The Bloomberg BNA Tax Management Weekly State Tax Report filters through current state developments and analyzes those critical to multistate tax planning.
States across the country are proposing and passing a wider, enhanced range of tax credits and incentives as they vie for companies to move to their state. In this interview, Dean Zerbe, director of alliantgroup and former counsel to the U.S. Senate Finance Committee, discusses factors that make some states stand out from the rest and what aspects of their credits and incentives help make their programs successful in attracting job-creating businesses.
Dean Zerbe, interviewed by Kathleen Caggiano
BNA: What factors do companies look at when deciding whether to relocate to, or remain in, a particular state?
ZERBE:While many factors are at play in a company's decision—such as education of workforce, quality of life, geographic location, infrastructure, right to work—when it comes to tax, companies certainly look at overall tax rates. However, I am seeing more and more that companies are becoming sophisticated; they will look less at the rate of taxation and instead project what their actual effective tax rate will be in practice, taking into account all the credits and incentives available.
BNA: Where do tax credits and incentives rank in importance as a factor when companies decide to relocate to, or remain in, a state?
ZERBE: For small and medium businesses, credits and incentives are playing a bigger role in decisions about where to relocate, expand, or remain in a state. For example, Louisiana has probably one of the top state research and development (R&D) tax credits in the nation—the credit is quite generous and refundable, so it is a real benefit to new companies. I've seen firsthand companies that are moving to Louisiana, keeping their doors open, or expanding their hiring thanks to this credit. So, in the case of Louisiana, the credit provided has been critical in the decisions by companies.
For a small or medium business, it is those benefits that are in the tax code—that are set—that matter the most. Small and medium businesses need to have something they can plan on and count on in making their businesses decisions about location. Quite frankly, these businesses cannot afford the cost, and do not have the luxury of time, to seek a special tax package from the state (and are probably unlikely to get it).
BNA: Which states stand out from the rest for attracting businesses because of their credit and incentive packages?
ZERBE: As mentioned earlier, Louisiana has an incredibly strong R&D tax credit. I would also note that Minnesota has a very good R&D credit that is also refundable. It is important to remember how many new jobs are overwhelmingly created by start-ups, so, for states wanting to see job growth, the refundable credit is key to consider. Other states that have been improving their R&D tax credit are Iowa, Virginia, and Arizona. New York has a very good refundable credit that is, unfortunately, expiring this year. Many states have a state R&D tax credit, but it is sometimes thin gruel.
Regarding other credits and incentives, probably the greatest interest to business has been hiring credits. New Mexico and Georgia have a good hiring credit, as does California. Most states have some kind of hiring credit, but it's often thin gruel or difficult to qualify.
It is also important how the state administers the credit or incentive. Too often, the legislature giveth and the tax administration taketh away—undoing all the policy benefit of the credit or incentive. While it is certainly necessary to administer the tax system, it is also important that it be seen as fair and not unduly burdensome.
BNA: What type of credit and incentive packages do these states offer?
ZERBE: As mentioned earlier, the R&D tax credit. Just as it is the biggest tax credit at the federal level for business, it likewise tends to be the biggest bang at the state level.
You often see states that engage in very geographic-specific or industry-specific credits—locate your semiconductor plant within two miles of the airport. I think of these as the "hop-on-one-foot; wear-a-pink-ribbon" school of tax incentives. They tend to not work very well (if at all), are usually designed with a specific company in mind, and are rarely of benefit to the engines of job growth—small and medium businesses. One interesting trend has been that given tight budgets states are more and more limiting their tax credits and incentives to small and medium businesses.
BNA: What types of industry are attracted by these packages?
ZERBE: For the R&D tax credit, the benefit for states (and part of the appeal of the credit for legislatures) is that it attracts exactly what the states are most desirous of seeing, i.e., good jobs, often manufacturing jobs, paying good wages in new industry. The biggest problem we see in the R&D tax credit is actually self-censoring by practitioners or business owners thinking they are ineligible for the R&D tax credit. The reality is that the R&D tax credit is a very broad credit.
With that said, architecture and engineering firms, biotech, computer software, and pharmaceutical companies are often overlooked candidates for the R&D tax credit, especially in a state with a refundable credit.
