Taxpayers have paid $500m-plus to subsidise big-budget movie makers. Is it money well spent, asks Karyn Scherer.

As screenplays go, The Making of the Hobbit surely has Oscar potential.

There's the whole back story for a start: the Kiwi kid whose talent took him to the top of Hollywood; the extraordinary enterprise that culminated in the celluloid version of Lord of the Rings; the bitter legal battles over the spoils; the scrap with the Tolkien family; the near-death of movie studio MGM, which owns half the rights; director Guillermo del Toro reluctantly quitting the project; the difficulties casting Bilbo Baggins - and that's all before a small island nation nearly erupted in civil war over where the damn thing would be filmed.

In marketing terms, it would also tick most of the boxes. Franchise film? Well, obviously. Disaster movie? Middle-earthquake, for sure. Ethnic movie? Talk to the Aussies. Coming of age drama? Well, we've all come out a bit wiser and a bit more worldly, haven't we? Rom-com? Maybe not, unless you count cuddly James Nesbitt as the token middle-aged Middle-earth crumpet.

As for horror - Hobbit co-producer Philippa Boyens did admit that foes who described her as a Nazgul might have a point. (Hobbit fans - shall we call them Hobos? - agree it wasn't a compliment).

Fans of European cinema might even enjoy the Fellini-esque touches, such as Boyens insisting at an industry conference last month that the reason Warner Bros was so determined to do right by the Hobbit actors was because the studio was acutely aware that 13 of them were dwarves. Or as Boyens quite seriously pointed out: 13-and-a-half, if you also count Scottish actor Graham McTavish.

For non-Hobos, though, the entire saga has inevitably thrust the swivelling searchlights on another issue: exactly what is the role of taxpayers in this ongoing drama, and were so many of us really required as extras? In this age of technical wizardry, couldn't we just use CGI instead?

AS WE all know, New Zealand's current status as a hot place to make Hollywood movies is largely the result of heroic efforts by those white knights Sir Peter Jackson and Sir Richard Taylor. But there are probably a few bureaucrats and politicians who fancy they might also have had something to do with it.

The decision in 2003 to launch what is known as the Large Budget Screen Production Grant must have seemed at the time to be a bit of a no-brainer by the Labour Government. Keen to transform New Zealand's economy from one that relied on good soil, stunning scenery and okay weather, to one that relied on a diverse range of sophisticated skills, Labour latched on to the screen industry as one of several sectors with the potential to provide exactly the kind of growth and innovation that everyone seemed to want.

The country was also reeling from an experiment with incentives in the late 80s that led to tens of millions of dollars being poured into a number of tax-driven, publicly marketed film projects - some of which didn't actually exist except in the minds of some clever lawyers and accountants.

Later projects were very real, but still took advantage of tax breaks. As an American screen industry report noted in 2005, New Zealand taxpayers were "instrumental" in financing Lord of the Rings - a trilogy listed in many league tables as one of the most successful movie franchises ever, with total revenue estimated to be in the order of US$3-$5 billion.

According to the US lobby group the Center for Entertainment Industry Data and Research (CEIDR): "The Government assisted New Line's Rings project by allowing the studio to form shell companies that got tax breaks and then 'sold' the finished film to New Line. That cost the New Zealand taxpayer more than US$100 million. The loophole was closed as soon as the Rings films wrapped and is highly unlikely to be reopened."

Jackson has consistently maintained that reports of the tax breaks given to Lord of the Rings have been greatly exaggerated. He has insisted the total was less than the $100 million paid in PAYE tax by the production. Inland Revenue maintains the eventual tally, including several other titles, was around $300 million.

It wasn't just New Zealand taxpayers who helped fund Lord of the Rings. As New York-based investigative journalist Edward Jay Epstein notes in his book The Hollywood Economist: "In the case of the Lord of the Rings trilogy, New Line covered almost the entire cost by using a combination of German tax shelters, New Zealand subsidies, British subsidies, and pre-sales."

