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Promoting Conservation Easements on Private Land with State Tax Credits
At the time GO TO 2040 was published, roughly 250,000 acres of land in the region had been set aside for conservation purposes, with another 50,000 acres primarily for recreation. While the majority is held by public agencies, the fastest growing slice of the pie, at least in percentage terms, has been private conservation. GO TO 2040 noted the critical need to support the work of private conservation organizations ("land trusts"), which protect land mostly by accepting conservation easements from landowners. A conservation easement is an agreement between a landowner and the easement holder -- usually a land trust -- to limit the type and intensity of development on the land. The easement donor retains the ownership and use of the land, subject to the terms of the easement.
One of the tools other states have used to encourage private conservation is a tax credit for those who take out a conservation easement on their land. While landowners usually enjoy federal income tax deductions for taking out such easements – they are treated as charitable contributions – a credit program sweetens the deal by offsetting state income taxes with a dollar-for-dollar reduction in taxes owed, which is much more valuable than a deduction. It can, at the very least, help offset the transaction costs associated with donating an easement, such as surveying, appraisal, and so forth. From the state's perspective, a tax credit program is attractive in that it offers a means of protecting land that is less costly than outright purchase. It can also increase the pool of parties interested in conservation, as some landowners may be willing to take out an easement and so retain the use of their land even when they would not want to sell.
This policy update reviews the features of other states' conservation tax credit programs, discusses the advantages and drawbacks of the approach, and makes an estimate of the program's potential in Illinois.
General program features
Thirteen states have conservation tax credit programs, while another two base their credit programs on the property tax, which is not considered here. Depending on the state, donors can include individuals, trusts, partnerships, or corporations. The credit is figured as a percentage of the fair market value of the easement (or the whole property, in states that offer the credit for donating the full interest in land.) Most states also set a cap on the maximum credit that can be taken for each donation, although it is unlimited in California, Virginia, Connecticut, and South Carolina. In Colorado, for example, the credit value is 50 percent of the market value of the easement, and the maximum credit that can be taken is $375,000. As the graph below indicates, the credit value and the maximum credit value vary significantly between the states.
For its part, the state develops criteria to determine the lands that would qualify for the conservation tax credit, either as part of the authorizing legislation or in the administrative rules implementing the program. The criteria can be the same as the federal criteria for qualifying conservation donations, or better, they could be more closely aligned with the conservation objectives of the state or metropolitan regions. In Illinois, for example, they could be based on the potential for the land to meet the goals of the Illinois Wildlife Action Plan or to help implement the Chicago Wilderness Green Infrastructure Vision. The application for the credit may require a specific review by the state, or it may be granted based on self-reported information (as, for example, a federal tax deduction would be) with the possibility of an audit. Requiring a specific review helps ensure that donated easements have bona fide conservation value, but it also adds a barrier to the use of the program and compounds the state's administrative costs.
A credit against a single year's state income tax liability may not be all that valuable. In particular, people with large landholdings but relatively little income would not find it especially attractive. If these "land-rich/cash-poor" donors were allowed to trade their credits, then a landowner who earns a credit through an easement donation can sell it at a discount to a person with a high state income tax liability, generally through a broker. In Colorado, where the usual discount is around 15 percent and the value of the credit is 50 percent, a donated easement worth $200,000 would earn a credit of $100,000, which at sale would have a cash value of about $85,000. The buyer would then apply the credit to his or her own state income taxes.
Allowing trading is not the only means of broadening the program's potential client base. A simple provision is to allow taxpayers to carry the remainder forward and use it in future tax years if the credit exceeds that year's tax liability. The longer the carry-forward period, other things being equal, the higher the benefit to the donor. Spreading these benefits out over a period of years is generally not as attractive as being able to sell a credit for a lump sum immediately. Another possibility is to allow a direct refund of part or all of the credit to the taxpayer if the credit exceeds taxes owed in one year. Only Colorado does this, and only in years in which there is a budget surplus. The table below compares the states' use of these provisions.
It is important to have some assurance ahead of time that the tax credit program would in fact encourage conservation. In other words, the program should pass the "but-for" test, meaning that it incentivizes conservation that would not happen but for the tax credit. Otherwise the only outcome of the program would be lost tax revenue. Since easement donations have been increasing over the past 40 years across the U.S., statistical research is needed to tease out the separate effect of the state tax credits – as well as the separate effects of variations in credit value, credit cap, and so forth -- but unfortunately little has been done in this area.
Using records from the National Conservation Easement Database (NCED), CMAP carried out a simple comparison of easement donations in states that adopted a tax credit as some point and those that did not. The analysis suggests that easement donations have in fact grown faster in the states that adopted a tax credit than in the rest of the states, as normalized for the land area of the state (graph below) and excluding easements in federal or tribal programs. However, the tax credits do not fully explain the difference in donation rates. The states with tax credits all passed their legislation sometime in the period 1999 – 2009, but donation rates were higher in these states collectively before then. Nor do donation rates appear to have been much higher in that period than they had been previously.