BNA: Do the tax credits really lead to the result they are seeking, such as job creation, economic development, cleaner environment, or others?
ZERBE: This was always the hard question that we faced on the U.S. Senate Finance Committee and tried to determine, but it is rare that you get easy answers. What I find in the R&D tax credit with the small and medium businesses that alliantgroup works with is that these dollars are going to spur and encourage further innovation and job growth in companies that are seeking to be competitive. Perhaps an easier way to think of it is that you are reinforcing, or rewarding, good behavior by these companies, so you should not toss and turn at night overly worrying about whether tax benefits are appropriately affecting behavior at the margin.
Certainly with a smaller company, and particularly those receiving a refundable credit, the benefits of the R&D credit are significant. Time and time again that check from the state, or the Internal Revenue Service, means a new person can be hired or a new machine can be purchased. I see firsthand the dollars translating into benefit for the economy.
Measuring the Benefit
BNA: How long does it usually take before the impact of a given incentive package can be measured?
ZERBE: The benefit to the companies receiving the dollars is immediate. It is a game changer for them overnight. I think of the bio credit (the qualifying therapeutic discovery project credit—Internal Revenue Code §48D) put forward at the federal level as showcasing the difference in terms of impact. Overnight, those dollars meant scores of companies in the biotech world kept their doors open, their research continued, and their jobs stayed in place.
Now, for the professors in academia to measure the benefits of an incentive package—that is harder to say. The long-term benefits of the bio credit are the continuation of vital research. Time will tell if great products have been realized because of the bio credit, but I can tell you some of the projects that we worked with to get the bio credit are doing just incredible things. And you also, of course, have the immediate benefit of jobs saved and jobs created.
For policymakers, it is perhaps easier to think of it as a choice between the government spending monies to achieve a policy goal or, alternatively, using the tax code to encourage actions by the private sector. The answer may depend on what is the policy goal of the legislator.
BNA: Do the tax credit packages actually benefit the states, or are they just an example of political wrangling?
ZERBE: I think the big tax packages for one company deserve a wary eye. These packages do raise questions of whether they are going to bring real bang for the buck. It is particularly frustrating that these big sweetheart packages are, in practice, not available for the small and medium businesses that are creating the jobs, but instead tend to go to the big boys who are actually shedding jobs. It is difficult for governors and legislatures to resist the pull of the ribbon-cutting ceremony of a plant with a 1,000 new jobs.
BNA: Do the benefits of tax credits and incentives outweigh the costs to the states?
ZERBE: I see in certain areas, such as the R&D tax credit, that it does bring a near- and long-term economic benefit to the states. However, just as the federal government is looking hard at credits and incentives, states also need to look harder at the justification and crunch the numbers for a credit or incentive. Too often, particularly in the field of energy, the argument is made that a credit or incentive is necessary to bring forward an infant industry. Well, the baby has grown up, so do we still need to have that credit or incentive in place or would it be better to just lower tax rates overall?
It is incumbent on state legislatures and governors' offices to look hard at these tax expenditures and incentives and make sure they are justified. I think what is overlooked is that the tax administrators at the state level give voice to what they are seeing in practice in the field. We were often astonished at the Finance Committee to hear how much of a slip between cup and lip there was between what was intended and what was happening in practice.
It is particularly important that the views of the small and medium business community, and their certified public accountants, be sought out and considered by policymakers when looking at credits and incentives. Small and medium business owners are often too busy creating the jobs and keeping the doors open to be bothered jawing with policymakers. The result is that policymakers get an earful from the big companies but often do not have a good understanding of what will really help those doing the hiring, i.e., small and medium businesses. The states need to ask and listen to what works for small and medium businesses.
BNA: What drives the competition for job creation and economic development among states if it has been shown that the costs outweigh the benefits for certain credits that are offered? (For example, the Center on Budget and Policy Priorities' 2010 report entitled "State Film Subsidies: Not Much Bang For Too Many Bucks" states that "film subsidies offer little bang for the buck.")
ZERBE: The film industry tax incentives at the state level have been stunning to watch. In some ways, perhaps, they are a good example of sunshine and analysis. As there has been greater clarity that there is not much economic bang for this buck, a good number of states have been putting these film credits to the side.
