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Policy Initiative Spotlight: Questioning the Wisdom of Corporate Tax Incentives

by Steven J. Markovich
November 8, 2013

The shuttered General Motors Willow Run Powertrain plant in Ypsilanti, Michigan, June 2012 (Jeff Kowalsky /Courtesy Reuters). The shuttered General Motors Willow Run Powertrain plant in Ypsilanti, Michigan, June 2012 (Jeff Kowalsky /Courtesy Reuters).

Many states and cities offer a variety of tax incentives (credits, exemptions, deductions) to businesses with the aim of spurring growth and job creation, but few carefully analyze the costs and benefits. Some recent research has brought the wisdom of corporate tax breaks into question, and several states are considering reforms to assess the public value of their programs.

In July 2013, Rhode Island passed the Economic Development Tax Incentives Evaluation Act. The law requires the state’s revenue department to evaluate new tax incentives within five years and reassess them every three years. Evaluation criteria include: the number of taxpaying firms receiving the incentive; the number of jobs supported by each firm receiving the incentive; the revenue generated by the incentive recipients and their employees; and the original goals of the legislation. Analysts will also report when data is unavailable or of low quality.

Just last year, Rhode Island (along with twenty-five other states) was identified in a report by the Pew Charitable Trusts as “trailing behind” in evaluating tax incentive effectiveness. And so in considering reforms, Providence consulted Pew’s experts, including Robert Zahradnik, policy director for work on state fiscal health and economic growth. Zahradnik told CFR that “the final bill does a lot of things that, if implemented the way it is intended, will make Rhode Island a leader in evaluating tax incentives.” He identified four important requirements of the law: routine evaluation of incentives; measurement of benefits and costs; drawing clear conclusions; and requiring the governor’s budget to recommend continuing, reforming, or ending each tax incentive.

Tax incentive programs vary in breadth from overall investment incentives, to industry-specific programs, to one-off arrangements designed to woo or retain a single employer. A study by Good Jobs First, a Washington, DC–based nonprofit promoting greater corporate and government accountability, has found that the frequency of so-called “megadeals”—deals with incentive packages over $75 million—doubled from ten deals in 2007 to twenty-one deals in 2012.

In 2012, Nike threatened to move a five-year, $150 million corporate expansion outside of its home in Oregon unless the state guaranteed the shoemaker’s tax burden wouldn’t increase for decades. Oregon, which ultimately met Nike’s demand, taxes multistate firms on a “single-sales factor” basis, which only taxes profits within the state, not on global sales, property, or payroll. Governor John Kitzhaber and Nike said the deal could directly and indirectly create twelve thousand jobs and net the Oregon economy $2 billion each year, but officials reportedly did not release data to support these claims. However, the legislation did require Nike to directly create at least five hundred jobs.

A special series by the New York Times last year highlighted many of the criticisms associated with corporate tax incentives at the local level, which are estimated at $80 billion per year. “A portrait arises of mayors and governors who are desperate to create jobs, outmatched by multinational corporations, and short on tools to fact-check what companies tell them,” wrote Louise Story. In one notable case, the town of Ypsilanti, MI, sued General Motors unsuccessfully in the 1990s after the town granted the automaker more than $200 million in tax incentives, only to have it close the facilities years later. The court ruled against Ypsilanti, saying that the statements GM made in lobbying for the tax abatements—“to continue production [at the facility] and maintain continuous employment for our employees”—were not legally enforceable promises.

While all states use tax incentives, an analysis of twenty years of data by economists Robert S. Chirinko and Daniel J. Wilson found that general state investment tax credits appear to only shift investment between states, and have no effect on new capital formation.

Chirinko and Wilson also determined that manufacturing locations are much less mobile geographically than overall capital. This is perhaps not surprising; manufacturing locations often have large, specialized equipment, a network of suppliers, and employees with specialized training, which would make relocation more difficult than a generic office building. However, manufacturing firms are the most frequent beneficiary of tax incentive programs. Other major beneficiaries include corporate offices, technology firms, tourism, and the film industry, which has enjoyed a rapid growth in targeted incentives from just a few million dollars in 2003 to $1.3 billion in 2011.

Rhode Island’s new program of analyzing its tax incentives should help lawmakers to better understand the ultimate value of these programs, and whether they truly accomplish their goals. Supporters of tax incentives typically see them as a means to attract large employers that provide good jobs, particularly those whose revenue draws from outside the local area. But competition between states in attracting these businesses may lead to a “race to the bottom,” though Chirinko and Wilson argued that states have historically reacted to common economic forces rather than each other’s programs.

Critics such as the Institute on Taxation and Economic Policy and the Center on Budget and Policy Priorities argue that incentive programs are expensive and provide uncertain benefits to cities, states, and the nation. It is also difficult to determine whether tax incentives are a pivotal factor in many business decisions. Lower tax revenues could even hurt growth by limiting a jurisdiction’s ability to provide public goods that attract companies, such as good physical infrastructure, a well-educated workforce, and a safe environment.

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