This story first appeared in the July 19 issue of The Hollywood Reporter magazine.
Under the current approach to tax law, states compete with one another for local film production. They offer various tax subsidies that differ widely in scope of coverage, qualifying costs and other terms. The result is a complex hodgepodge of confusing laws and regulations. In other words, it's massively inefficient, as evidenced by the huge discounts (often more than 20 percent) that producers accept to monetize subsidies. We have a system where the states squabble among one another rather than the country competing against the rest of the world. The Commerce Clause of the Constitution was intended to stop this type of interstate rivalry, and it is time it be taken seriously.
The U.S. has made a halfhearted attempt to promote film production through section 181 of the tax code, which permits a deduction for the first $15 million of production costs of films shot in the U.S. Unfortunately, this section doesn't work for several reasons, including (a) it keeps getting passed on a temporary basis and often retroactively (failing to promote U.S. production because the films already are shot); (b) it merely accelerates a deduction that would otherwise come shortly, and in a near zero percent interest-rate world, that is not worth writing home about; and (c) most individuals cannot use the deduction because of the "passive loss" rules and other restrictions on deductions.
So what's the solution? Easy. It is time for the federal government to replace section 181 with tax credits for U.S. production costs. The credit should be assignable in order to provide actual financing for production. As part of implementing this tax credit, the federal government should use its power under the Commerce Clause to pre-empt all state laws (and don't let Puerto Rico sneak away) that give tax credits for production. That way, the states could go back to competing for production based on services, infrastructure and locations -- just like in the good ol' days. Ads should tout states because of their sweeping vistas rather than sweeping tax credits.
There are potential impediments: The plan shifts the tax cost of the subsidy from the states to the U.S., which might be difficult, given the U.S. deficit, if the U.S. views itself as separate from the states. Also, states that perceive themselves as winning the tax credit battle (such as Louisiana and New York) might not want to level the playing field. But if we are going to seriously battle runaway production to foreign shores, then we'd better stand together and adopt a national plan. And the best way to do that is a single federal tax credit that is assignable (to permit badly needed financing for production) or, barring that, that is at least refundable. One way or the other, we'd better do something intelligent -- and soon.
Schuyler M. Moore is a partner at Stroock and the author of Taxation of the Entertainment Industry.