Epstein marvels that the studios have gotten away with such schemes with so little scrutiny for so long.

"Hollywood studios try to reduce the amount of money they lay out to make a movie to as small an amount as possible," he told The Business.

"They have whole teams of MBAs working on it. One of the ways they reduce costs is getting the Government to subsidise them, either through direct subsidies or through tax credits."

In his book, Epstein describes Jackson's fixed compensation for King Kong as a "relative bargain" for Universal, partly because it was more than covered by the Large Budget grants. He believes Warner Bros is probably being just as tough on The Hobbit, largely because of the weakness of the US dollar.

"In the case of The Hobbit, a large part of the budget, maybe as much as 50 per cent, will be in post-production. Even though the budget might look huge, the actual extras and everything else might be less than US$100 million or US$50 million. The subsidy allows you to do the under-the-line work at no cost."

STUDIO shenanigans aside, the Large Budget Screen Production Grant was actually intended to limit taxpayer exposure to big budget movies and TV series, by restricting rebates to 12.5 per cent of production expenditure. The original proviso was that at least 70 per cent of the total production budget had to be spent here, and that the budget had to be at least $15 million.

The scheme was largely copied from Australia, which had introduced it after its own run-in with Hollywood.

When the Australian Tax Office refused to allow tax breaks for Australian investors in Moulin Rouge, 20th Century Fox was furious and made its feelings known to the Australian Government. According to CEIDR, politicians fast-tracked a review of the situation.

"Mutterings were heard that runaway production would decamp to countries like Canada and Ireland, which offer clear-cut concessions. The Government consulted closely with the Motion Picture Association and reps of studios, including Warner Bros and Fox, on the kind of incentive needed," it says in its 2005 report.

CEIDR notes that between 1998 and 2005, Australia and New Zealand increased their share of what are known as runaway productions from the United States from 7 per cent to 19 per cent.

It concedes that subsidies have not been the only factor. A favourable exchange rate and lower labour costs in Australia and New Zealand helped reduce production costs by as much as 44 per cent compared to the US, it says.

The gap has since shrunk, particularly in Australia because of its strong dollar. As an Australian producer put it at an industry conference in Auckland last month: "We're no longer Mexicans with mobiles, but Mexicans with very expensive mobiles".

But it was subsidies that mostly concerned two American academics when they put together a paper on "the creative economy as big business" for the Journal of Planning Education and Research earlier this year.

The paper notes that many countries regard the entertainment media industries as particularly attractive economic development targets because they are perceived as creating "clean", knowledge-intensive jobs, with spin-offs ranging from audio-visual trade to boosts in tourism and image.

As the authors of the paper, Susan Christopherson and Ned Rightor, point out, this view has become so widespread that even within America, more than 40 states now compete to lure productions away from Los Angeles and New York by offering generous subsidies.

Having viewed all the available literature, however, the authors conclude that many countries, and many US states, may be taking part in a "race to the bottom" without any reliable evidence that the benefits do indeed outweigh the costs involved.

By agreeing to subsidies, governments are falling for industry spin aimed at protecting the studios' own profitability in a highly volatile market, they argue.

"As a consequence, when states undertake subsidy programs, they are not subsidising the movie or the moviemaker but a major transnational firm such as News Corporation or General Electric... Thus, these public subsidies raise serious questions about market distortion."

This wouldn't matter so much for New Zealand if it could be demonstrated that the subsidies were still worthwhile. But according to Christopherson and Rightor, the few in-depth studies that have been done internationally cast doubt on whether that is the case. In the US, the "overwhelming majority" of studies conclude that subsidies have a negative impact on state revenues, the authors claim.

