Connecticut 's new stranded tax credit program aims to unleash investment

HBJ Photo | Steve Laschever Paul Pescatello, executive director of the Connecticut Bioscience Growth Council, says the industry is grateful for a new tax-credit program allowing firms to cash in R&D tax credits.

Photo | HBJ File Pratt & Whitney's new East Hartford headquarters was financed with stranded tax credits, a deal DECD Commissioner Catherine Smith helped put together.

PHOTO | HBJ File DECD Commissioner Catherine Smith

Fred Carstensen, Economist, UConn

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By Matt Pilon

In 2014, Connecticut agreed to let United Technologies Corp. use up to $400 million in “stranded” research and development tax credits to keep and expand the presence of its Pratt & Whitney subsidiary in East Hartford.

Allowing a company to extract value from tax credits it already earned, but hadn't been able to use, was a significant shift in the state's economic development strategy, compared to its more common practice of handing out grants or favorable loans in exchange for company pledges to create or retain jobs and invest in new facilities and equipment.

Now, the legislature wants to expand on the concept. Slipped into the latest state budget is a provision that opens up the use of stranded tax credits to a broad array of companies — albeit on a smaller scale than the UTC deal (the program is capped at $50 million).

Starting this year, the Department of Economic and Community Development (DECD) will accept applications from other companies that want to use their stranded credits in exchange for making major investments in buildings, infrastructure and Connecticut-based venture funds.

Projects that are accepted into the program will be required to show that their investment generated enough economic opportunity to make the state whole on the future tax revenue it's foregoing by allowing the credits to be used.

“So many times in economic development, you're promising to do things in the future,” said Paul Pescatello, executive director of the Connecticut Bioscience Growth Council. “Here, you only earn the credit after you've made the investment.”

The bioscience sector is expected to be one of the biggest beneficiaries of the program because the industry spends heavily on research and development.

Economic impact

The policy was a response to the fact that some Connecticut companies have accumulated significant tax credits, particularly R&D credits, they haven't been able to use. That's because the value of some companies' tax credits exceed their relative corporate income tax liability and there are state-imposed limits on what portion of a tax liability a company can offset with tax credits.

In fiscal year 2016, the latest data available, Connecticut companies had $1.8 billion in R&D tax credits they carried over because they were unable to use them.

For years, UConn economist Fred Carstensen has championed allowing companies to use stranded R&D tax credits in exchange for making impactful investments.

The Connecticut Center for Economic Analysis, which Carstensen oversees at UConn, studied the matter in 2010, concluding that such a policy could more than pay for itself in the long run.

Carstensen was elated when he heard recently that legislators had decided to extend the program to other companies beyond UTC.

“It's hands down the most powerful economic development tool we've seen,” Carstensen said.

However, his bubble burst quickly when he learned the program would be capped at just one-eighth the size of the Pratt deal, or $50 million.

“That shows that the legislature didn't understand the [CCEA] analysis,” he said. “Properly structured, any deal is revenue neutral in the short run but delivers huge fiscal dividends in the long run.”

CCEA calculated in 2010 that every $1 billion in stranded credits that companies use would create up to 45,000 jobs. Against that measure, $50 million would create no more than 2,250 jobs.

While he's frustrated, Carstensen still sees upside in the new program. Even if it doesn't change the state's economy in any significant way right now, at least the program is now enshrined into law.

“That's what we had never done before, is put the concept in place,” he said. “You can always change the rule.”

Pescatello, too, wishes the $50 million cap was higher.

“Obviously the power of it as an economic driver would be increased if there was no cap, but we also understand the state's limitations with the budget and we're trying to take that into consideration,” he said.

He's also optimistic about anything that could boost the amount of venture capital investments made in Connecticut, which declined in 2015 and 2016.

Under the program, companies that form their own venture fund and invest in Connecticut companies and technologies will also be able to use their stranded credits.

“We really need to encourage more VC investments in the state compared to our major competitors, which in the biopharma world are really California and Massachusetts,” he said.

A new tool

At $50 million, the stranded tax credit program won't be the largest at DECD's disposal, but it will be significant, and could be used in conjunction with other programs like “First Five,” said DECD Commissioner Catherine Smith.

“I think it could be a really nice tool in the toolbox,” Smith said.

She said several companies have been persistent in lobbying for the program in recent years.

She declined to name them, but one that has testified publicly is Ridgefield pharmaceutical giant Boehringer Ingelheim.

James Baxter, Boehringer's senior vice president of development, said the company is grateful the legislature created the program.

“We have a large and active research site in Ridgefield that we invest in heavily, and have accrued tax credits much faster than we have been able to apply them under the current R&D tax credit structure,” Baxter said. “As a result, we have millions of dollars in stranded tax credits, and are currently evaluating how this new program may impact our future capital investment projects.”

As for the cap on the program, Baxter said he is waiting to see what happens.

“There is still a lot of detail that is yet to be known about how it will be implemented, and we recognize the state's need to balance this newly established program during the current budget climate,” he said.

While DECD's Smith — who has run economic development for Gov. Dannel P. Malloy since he took office in 2011 — generally speaks positively of using stranded tax credits, she was not always supportive of the concept. Five years ago, after Carstensen and CCEA released a report criticizing the state's economic strategy, she was lukewarm to the idea and argued it may not be entirely self-funding.

Asked about it recently, she said she has softened on that position.

“Part of the reason I was kind of lukewarm about it is we were kind of in big discussions with UTC,” Smith said. “I didn't want to underdeliver.”

She said not having to put up new capital to incentivize economic growth is a plus. DECD will aim to structure the deals so that the state pays out as little cash as possible for the credits, either by having companies apply them to sales-and-use tax liabilities or permitting them to apply R&D credits to a greater portion of income tax liability than is normally allowed.

”For most of it, we expect it to be non-cash,” she said. “As you know, we're kind of cash-strapped these days.”