It is a strong impulse for legislators and governors, particularly with a down economy, to show voters that they are putting oars in the water to help. With many policymakers shy of increased spending, there has been a reach for the tax code to accomplish their goals. It also perhaps recognizes a philosophical view that it is better to look at encouraging economic growth through incentivizing the private sector. With that said, legislators and governors have a responsibility to sharpen their pencils to craft proposals that will bring real benefit and to consider the benefits of a simpler tax as well.
BNA: Considering the current state of the economy and the fact that many states are struggling to balance their budgets right now, should states continue offering these credit and incentive packages?
ZERBE: It is a difficult balancing act. I've seen firsthand that a robust, refundable R&D tax credit can be a real difference maker for states and their economies. This kind of credit appears to be a winner on a number of levels—job creation, good wages, new industry, etc.
On the other hand, there are many credits and incentives, particularly of the hop-on-one-foot, bow-in-hair variety, that seem to be designed more for a press release than to bring real economic benefit. One reality that has been driven home to me working with companies and CPA firms across the country is that when you make a tax code provision too complicated, it is small and medium businesses that will not take advantage of it. A tax credit that makes sense to the academics, for example, one that is perfectly drafted to ensure that it will encourage behavior at the margin ("but for" this tax incentive, x activity would not happen), is often a disaster in actual practice. These types of credit might best be discarded and the funds saved to either put more giddyap in other credits and incentives that are beneficial (or potentially beneficial) or to lower the tax rates overall.
Going to an earlier comment, I think it is vital that state policymakers seek out the voice of small and medium businesses in looking at what credits and incentives will be of benefit. For example, there is such an emphasis on the corporate tax without recognition that the vast majority of businesses and jobs in a state are with passthrough entities. Policymakers need to ensure that a credit or incentive is going to work for a passthrough entity and not just for a corporation.
This concern works the other way—even at the federal level, and at the state level, I hear talk of eliminating a credit or incentive to lower the corporate rate and not recognizing that many passthrough entities benefit from the same incentive or credit. The end result is a lower corporate tax rate for the big companies and a higher effective tax rate for small and medium businesses, which is probably not the desired result of most policymakers.
BNA: How will states handle competition from foreign countries offering tax breaks to encourage businesses to locate overseas?
ZERBE: States need to be mindful of this reality, especially with the comparatively high statutory U.S. corporate tax rate. For a major foreign company (and for a domestic company, for that matter) it may be worth the state economic development office highlighting what they believe would be the effective, as opposed to statutory, state tax rate for a foreign company.
Again, a good deal of political grief can be avoided if the foreign company avails itself of all the tax credits and incentives that are available for domestic businesses, as opposed to getting a sweetheart deal.
BNA: Should the federal government intervene at some point to help states deal with the competition from foreign countries?
ZERBE: The federal government would do the most help for states by reforming the federal tax code, especially the corporate tax, to be more competitive internationally. I have difficulty seeing a happy place with the federal government taking an active role in this area specifically to assisting an individual state, as the federal government has enough on their plate.
BNA: What do you think will happen in the next five to 10 years regarding the states' ability to attract businesses with their credit and incentive packages?
ZERBE: States are already going through a process of shedding some questionable incentives and credits and bolstering others that have shown to be beneficial. I expect that process to continue with an eye to what the federal government does in terms of corporate and individual tax reform. If you see significant tax reform at the federal level, then that would serve to incentivize many states to follow suit.
While you still see the big sweetheart deals—I expect to see less and less of them. The sweetheart deals rarely deliver and they always comes with an eye-popping price tag of jobs per lost dollar of revenue.
In the area of R&D tax credits—the trend line seems clear that you will see more states look to a refundable credit and a more robust credit targeted for small and medium businesses.
BNA: Do you think incentive packages at the state level make good tax policy?
ZERBE: When I see the positive impact of the R&D tax credit for hundreds of small and medium businesses in dozens of states, the answer is a strong yes. There are clearly policies that are placing more dollars in the pockets of cutting-edge firms to further innovate and to create new jobs. These businesses are going to be the mainstay of our economy for the future.
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