Enormous Sales and Huge Tax Breaks, U.S. Video Game Makers Have It All
The United States government grants tax incentives to companies working on medical breakthroughs, urban redevelopment and alternatives to fossil fuels, all endeavors that could improve lives worldwide.
Many subsidies are directed at enterprises that are not likely to see profits for years, but are perceived to have a broad benefit to society, like reducing pollution or improving public health.
But the U.S. government also grants tax breaks for the video game industry. Tax analysts are asking, "Why?"
No video games, however entertaining and addictive, could contribute to a community's sustainable development. It can neither reduce pollution nor improve public health. Video game makers create amusing, entertaining, perhaps stress-relieving games for individual gamers who can afford to shell out cash to play a game.
In a country that provides tax breaks for a company that created a video game about killing space zombies, tax analysts are baffled, to say the least.
The tax incentives comprise a collection of deductions, write-offs and credits mostly devised for other industries in other eras.
California-based Electronic Arts shipped more than 2 million copies of Dead Space 2 in the game's first week on the market this year. It shows a total of $1.2 billion in global profits the last five years using an accounting method that management says captures its operating profits.
But thanks to deferred revenue, deductions for executive stock options and a variety of accounting requirements, EA reports a net loss for the period, noting it paid out $98 million in cash for taxes worldwide in those years.
A tax professor at the University of Texas at Austin, Calvin H. Johnson, says video game production is one of the most highly subsidized businesses in the United States. Johnson worked at the Treasury Department before joining academe.
Video game makers explore the blurry lines between software development, the entertainment industry and online retailing. This is primarily the reason why they are able to combine tax breaks in ways that companies like Netflix (online retailer) and Adobe (software developer) cannot.
The government gave $123 billion in tax incentives to corporations in 2010, according to the Joint Committee on Taxation.
On the other hand, the fact that video game companies are doing constant research and innovating for the market means that they do encourage technological progress and more important, provide some jobs.
When the tax code was rewritten in 1954, Congress included a new break allowing companies to deduct all laboratory-based research and experimentation costs immediately to simplify the tax code.
At the time, Daniel Reed, chairman of the House Ways and Means Committee, said the tax break would indirectly bolster national security by stimulating "the search for new products and new inventions upon which the future economic and military strength of our nation depends."
This tax break was actually a proposal based on the condition of country's technological edge, which seemed eroding at the time of the cold war and nuclear arms race. About 20 years later, video game makers got into the picture.
In 1969, the IRS expanded that tax break to allow companies to deduct the cost of software development, which was a small part of a business that was then dominated by bulky mainframe computers. When the video game industry sprouted in the early 1970s, game developers reaped substantial tax savings because most of their costs were for software development.
The game developers' entitlement to write off the vast majority of their development costs immediately gives them a substantial financial advantage over other entertainment companies in taxes and cash flow.
Electronic Arts, founded in 1982, is one of the world's prolific video game companies. It has produced globally popular titles like SimCity, FIFA soccer, Harry Potter and Madden NFL.
Video game companies also get other research-related breaks. In 1981, as Americans worried that Japan's growing dominance in the auto business would spread to high tech, Congress added another research and development ground for tax breaks, this time companies that increased their research and development spending from the previous year.
The Treasury hoped the new credit will encourage companies to invest more in research and pave the way for the next Bell Laboratories to rise.
But within a few years, the credit was being abused by businesses with little technological background, like fast-food restaurants, hair stylists and fashion designers. Congress tried to restrict what research would qualify, and excluded social science research and marketing.
There was a proposal to allow the credit only for research that produced an actual innovation, but it was dropped in 2002.
Tax policy analysts say the breaks for the video game industry illustrate the point that the U.S. tax system defies common sense. After all, the video game industry's domestic sales alone reach $15 billion a year; it even exceeds the sales of music albums.