Many governments have realised that tax credits are self-defeating and, like New Zealand, now prefer to rebate actual expenditure. But the opportunity costs are often ignored, and little analysis is done on how big the rebate needs to be and its importance in attracting the production in the first place, they argue. In some cases, rebates have even been granted after the fact, resulting in a "tax windfall" - as was the case in New Zealand with The Last Samurai.

The authors also claim that jobs growth is sometimes misleading, and that the temporary nature of the work is sometimes ignored. It can also be difficult to draw conclusions about the economic motives of studios, given the opaqueness of their accounts.

"Even as subsidy programs have proliferated, this vital information is rarely, if ever, made publicly available. As a consequence, there is scant analysis of the economic impact of subsidies based on real numbers. Thus, assertions of the efficacy of subsidy programs as an economic development tool remain speculation."

Many of these issues were indeed highlighted when the Ministry of Economic Development commissioned an independent review of the Large Budget scheme in 2005.

The report, by Outcome Management Services, concluded that in its first two years the scheme may have benefited the economy by as much as $33 million. However, it also noted that it was equally possible there was a net loss of $38 million.

Officials dismissed the report as too conservative, and argued that two years was too short a timeframe to consider the big picture, given the volatility of the industry. They also suggested that King Kong may have skewed its conclusions, as it was by far the biggest production at that time.

Nevertheless, the report made some salient points. The author, who was an economist, attempted to quantify how important the scheme was in attracting productions to New Zealand, and concluded that overall, economic factors made up less than half the equation.

The report points out that not all of the wages paid by production companies stay in New Zealand. And although they can claim for half their airfares, that doesn't mean they're flying with Air New Zealand.

Producers can also claim for film stock and overseas rentals, even though they are imported. And it is often overlooked that the money earned by contractors might have been paid by somebody else had that particular production not come along.

JONATHAN HANDEL is a Los Angeles-based entertainment lawyer and contributing editor for trade paper The Hollywood Reporter. He has closely followed the Hobbit saga, and was impressed with the deal the Government struck that will see New Zealand promoted on Hobbit DVDs.

But Handel is somewhat cynical about the rest of the script. The fact that New Zealand was so willing to sweeten the deal for Warner Bros was a "pretty extraordinary example" of the power of a multinational media conglomerate, he says.

"To see an American movie studio send executives almost on a diplomatic mission down to a sovereign nation, and extract greater production incentives, raises the question of: 'Why?'. Wasn't this about a union dispute and a potential fear of disruption? I'm sure they spent some money on legal fees analysing the situation, but I don't think they spent $25 million. It's hard to look at that as anything other than: they came, they saw ..."

Handel doubts Warners would have moved the movie, even though its producers insist they were asked the run the numbers on alternative locations.

"There would have to have been an awfully big hit on the balance sheet for Warners to have then said it was worth their while to actually rip up and move. I think this was a game of chicken."

It is possibly worth noting that even before John Key met with Warner Bros, a popular Hollywood website was betting that the studio would emerge with a sweetened deal. "Estimates I'm hearing include incentives that shave US$10 million to US$15 million off the budget," wrote Deadline Hollywood reporter Mike Fleming on October 23.

The perception within the film industry is that the public was very keen to let the Government know it was right behind it - until the deal itself was actually done.

One industry insider estimates that the two movies, which will be filmed 10 weeks apart, will provide work for at least 500 people. But at a total cost of around $50-$75 million, that's a fairly expensive training scheme, he argues.

And it wasn't just law professors who were outraged that Parliament was prepared to pass emergency legislation that will supposedly ensure that independent contractors cannot later argue they were really employees.

Labour MP Charles Chauvel helped litigate the now-infamous Bryson case which prompted the law change. Bryson is a former Weta model-maker who successfully argued before the courts that he was really an employee, even though he had been hired as a contractor.

The case, which went all the way to the Supreme Court, was funded by the Council of Trade Unions and according to Boyens it was the CTU's involvement in the Hobbit stoush that really alarmed Warner Bros.

Handel's take is that the studio probably realised the National Government was happy to have its arm twisted over that particular issue.

