Finance

A Sneak Peek of the Seismic Shift in Corporate Tax Breaks

New rules are forcing states and localities to calculate how much revenue they’re losing to business deals -- and whether they pay off. It’s something Washington state has been doing for a decade.
by | November 2016
(Shutterstock)

Earlier this year, Washington state lawmakers got a wake-up call. A tax incentive package they’d approved in 2013 for aerospace giant Boeing -- largely regarded as the most expensive incentive deal in history -- was actually on pace to surpass its estimated $8.7 billion cost. According to a Department of Revenue report, the deal, which extends to 2040, had already amounted to half a billion dollars in giveaways in just the first two years alone. In other words, the state was losing out on a whole lot more money than it had planned.

And the kicker? Just months earlier, Boeing had announced plans to cut roughly 4,000 jobs in Washington. The year before, the company had transferred thousands more jobs out of the state.

Some lawmakers were livid, openly contemplating whether the state should consider revoking the tax breaks if the company didn’t add back some jobs. (Boeing, for its part, says it has continued to invest in the state, including $1 billion last year for a plant to build its new 777x aircraft.) But on the whole, response from officials and local media was measured. Most lawmakers said that in the bigger picture, the company was still good for Washington. While “deeply disappointed” in the job losses, state Sen. Reuven Carlyle, who has long pushed for greater transparency in the state’s incentive deals, says he still stands behind the Boeing agreement. “The overall return on investment for taxpayers, including ensuring the future of aviation in our state,” he says, “is overwhelmingly strong by any standard or definition or criteria.”

The fact that Washington lawmakers can even have this conversation puts them at an advantage over most other states’ legislators. In the vast majority of states, officials simply do not know how well their tax incentives programs are working, or how much the deals are actually costing them. They don’t have the data. Washington does, thanks to a tax preference auditing program, already one of the most robust in the nation, that was made even more transparent with the passage of a 2013 law. For the first time, lawmakers and citizens know just how much individual companies receive in tax benefits -- in other words, how much the state gives up in foregone tax revenue from them.

Some other states have begun to take a harder look at the incentives they give out. Delaware has initiated a biennial tax preference evaluation. Louisiana takes a yearly look at key incentive programs. Most states, however, just haven’t reported that kind of information with any sort of regularity.

But that’s about to change. New nationwide accounting rules now require state and local governments to report all economic development incentives programs -- like Boeing’s -- as foregone tax revenue. Beginning with fiscal 2017’s annual financial reports, the Governmental Accounting Standards Board (GASB) is requiring governments to report things like the total number and value of tax abatements that year, the criteria that businesses must meet, and how the government will get that money back if the goals aren’t achieved (commonly referred to as clawback provisions). Reporting the annual value of these abatements will clearly show their effect on governments’ bottom lines.

In terms of transparency, the impact of this accounting shift will be seismic. One reason Washington’s discussion about tax breaks is so intense is because it has an incredibly high number of them compared to other states: nearly 700 separate incentives programs, up from just over 500 a decade ago. But every state has plenty of its own programs. One prominent estimate, calculated by The New York Times in 2012, figured that state and local governments give up more than $80 billion annually in corporate tax breaks. While that estimate includes some measurements that the new accounting rules won’t cover, the new regulations will still highlight billions of dollars that governments forego every year.

Washington offers a sneak peek at the debate other states and localities could soon be having. State tax deals are public information, but they tend to trickle out in one-off reports and news headlines; most states don’t collect or report on them annually in any kind of comprehensive way. And few places really review clawback provisions once a deal is in place. Now, lawmakers and citizens everywhere may find themselves engaged in the kinds of conversations that have taken place in Washington state for the past decade, an ongoing attempt to assess whether tax incentives are really worth what states think they are.

Washington Gov. Jay Inslee signed a nearly $9 billion tax incentives package for Boeing in 2013. New data suggest the deal may have cost the state even more than that. (AP)

States have offered incentives to companies for decades, either to entice them to move there or convince them to stay. The tax breaks have long been public information, but the practice has gotten more scrutiny in recent years because of the growing number of eye-popping deals. Since 2008, the average number per year of deals valued at more than $75 million has doubled, compared to the previous decade, according to Good Jobs First, which follows corporate tax subsidies. Meanwhile, their aggregate annual cost has roughly doubled as well, averaging around $5 billion. In addition to the Boeing deal, the list includes Nevada’s $1.25 billion tax break that wooed Tesla Motors in 2014 and an income tax break Oregon awarded to Nike in 2012 worth approximately $2 billion over 30 years.

Critics debate whether these deals are good policy -- or whether they even really work. Some say they’re simply a Band-Aid approach to compensate for a government tax structure that isn’t business-friendly. Others say that the incentives don’t actually result in any net economic gain because corporations simply move around like pieces on a chess board. One example of that futility is in metropolitan Kansas City, which straddles Kansas and Missouri. The two states have long competed against each other to woo businesses across the state line -- AMC Theatres, Applebee’s and JP Morgan Retirement are just a few businesses that have crossed the border in recent years.

