Pennsylvania’s Independent Fiscal Office has suggested making the Keystone Innovation Zone (KIZ) tax credit refundable, which would eliminate the portion of the tax credit going to tax brokers and increase the funding available to target businesses. Other proposed changes would strengthen the applicant review process and expand data collection to improve program accountability.
What is the KIZ Tax Credit?
The Keystone Innovation Zone program provides tax credits worth up to $100,000 for qualified firms located in one of 28 zones across the state. To qualify, a firm must have been in operation less than 8 years and produce a proprietary technology in a targeted industry sector.
The tax credit is intended to encourage entrepreneurial activity by providing financial assistance to new and young firms. In turn, the state hopes these start-up companies that are typically near universities will generate more output and employment in targeted, high-tech sectors across the state.
According to the Department of Community & Economic Development (DCED), the program has led to 11,000 jobs since 2004 and kept 3,500 college graduates in the state. DCED also reports $275 million in licensing revenue and 900 patent awards among KIZ firms.
How the KIZ Tax Credit is Used
- About 250 firms are awarded tax credits annually. The request for credits regularly exceeds the annual program cap of $15 million.
- The average award in FY18-19 was approximately $59,000.
- Most awards have gone to firms in the professional, scientific and technical services field, followed by the manufacturing and information sectors.
- Most of the qualified firms do not have sufficient tax liability to use the credits, so they sell the tax credits for cash. The tax credits are sold for an average of $0.92 per dollar of credit award, and a broker or facilitator earns a fee of about $0.05 per dollar.
- When tax credits are sold, “approximately 10 to 12 centers per dollar awarded does not stimulate technological development.”
- An economic impact analysis found that the state’s fiscal gross return on investment is calculated at $0.32 per tax credit dollar and the net ROI is $0.27. The report explains that the gross ROI means that the tax credit does not pay for itself, while the net ROI indicates that the tax credit generates more tax revenues compared to the state’s assumed alternative use of the funds.
- The impact analysis also indicates that the tax credit increased annual state GDP by $52 million.
Recommendations
Consider remuneration for KIZ coordinators
Each zone has a designated coordinator. KIZ coordinators often work for one of the zone partnership organizations, typically an economic development entity. The coordinators’ KIZ responsibilities are usually added to their full-time job activities, even though it can involve a substantial amount of work in vetting and managing applications. It would be appropriate to consider paying the coordinators for their work, especially if the state will require stricter review and reporting procedures.
Require more data collection and verification
Statutory program deadlines should be revisited to facilitate a firm’s ability to include supporting documents, especially tax returns, with the application to allow for a more thorough application review.
The lack of reliable data make it difficult to quantify the impact of the tax credit. Additional data, such as new jobs created and wages and salaries. should be required. Information should be verified, not simply self-reported. State agencies suggest allowing data sharing between the Department of Revenue and DCED to validate information provided.
Data on firm performance after leaving the program (to determine long term economic impacts) and other state incentives received by KIZ firms should also be reported.
Enact reforms to deter fraud and abuse
In 2019, a scheme for fraudulently obtaining KIZ and R&D tax credits by a couple acting as tax brokers was revealed. A grand jury made several recommendations to reduce the opportunities for fraud. These include requiring audits, extending the review process period, strengthening application verification procedures, licensing tax brokers and training KIZ coordinators.
The IFO also notes that the tax credit could be made refundable for 95 cents on the dollar to eliminate the role of tax credit brokers, while also simplifying program administration and increasing the amount of money going to the intended targets.
Pennsylvania’s Independent Fiscal Office, which provides analysis of fiscal, economic and budgetary issues, released Pennsylvania Keystone Innovation Zone Tax Credit. An Evaluation of Program Performance in January 2020. The evaluation was conducted to comply with Act 48 of 2017 requiring the IFO to review state tax credits over a five-year period.
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