"Warners aren't fools. They knew in some sense they were doing the Government a favour with the passing of legislation that was going to suppress, if not completely prevent, unionisation of this industry in New Zealand. And if the Government should have the occasion to use this legislation for other industries, they know they have the language to use it as a model to extend anti-unionisation."

Studios are also acutely aware of the power they have over people who are easily star-struck, he says.

"Hollywood is a hot potato for people outside Hollywood because they're attracted to the glitter and glamour of the stars and the money, but there's a lot of suspicion, obviously. This is the fear and concern that multinational companies are able to play on."

THESE days MPs generally avoid that especially toxic expression: "picking winners". But the truth is, by subsidising film production in this country, that is exactly what both National and Labour have chosen to do.

There are, of course, some people who argue that "picking winners" is exactly what New Zealand should do a lot more of. And more than three decades after "Think Big", the idea does seem to be slowly coming back into vogue.

Despite that, New Zealand still appears resolutely opposed to offering direct subsidies to other major industries - agriculture, for example - so why movies?

It is not as if the amounts involved are insignificant. Each year the Government provisionally sets aside around $35 million, exclusive of GST, for the Large Budget scheme, but it often ends up spending much more than that.

Information pieced together from Film Commission annual reports and Cabinet papers appears to show that major productions have received more than $220 million in grants from the scheme over the past six years. A detailed breakdown of that spending (see table, this page), does not include recent projects such as Spartacus, as those details have not yet been published.

The financial year ending in June 2006 was a bumper one for the industry, with around $76 million paid out in grants to production companies. In 2007 it dropped to $13 million, but it has been rising ever since. In 2008 it was $29 million, then $48 million the year after that. For the last financial year, applications were received for just over $52 million.

Given that for most of this period the rebate was set at 12.5 per cent of expenditure - it was upped to 15 per cent in 2007, and other tweaks were made - it could reasonably be assumed that major productions spent more than $1 billion here to qualify for such grants.

Some of this money was distributed as part of another incentive introduced in 2007 known as PDV, for post-production, digital and visual effects. And to further complicate matters, some production companies were also claiming tax breaks by "selling" themselves to their overseas owners for the cost of the production, minus the tax-free subsidy. The New Zealand company would then claim the subsidy as a loss, and use it to offset income from other group companies.

Legislation passed last year ended the breaks, saving taxpayers about $10 million a year.

TAXATION issues aside, it is difficult to argue with more than $1 billion supposedly spent here, even if the true figure is somewhat less than that.

Nevertheless, industry veterans despair at the number of graduates pouring out of tertiary institutes who are very quickly learning that even Weta Digital will never be able to absorb more than a tiny fraction of them. And it does not yet appear to have been ascertained whether taxpayers' money might have been used even more productively elsewhere.

As Treasury pointed out to the Government in February this year, the total assistance provided to the film industry has in some years exceeded support for the entire tourism industry, New Zealand's biggest export earner.

"It can also exceed Government support for private sector research and development through Technology New Zealand ... where the evidence of benefits to the wider economy is strong."

Treasury noted that Weta Digital also received support from NZ Trade & Enterprise, and had a three-year research partnership with the Foundation for Research, Science and Technology worth $5.8 million. Between July 2006 and June 2009, it was also given close to $8 million in research grants.

Following on from its assertion in 2006 that there was "insufficient evidence" of large spillover benefits to the economy, Treasury urged the Government "to approach any extension or reconfirmation of the [Large Budget] grants with caution".

However, it has hardly gone into battle against the scheme. According to one insider, "that's because they've given up trying to tell the Government what it clearly doesn't want to hear".

Some industry figures worry about the fickleness of studios. Australia is a good example of how the "build it and they will come" mantra does not always pay off, they believe. Fox Studios in Sydney has been noticeably idle in recent years, and if local reports are correct, initiatives intended to attract productions to West Auckland may also be in trouble.

