A week ago the Pennsylvania Attorney General’s office announced charges against Wing Tat Chiu and Ivy Hiu-Ying Li, a married couple whom they accuse of earning $6 million in illegal profits by defrauding the state. Chiu and Li fled to Hong Kong in 2016, where they had already stashed the money. The outrageous thing is less that two thieves allegedly committed a crime than that the state, which loves to give away free money, made it so easy.
Eighteen shell companies controlled by the same couple obtained $10.6 million in tax credits, which they sold for an alleged $6 million gain.
Chiu and Li allegedly exploited two of the state’s tax credit programs, the Pennsylvania Research & Development (R&D) program and the Keystone Innovation Zone (KIZ) program. The programs grant businesses a reduction in their tax bill for, respectively, spending money on loosely defined “research” or for operating within certain geographic areas. The key to Chiu and Li’s scam, according to a grand jury report, is that these particular credits need not be used by the applicant. The R&D and KIZ tax credits, once awarded, can be sold.
The sale of tax credits is in fact common business practice in subsidized industries like renewable energy and multifamily housing. The government doesn’t mind who actually uses the credits so long as the activity it aims to subsidize (construction of a solar farm or a housing project, for example) takes place. Where the government runs into trouble is in trying to distinguish between a legitimate enterprise and a fraud undertaken solely for the purpose of acquiring salable credits.
Pennsylvania offers 29 tax credit programs and dozens of grant, loan and guarantee programs.
Chiu and Li studied at Michigan State University in the 1990s, resided for a time in Bucks County and established businesses in 2004 and 2009 according to the grand jury report. Their initial applications for R&D and KIZ tax credits might have been connected to real business activity. Very quickly, however, the couple apparently realized the more lucrative business was in simply trading the credits. They proceeded to establish 18 shell companies and in the years 2012-2017 successfully applied for $10.6 million in credits tied to fictitious business activity. They re-sold the credits for an estimated $6 million.
Chiu and Li did nothing elaborate: their efforts appear to have consisted solely in forging some application materials and working through middlemen to sell the credits. Simple accountability standards like site visits, for example, would have exposed the couple’s schemes. The grand jury report also noted there is no recapture provision that lets the state rescind a tax credit improperly awarded.
The state has a political interest in avoiding embarrasment when it gets cheated. It has no interest in stopping the flow of money to well-connected businesses and favored groups.
The grand jury report suggests remedies for this and other obvious failings. Tightening up the tax credit application process could prevent the most obvious frauds. A recapture provision would motivate tax credit buyers to closely scrutinize sellers. The root of the problem, however, is not in any specific procedure but in the massive volume of money the state hands out. Pennsylvania administers 29 different tax credit programs; 23 of them together award a maximum of $558 million per year while six others have no maximum and awarded $92 million in fiscal year 2017-2018. On top of this the state runs dozens of grant, loan and loan guarantee programs. State bureaucrats are neither equipped nor motivated to audit even a fraction of the entities to which they are giving money. The state has a political interest in preventing embarrassment when it gets cheated. It has no interest, however, in stopping the flow of money to well-connected businesses and favored groups.
The state’s numerous business giveaways generally fall into one of two categories: their terms are either so ambiguously defined as to call their purpose into question, or so specifically worded as to look like a targeted favor. The governor’s annual budget (section D) and the programs list web page of the Department of Community and Economic Development are full of both. For example:
- Minority Business Development Loans carry an interest rate of just 2% and can cover up to 90% of total project costs, including for real estate acquisition. No responsible banker would ever offer such terms.
- The Waterfront Development Tax Credit makes a total of $1.5 million available to “firms making a donation of cash or property to a waterfront development organization to fund a waterfront development project.” The small dollar amount and hyper-specific language make this program look more like an earmark than a competitive award.
- Historic Preservation Tax Credits offer each awardee up to $500,000 to rehabilitate and preserve commercial buildings with historical value, poorly defined. The public, of course, don’t get to share the awardee’s gains when he sells his refitted building for a profit.
- The Pennsylvania Capital Access Program guarantees qualifying commercial bank loans in amounts up to $500,000 each to “support a wide variety of business projects.”
- The Alternative and Clean Energy Program provides grants and loans for energy projects and can cover 50% of project costs in certain cases and up to $5 million per project.
- Film Tax Credits can cover up to 30% of film production expenses incurred in Pennsylvania.
- The Video Game Production Tax Credit will cover up to 25% of qualified expenses for game development, again poorly defined.
- The Ben Franklin Technology Development Authority Venture Investment Program provides financial assistance to venture capital investment funds.
The list goes on, and legislators are even now proposing new giveaways like the Keystone Energy Opportunity Zone Tax Credit. Instead, lawmakers should pursue broad tax and regulatory reforms to improve the business climate for everyone.
The story of Chiu and Li is outrageous but unsurprising: cheaters will always cheat given the opportunity. Worse than the alleged crime is the legal, and far larger, siphoning of public money by businesses that don’t need it or can find private funding like everybody else.