An incentive effect becomes more apparent when the states in the NCED are sorted into groups by the size of credit cap. In the graph below, states with larger available credits had a significantly higher rate of easement donations after about 2000. This suggests that tax credits can stimulate easement donations, at least if the program allows large maximum credits. Programs with maximum credit values lower than $100,000 seem to have no discernible effect on easement donation, which is consistent with earlier findings by the Conservation Resource Center.
Before concluding the discussion of program effectiveness, it should be noted that the NCED is not a perfect data source. Many records in the database do not show the year the easement was recorded. Furthermore, the NCED may have better records in states where tax credits are in place since those states track donations for their programs, which would tend to bias the results. An alternative source of data would be the Internal Revenue Service, which tracks conservation easement donations if they are taken as charitable contributions. However, the IRS has never released state-level information.
Advantages and disadvantages
A tax credit program is a way to protect land more cheaply than buying it. For example, if the credit is 50 percent of fair market value, then the public gets the benefits of conserving the land for half the cost of buying it. If a public agency does not own the land, there will also be long term savings on the costs of operation as well. Even if there is a certain amount of waste because of windfall tax benefits to those who would have donated without the credit, large savings redound to the public sector.
There are several downsides, however. One is that an easement might not grant public benefits equal to that of land acquired by a public agency. Some conservation easements curtail public access or certain kinds of activities – after all, the land would still be privately owned. The credit may also be seen as creating a tax benefit primarily for the wealthy. Unlike an income tax deduction, a credit is not inherently an "upside-down" incentive in that it does not become more valuable as income -- and therefore marginal tax rate -- increases. However, practically speaking, annual limits on use of credit and carry-forward years may make the credit more useful for higher income people.
If the credit is tradable or refundable, however, this equity objection should disappear, since the credit can be converted to cash regardless of income. The credit could also be reduced or eliminated for higher-income donors. Since higher income donors already benefit the most from federal tax deductions, the additional credit may not be a deciding factor in their decision to donate. If so, higher-income donors could be excluded from credit eligibility without significantly reducing the new donations it stimulates.
As a tax expenditure, finally, the conservation tax credit is both attractive and slightly dangerous, since programs that work by not collecting taxes are generally less conspicuous in a budget than those involving legislative appropriations, even though they have the same budgetary effect. While that tends to protect tax expenditure programs from cost-cutting and fund-raiding, it makes it harder to grapple with budget implications. Virginia, Arkansas, and now Colorado address this issue by placing a statewide yearly cap on the total tax expenditure from the program, which sets an upper limit on revenue loss, but other states generally do not have such program limits.
Potential in Illinois
New easements recorded in Illinois over the past decade averaged 43 per year, according to the National Conservation Easement Database, again excluding federal programs. The experts consulted by the Conservation Resource Center (discussed above) believed that programs with a high maximum credit cap and trading provisions led to a 20 – 25 percent increase in easement donations over having no credit at all, but analysis of the NCED data suggests that cumulative donations are actually 50 percent higher (over time) in states with credits. In that case, a rough estimate of annual easement donations after the program begins would be 65 donations per year.
For simplicity, all who are eligible for the credit are assumed to take it, even though an unknown number will not because they have loftier motivations, were unaware of the credit, found the application process trying, or for other reasons do not participate in the program. To estimate the effect of a maximum credit cap, it was assumed that the size distribution of newly donated easements would be same as the size distribution of existing easements in Illinois. Three different fair market values were considered, partly to reflect differences in land values across the state, but also to reflect the fact that a program could allow donations either of easements or whole interests in property, the latter being worth more.
The table below shows potential outlays (in 2010 dollars) for a program in Illinois, using common credit values and maximum credits from programs in other states, at 65 donations per year. The credit is assumed to be transferable with demand high enough so that all the credit granted under the program is directly used by the donor or sold to others to offset taxes. The results suggest that a program would be relatively small but still appreciable. By contrast, the average amount of the Real Estate Transfer Tax collected (if not spent) for parks and conservation programs in 2006-08 was $50 million per year.
A conservation tax credit program could be a valuable complement to existing conservation programs in Illinois. States which have passed tax credit legislation appear to enjoy higher rates of conservation easement donations, although more research is needed to verify the effects of different features of the tax credit programs. There are several program features to consider, among them the size of the maximum credit and the decision whether to allow a trade in tax credits. Some evidence suggests that high maximum credits and trading provisions encourage more donations. Consideration should be given to equity in the tax credit program. The states have taken different approaches to program design, but the Conservation Resource Center has developed model statutory language that could be used to guide a future effort in Illinois.