Developing Concerns : Video Game Development Lawyers & Attorneys: Reed Smith Law Firm: Intellectual Property, Marketing, Promotions & Privacy Law

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In November we wrote that the Michigan Film Office had approved its first video game applicant for tax credit financing.  Now that application - Pixofactor Entertainment - and other entertainment-related companies thinking about locating their next project in Michigan may have to think twice.  According to the AP, Gov. Rick Snyder's first budget proposal calls for the elimination of the film tax incentive program, and orders a $25 million cap on film credits starting later this year (although current commitments would be honored).  And Michigan is not alone in the desire to stop tax credit and tax incentive financing - in Missouri, Gov. Jay Nixon has recommended dropping funding for that state's film office.

Why are states trying to shed their tax credit regimes?  Because, according to opponents of these plans, they don't work.  In September of 2010, the Michigan Senate Fiscal Agency published an issue paper (PDF) finding that the tax credit system failed to generate significant returns in private sector activity.  The issue paper found that in FY 2008-09, the tax credit caused Michigan to spend $37.5 million, while it generated only $21.1 million in private sector activity.

Yet a study conducted by the Texas Comptroller of Public Accounts found that Texas' tax credit system worked (PDF).  From April 23, 2009 to August 31, 2010, the state awarded $48.4 million in grants, and in return expected more than $414 million in Texas spending by the applicants.  Moreover, Texas found that the cost to the state for the tax credit was just $117 per each $1,000 of proposed Texas spending by approved applicants.

So what gives?  Why the disparity between the findings of Michigan and Texas?  And if there are weaknesses in tax incentive plans, do they apply universally to video games, film, television, and commercials?

Taking them one by one, Texas offers two incentive programs that are applicable to video game development: a rebate on eligible in-state spending, and a tax exemption for the purchase or lease of qualifying items used in the development of a finished video game product (this includes games, hardware, etc.).  There is a minimum $100,000 spend in Texas by the dev, and there are other conditions on the residence of the dev team, and the number of production days spent in Texas.  So the basic gist is that, for money spent developing games in Texas, Texas will reimburse you up to 7.5% of that amount.

Michigan, on the other hand, offers a refundable, transferable tax credit, up to 42% of qualified expenditures.  There is a minimum spend of $50,000, and not as many exclusions or conditions as the Texas program. Thus, even a quick comparison between the two programs shows that Michigan's incentives can be much more generous than Texas'.  So perhaps the level of benefit being offered is one reason for the difference between the two.

A second notable difference is that Texas supplied funding to a good deal more games projects than Michigan.  While the November 2010 grant to Pixofactor for Ben Hogan's 5 Lessons was the first games project approved for Michigan funds (which theoretically had been available since April 2008), Texas doled out approximately $9 million to games projects between April 2009 and August 2010, and boasts an estimated 1,694 jobs (FTEs) created in the video games sector during that time.  This increased funding for games projects may be another reason why Texas has experienced more success with its program than Michigan.

Finally, Texas has separate conditions for production of TV/Film projects and games projects.  In contrast, Michigan did not separate the two kinds of projects (though there are separate requirements for "interactive web site projects," which are different from games projects).  Yet lumping video games in with TV and film can be inappropriate when it comes to deciding what to fund.  While a TV or film shoot may spend a few months in the state offering financing, they typically break up afterwards and everyone goes on their way.  This is known as the "bivouac" model of production, and leads to less permanence of any one group. 

However, game projects are different, and that difference should lend itself to having a larger impact on a tax incentive program.  First, coding and artwork can be done from just about anywhere (you don't need majestic vistas or sandy white beaches to code, though having those things can't hurt, in my opinion).  This means that, once a company sets down roots, there is less need to pick up and move to a new location based on the needs of a particular project.  Second, games (at least AAA titles) typically take longer than a few months of work to complete.  So when you put these two differences together, you end up with games companies being more likely to stay longer, and less likely to move in the future, than film or TV productions.  (In the interest of full disclosure, some have argued that the games industry should adopt the "bivouac" model of film and TV production).  But for now, game projects should not be treated like film or TV projects, at least in terms of financing metrics.

One final though on this issue - it is possible that a straight cost-benefit analysis is not the only appropriate way to measure the success of a tax incentive program.  There are other considerations, including the revitalization of underprivileged areas, promoting education and STEM skills in the area's schools, etc., that may not lend themselves to a "hard cash" analysis, but are nevertheless worthy goals. 

In sum, the bottom line is that tax credits and incentives are tricky, complex beasts, and can cut for the better or for the worse.  I for one would like to see more study of this, but based on the limited information available from a comparison of two state systems (Texas and Michigan), it seems to me that games projects are well-suited for tax credit financing, and that treating games as their own form of media, both for the purposes of project approval and payouts, is a strategy worth considering.