There is of course, the intangible benefit to our national pride in being able to compete with, and even beat, the world's best movie-makers - and our hope that foreigners will finally stop seeing us as a rural backwater.

Goodness knows, the value of intangibles is taken just as seriously these days in business as good old-fashioned cash. But the question remains: why movies?

As as any independent filmmaker will tell you, it is vital to our cultural development that we see our own society reflected on our own screens.

But as to whether the relatively poor taxpayers of New Zealand get sufficient value from the subsidies we give Hollywood productions, the honest answer seems to be: we don't really know. And what's more, we've known for many years that we don't really know.

In 2006 the Labour Government decided it would be pointless to decide the fate of the Large Budget scheme until it had been in place for several years. A comprehensive review was due to take place in 2009, but was deferred until 2011. And National has decided to delay it once again, this time until 2012.

By then the scheme will have been in place for nearly a decade, and will have dished out around $300 million to some of America's largest conglomerates. If the tax breaks given to Lord of the Rings and others are included, we're talking well over half a billion dollars.

Former Screen Council head Tim Thorpe believes some rigorous analysis is well overdue.

"There are three things that need looking at," he says. "One is the benefit of having the grants for the screen industry. Then there's the comparative benefits if the money was put into other sectors. And the last one is the benefits to other sectors. It's probably too hard to work that out, but tourism definitely needs a close look because that's the one that's often quoted."

Thorpe, who is now a consultant, insists he's not opposed to the scheme itself. "People are generally supportive and I'm not saying I'm against it, either. I'm just saying that certain things need looking at."

In his review of the New Zealand Film Commission, Sir Peter Jackson noted that the Australian film industry was lobbying hard for a further increase in subsidies. He also noted that the Australian Government appeared supportive of the sector.

"A loss of competitiveness could see even major New Zealand films pushed offshore, in pursuit of lower costs," he warned. "While that might make sense for individual films, for the industry as a whole the result would be a dissipation of talent, skills and infrastructure, all hard-won."

Furthermore, removing the incentives would undermine the studios' appetite for bringing expensive productions to New Zealand "and there are plenty of other countries, as well as states and provinces, that would be only too willing to take those films and those dollars," he argued.

Jackson insists that without the Large Budget grant, Universal would have moved King Kong to Canada "in the blink of an eye". Which is interesting, given that the report by Outcome Management Services concluded that the subsidy was only a very minor factor for King Kong.

Philippa Boyens also appeared impatient with the debate at the screen producers' conference in Auckland last month.

"We have to grow up. So, okay don't spend $100 million and don't have a movie here," she grumped. "Choose."

Greens co-leader Russel Norman says the Greens like the scheme. However, they would still like to see a limit on each project. "We've been very supportive of the projects and the films because they are about the transformation of the New Zealand economy, and they have had a significant impact - it's just that at the end of the day there should be some kind of limit for taxpayers."

Act MP Sir Roger Douglas, however, is not nearly so generous. "It's a transfer of wealth from the average New Zealander to the rich beggars of Hollywood," he was quoted as saying in June.

According to Christopherson and Rightor, at the very least the issue demonstrates the difficulties involved in sorting out competing claims about the worth of such schemes, and evaluating their economic impact.

"Ultimately, close questioning of those claims may drive policy reform requiring data transparency and substantiation of economic development benefit," they suggest. "Meanwhile, however, the worldwide taxpayer-funded production financing 'gold rush' in entertainment media is still on."

Given the behind-the-scenes dramas that seem to plague almost every movie ever made, it does seem particularly miserly for audiences to begrudge forking out a handful of dollars to witness what is often the result of several years' worth of creative effort by hundreds of people across all sorts of industries.

Unless, of course, you take into account the notes that have already been taken out of your wallet to help fund the thing in the first place.

Next Week

Big Picture II - Accounting
Goes to Hollywood