Baiting Hooks

Tax incentives have long been endorsed as the highway to prosperity -- attracting businesses, providing jobs and enriching the state. That's been conventional wisdom in...
by | January 1, 2008 AT 2:00 AM

Tax incentives have long been endorsed as the highway to prosperity -- attracting businesses, providing jobs and enriching the state. That's been conventional wisdom in most states and cities.

One problem: Most public finance experts consider them bad policy. Tax incentives that target specific companies create inequities, complications and inefficiencies -- and they shrink the tax base. Meanwhile, there's little evidence that targeted incentives bring growth in good-paying jobs. In short, big-ticket targeted tax incentives fail the test of any investment: the presence of a clearly identifiable return.

For some companies, they aren't a major factor. In 2006, when Honda decided to put a $550 million automobile plant in Indiana instead of Ohio, it seemed at first blush that it was tax incentives that won the day for Indiana. In truth, Honda encouraged both states to stay away from pure cash tax incentives. "They needed a 100 percent check-off on what the states could provide in terms of water, sewer, environmental characteristics, roads, bridges and so on," says Bruce Johnson, former lieutenant governor and head of economic development in Ohio. In the end, the deciding factor revolved around Honda's concern that settling in Ohio would have potentially driven up workforce costs for suppliers located there.

Many companies still seek incentives, and it's difficult for states to back away -- particularly when there are lots of jobs involved. But there are questions states can focus on to mitigate the damage: Are the incentives transparent? Is there a look back to see if promises are met? Are there clawbacks -- to retrieve the dollars spent if companies fail to hold up their end of the bargain?

Last November, New Jersey passed major legislation aimed directly at providing this kind of disclosure and transparency. Under terms of the new law, companies that receive a subsidy will have to report such things as their job-creation numbers, benefit rates on subsidized jobs, the number of current workers who get health insurance, and the number of subsidized employees represented by a union. "So many companies are more or less gaming the system," says state Senator Shirley K. Turner, one of the bill's sponsors. "This is our way of holding them to their commitments."

The Pew Center on the States, working in collaboration with the George Washington Institute of Public Policy, looked into the 282 tax incentive programs aimed at encouraging investment and job creation in the 48 states that offer tax incentives for economic development. (Alaska and Wyoming do not.) Some of the findings:

o In a dramatic change from a decade ago, every state that offers tax incentives for economic development undertakes one of three forms of incentive monitoring. Some states pre-certify: Before the recipient of an incentive can claim the tax break, it must prove that a level of investment or job creation has been met. In some states, recipients are allowed to begin taking advantage of the tax benefits before investment and job criteria are met, but they must file periodic reports with the state showing that progress on the criteria is being made. And in other states, the government conducts audits of recipients to determine if they are meeting their obligations.

o Eighty percent of states impose a penalty on recipients that do not meet their obligations. A decade ago, almost no states did so. Penalties include repayment of tax benefits received plus interest. In some states, there are fines and damages as well. Over the past two years, for instance, Pennsylvania took enforcement actions against 10 companies that received incentives from the state -- recovering about $2.3 million.

o Thirty-two states publicly disclose information about tax incentive recipients -- either identifying the recipients, identifying the amounts of tax dollars involved or both.

o Eighty percent of states have tax expenditure budgets, which provide data on the amount of potential tax revenue lost when exemptions or credits are granted. These reports provide information on the total cost, or fiscal impact, of all tax preferences, personal income tax deductions and sales tax exemptions. In practice, however, states vary widely in how much information they provide. California, Connecticut and Pennsylvania provide a great deal of useful information; Florida, South Carolina and several others do not.

Building on the work of tax expert John Mikesell, the Pew-George Washington team categorized state tax expenditure budgets according to various characteristics, including whether the reports are available online and which taxes are included. They also asked questions such as whether there was a description of the tax expenditure, whether the dollar amount of revenue lost is presented, and whether there is a distributional analysis of the impact of the tax expenditure. These criteria were used to rank the states.