Tax Credit or Tax Cut?

Political rhetoric comes down to being for or against taxes with little discussion about their effect on economic development.
July 2011
William Fulton
By William Fulton  |  Columnist
Director of the Kinder Institute for Urban Research at Rice University and former mayor of Ventura, Calif.

When California Gov. Jerry Brown released his proposed budget in January -- the one that would have erased a $25 billion budget deficit half through cuts and half through taxes -- one of the programs he proposed eliminating was the state’s version of enterprise zones.

Nobody was surprised. Enterprise zones were a hot Reagan-era idea, essentially providing businesses located in low-income neighborhoods with tax credits for creating jobs. The idea, however, had gone cold in recent years. In California, zones made a difference in a few locations, but a 2009 report from the Public Policy Institute of California (PPIC) found that enterprise zones had no statistically significant effect on job creation. Among other things, the benefit of a California income tax credit is small compared to the possible benefit of a federal income tax credit, which of course doesn’t exist.

Yet when Brown released the “May revise” of the budget -- a long-standing tradition in California -- the enterprise zones program had been restored. The only difference was a proposed change requiring employers to document that they actually created jobs using the tax credit rather than simply employed people. It is hard to know the precise political reasons why enterprise zones were back in the budget. For one thing, with $6 billion in additional revenue, the state required fewer cuts. For another, the governor might have wanted to send a message that he was serious about job creation.

But there may have been another reason: Brown clearly wanted to keep open the option of negotiating for a balanced budget, and some Republicans had made noise publicly that eliminating the enterprise zones tax credits was a “tax increase.” They also said the available tax credit helped make California more competitive with surrounding states.

California’s enterprise zones debate is indicative of how polarized the overall discussion on taxes and economic development has become in states throughout the country. It’s common practice to provide tax breaks in hopes of keeping or attracting businesses. But is a tax credit or tax abatement a tax “cut”? And if the credit or abatement is eliminated, is that a tax “increase”?

Many Republicans would say it is a tax increase. And therein lies the basic problem with the current debate: Political rhetoric has come down to being for or against taxes, broadly defined. There is little discussion about what motivates businesses to relocate or stay put, whether the tax credits actually work and whether eliminating the tax credits would harm the business climate.

Even in a blue state like California, this puts Democrats in a box. In a down economy, nobody wants to be against jobs. So Democrats often respond within the same narrow political context, arguing that their tax credits are better than Republican tax credits.

Yet facts matter. Yes, California has a high income and sales tax burden compared to surrounding states, many of which have no income tax. However, because of California’s Proposition 13, property tax burdens are low, especially for longtime business landowners. Yes, California has a tough regulatory climate. But taxes and regulation rarely top the list as the most important factors in business location. They affect some business sectors even less than others. (Some blue-collar industries are more concerned with, say, air quality regulation.)

While other researchers have disputed the PPIC’s disappointing findings on tax credits, the research on incentives such as tax credits in general is decidedly mixed. Maybe they encourage job creation; maybe they don’t. Perhaps more to the point, sometimes they do and sometimes they don’t. And then, of course, there’s the actual cost of the tax credit or tax abatement. Sometimes tax incentives can add up to $50,000 or even $100,000 per job. Is that worth it to the taxpayers?

More than anything, the recent debate about enterprise zones shows how much the political rhetoric about taxes and economic development has changed since Reagan’s time. Democrats used to advocate for targeted tax credits, while Republicans simply argued for lower taxes and less regulation, suggesting that tax credits were the wrong approach.

But when a Democratic governor proposed killing a tax credit, Republicans squawked, saying that was actually a tax increase. In other words, the debate is no longer about tax credits for some vs. lower taxes for all. Now it’s all mushed together. Lower taxes for some -- i.e., a tax credit -- is considered in and of itself a good, no matter whether that benefits everybody or not. No wonder California can’t pass a budget.