But whether or not incentives are smart policy, it’s been difficult for most states to even say whether they achieved what they were supposed to, thanks to a lack of transparency and accountability on the deals. Greg LeRoy, Good Jobs First’s executive director, says he often holds up Washington state as a good example of accountability, particularly for its history of annual reports on its tax incentive programs. Regular performance auditing came to Washington state in 2005 via a citizens’ ballot initiative directed at the state auditor's office. A year later, legislators decided to require similar audits of Washington’s tax preferences program and tasked the legislative audit office with the job. The legislative audit office typically evaluates about 25 tax incentive programs each year, looking at the stated purpose of the program and determining whether or not it’s meeting that goal. The office then presents its recommendation to a seven-member citizen commission, which hears public testimony on the audit. Both the audit office and the citizen commission present their findings to the legislature.

This process has led to real changes in Olympia over the past decade. On 12 occasions, either the audit office or the citizen commission has recommended that legislators get rid of a certain tax break; on nine of those occasions, the lawmakers agreed. They also terminated two other programs and allowed an additional eight to expire based on audit findings. One of those was a high-tech research and development tax credit for capital investment and operating expenditures. The audit team, working with outside economists, analyzed how many new jobs could actually be attributed to the credits. “The basic finding,” says legislative auditor Keenan Konopaski, “is this preference does create some jobs, but the job effect is not very big. It provided a solid piece of information, and I think that was enough to start a debate on, ‘Is it worth the price tag?’”

The audits were making a difference, but they also unearthed a consistent problem: It’s hard to track the progress of a program when lawmakers don’t outline what the intended effect is supposed to be. More than a third of the tax incentive audits simply recommended that lawmakers go back and clarify what it was a given program was supposed to achieve. “In many cases we were pretty lazy in past years, rubber-stamping a company’s request” for a tax break, says Sen. Carlyle, who was the author of the state’s tax break transparency law. “We didn’t have vigor.”

For the audit process to have real teeth, it was clear to Carlyle that the state needed more transparency and specificity regarding its expectations of what companies where supposed to deliver in exchange for their tax breaks. He pushed through his 2013 bill, which requires lawmakers to outline what the expectations are for any future tax incentive program. It also meant, for the first time, that incentive data would be linked to specific companies, which led to the new disclosures about Boeing from the state Department of Revenue. “Transparency categorically changes the conversation to, ‘What’s the value and return on investment?’” Carlyle says. “In other words: Does the damn thing work?”

That’s a question most states can’t answer right now. In most places, once the ink is dry on tax deals, they’re rarely tracked with any consistency. Back in 2000, Good Jobs First released a report that looked at 122 audits of state economic development programs in 44 states. It found that auditors were having trouble doing their jobs because “they are hampered by lack of data and objectives.” Things have improved somewhat since then, says LeRoy, but it’s been a painstakingly slow process. Massachusetts, for example, has been particularly slow at revealing any information about the hundreds of millions of dollars it foregoes each year. For the last half-decade, Massachusetts State Auditor Suzanne Bump has tried -- so far unsuccessfully -- to get the authority to see business tax returns so she can audit the effectiveness of incentives programs.

Now that governments will be required to report on their tax breaks with greater transparency, they could start to look more like Washington -- to a point. The new rule, known as GASB 77, doesn’t require governments to analyze their tax programs, as Washington does. And states won’t have to report tax giveaways on an individual company basis, as Washington has begun doing. And the rule doesn’t necessarily mean that the lost tax revenue will have any bearing on budget discussions. Even Washington doesn’t use the information in budgeting very often, except during times of shortfalls or funding crises.

But GASB 77 does require states to tally up all their incentives as lost revenue. And it does call for reporting clawbacks: Officials must outline what their expectations are when a tax break is offered, and if those expectations aren’t met, the tax incentive may be revoked. Governments without a history of tax break transparency will likely have sticker shock when the full impact of their foregone tax revenue is released. States like Washington, says LeRoy, are better positioned. “States where they have already had the big debates will perhaps be out the gate sooner,” he says. “They are certainly more prepared to take advantage when the data comes online.”

The full impact of these incentives will hit most governments beginning later next year when fiscal 2017 reports are released. But it will likely take a few years for the data to sink in, as it did in Washington. It’s important to remember that the evolution in Olympia was a 10-year process: tax program audits that led to greater transparency, which led to more specific clawback provisions and expectations with company-specific reporting. That will likely be the pace for other states going forward, even those that want to move quickly on tax transparency.

And none of this necessarily means states will come to see tax incentives as a bad idea. Indeed, as the conversation in Washington has matured over the past decade, many people have taken a more measured view of tax breaks. Rather than eyeing them suspiciously as giveaways, the release of regular information has allowed lawmakers -- and to some extent the public -- to see them as an investment.

That, says GASB chair David A. Vaudt, is the whole point of requiring incentives reporting: to provide a truer, fuller picture of a government’s financial health. Officials will be able to see tax breaks as not just one-offs, but as investments that impact their bottom line. It’s also up to each government to decide what to do with the new information. But eventually, lawmakers everywhere could be asking the same questions those in Olympia are now: Was our investment worth the price?

*CORRECTION: The original version of this story suggested that Washington's tax incentives audits program was a result of the 2005 ballot initiative on performance auditing. In fact, those were separate efforts. This story has been updated.

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