Making movies is expensive. The latest Superman movie Man of Steel received a $215 million investment from Warner Bros. and parent company Time Warner (TWX). Man of Steel reaped a positive return, but many movies do not. Taxes in the U.S. can drive those small profits or losses down even further, to the point where production companies will happily film elsewhere.
Countries around the world see this opportunity and they have lowered their taxes to give film companies more incentive to produce within their borders. Hollywood production now makes up a mere 8% of global movie production. Can Hollywood change its own tax system before it's too late? Regardless of what California does, investors should be cheering lower-cost films.
The tax-incentive carrot in countries that are doing it right
Eastern Europe has become the most recent international market to offer extensive film-production tax breaks, with Lithuania the latest in a list of countries like Slovenia and Hungary that seek to lure movie makers. With tax rebates for up to 20% of local spending, Lithuania hopes that companies will come to a country that is already full of camera-ready backdrops, such as ancient forests, long sandy beaches on the Baltic Sea coast, ancient cities, monasteries, and castles.
This trend is not just taking place in developing regions. The New Zealand government now offers a new funding grant, effective April 20, which offers funding and support to film producers as well as a 20% tax rebate.Similar trends are happening in Australia and other developed countries.
Movie production follows the carrot abroad
The carrot and stick tax incentives are working. Hollywood production made up 64% of total worldwide film production in 1997, and this has now dropped to just 8%. Even when it only involves specific parts of a film, production abroad has increasingly become a trend for film makers looking to cut costs.
Lionsgate's (LGF-A 0.90%) box-office blockbuster Hunger Games: Catching Fire was a highlight of the company's 2013 results. The great music scoring of that film? Part of that was outsourced and produced offshore, where international musicians were happy to lend their talents for less than the company would have paid in the United States. This helped the company control costs on the expensive production, so it took more profits from the box-office revenues.
Hollywood is trying to catch up, is there still time?
If Hollywood and the U.S. government want to regain their lost media-production tax revenue, California needs to change its own tax policy. That might happen sooner rather than later.
A new bill sent to the California Assembly last month seeks to increase the state's current film and television tax credits. The legislation would not only offer increased funding, it would also allow for increased tax subsidies for large-scale movies and network television shows.
With the California state budget back in somewhat of a balance recently (well, to the extent it can be ... but that's a topic I don't even dare touch), analysts expect that $400 million a year in tax credits could be allocated to media production over the next five years. That would give the media producers the incentives and security that they consider when they decide where to produce their movies, which could persuade more films to come back to Hollywood.
Other states in the U.S. are competing for film production as well. More than 40 states offer some forms of tax credits and subsidies. According to supporters of the California legislation, of the 41 big-budget feature films released in the last two years, only one was shot exclusively in California, while most were shot in multiple locations around the country. These supporters also noted that over the last 10 years, California's share of one-hour TV show production dropped 35% and the industry lost nearly 10,000 jobs in California.
Even Disney becomes a tax lobbyist
In a presentation to the Ways and Means committee in the House of Representatives, The Walt Disney Company (DIS -0.84%) representatives advised the government on the need for lowering taxes on media production in the U.S. The company said that it believes that the U.S. should actively encourage companies to locate their creation, ownership, and commercialization of productions in the U.S.
Disney reps said that two areas need to be addressed: a "meaningful reduction" in the corporate tax rate and the "adoption of incentives" to bring films, including jobs and tax revenues, back to the United States. The company said that by not doing so, the U.S. industry operates at a major disadvantage.
Foolish conclusion: Hollywood is suffering, but competition among regions is good for investors
Yes, movie production has gradually moved out of Hollywood over the last two decades. Film markets around the world are working hard to incentivize the big movie makers to come produce within their borders.
However, the same major U.S. media companies still produce the bulk of the blockbuster hits and collect the bulk of the global revenues, such as Disney and Warner Bros. Therefore, investors in these companies should cheer the lower costs of international production as they can be happy that this trend will bring them more profits.