The Iowa Office of Auditor of State has released a report on the state’s film tax credit program, which erupted in scandal last fall. The Iowa-based Tax Update Blog, which has naturally kept a close eye on the story over the months, summarizes the report:

Before the Iowa Film Tax Credit program exploded in scandal in September 2009, the state had granted $31,967,641 in transferable tax credits to filmmakers. Yesterday the State Auditor reported that $25,576,301 were issued improperly — a full 80% of the credits granted.

The 127-page report identifies two principal sources of the bad credits: the use of “in kind” expenditures, and double-dipping on the credit computation.

The in-kind expenditures were “transactions” for which no money changed hands, such as sponsor agreements where vendors provided services or equipment to film productions free of charge in exchange for the vendor being named as a sponsor. There is nothing wrong with such an arrangement in and of itself, but whether it is a qualified expenditure for purposes of the Iowa film tax credit is another question.

Iowa’s tax authorities perhaps inadvertently encouraged the use of pretend dollars in the film business. In a set of e-mails, a top Department of Revenue policymaker signed off on the concept. […]

The Department of Revenue later repudiated this position, issuing rules saying that only cash expenditures qualified. The revised position is probably the right one, as the tax law generally only gives you the benefit for the cost of business expenditures, not their fair market value, when computing a deduction or credit.

Still, the emails were enough to send the film companies off to the races.

Iowa’s film tax credit problems are largely unique to their state (we hope), but movie production incentives are bad policy whether or not fraud and creative accounting are involved. They don’t deliver on their promises and just serve to funnel public funds to film companies at the expense of taxpayers. States that offer film tax credits are caught in an unproductive arms race. When everyone is part of the incentive battle, the only winner is the film makers who can leverage states against one another.

And states are competing not just with each other but with other nations as well. For instance, New Zealand has recently agreed to shell out US$25 million to convince Warner Bros. to film the two upcoming The Hobbit films there. Prime Minister John Key, who played a key role in arranging the $25 million deal, had only days ago seemingly taken a tough stance:

“From the conversations I’ve had with Warner Bros so far I’ve made it quite clear if it comes to a bidding war, then New Zealand is out because I don’t think that’s the right way to run this.”

He said there was a risk that giving special concessions to Warners [sic] would allow other production companies to try for the same deals in the future.

“We don’t want to be re-negotiating with every single production company that comes to New Zealand.”

Good luck.