work has been repeatedly shown to be pathway for economic security for workers in New York and thus for overall prosperity of the region and its people, projects receiving public funds should be paying prevailing wage. If the uncertainties around a project only comes down to paying workers a just and fair compensation, I think in the spirit of the law, we should extend it to cover these workers.
Thank you again for the opportunity and if you have any questions, please reach to me at dchatterjee@cssny.org.