Have you ever felt like your state is spending millions, or even billions, to benefit a specific slice of the economy, which brings no apparent broader economic benefit? You are not alone. State governments are beginning to wonder whether targeted tax credits and incentives are working as they should, and whether the state economy is seeing a positive return on the government’s investment. Tax credits and incentives have become and popular policy tool, resulting in dozens of different programs in each state. Growing with this activity, however, is the chorus of voices questioning such incentive’s effectiveness and their effect on state economies. Facing increasing pressure and scrutiny, state governments have announced plans to evaluate their incentives. Oklahoma, New York City, Missouri, and Kansas are each at various stages in their credit review.
Missouri Review Findings
On June 30, 2017, Missouri released a report evaluating several tax credits offered within the state. Since 1998, Missouri has experienced explosive growth in the number and amount of credits being claimed by taxpayers. These incentives accounted for $575 million in redemptions in 2016, up from just over $102 million in 1998. The report evaluated the 12 largest incentives by issuance on the basis of six factors: simplicity, fairness, keeping taxes low, efficiency, transparency, and stability/predictability. The committee responsible for creating the report not only looked at the hard data compiled by the Department of Economic Development, but also heard testimony from dozens of subject matter experts.
The report made several suggestions to reform state incentives according to the six criteria used in the evaluation. Perhaps the most intriguing of the report’s recommendations is to subject all state credits to an appropriations process. Some credits are statutory in nature and, as a result, lock the government in to paying the redemption. Subjecting credits to the appropriations process allows the state to deny an appropriation to pay for a credit, potentially freeing up revenue for essential government services.
The report also suggested changing the low income housing tax credit into a low interest loan forgiveness program. The committee found that too often, the credits were being claimed by either wealthy developers or banks and financial institutions to whom the credits were transferred. Replacing the credit with a loan forgiveness program would not only benefit more low-income households, but would save Missouri taxpayers an estimated $200-250 million over the next 10 years.
Oklahoma Review on Schedule
At the end of 2016, Oklahoma finalized plans to move to year two of an ambitious multi-year review of their state incentives worth approximately $228 million, as reported by Bloomberg BNA’s Paul Stinson in Daily Tax Report: State (subscription required). Oklahoma hired financial and investment advising firm PFM Group to oversee the incentive review.
Under the review, 12 incentives will be evaluated, each with their own set of criteria related to the intended purpose of the incentive. For example, the coal production credit will be reviewed according to the expected changes in employment, wages, investment, and production if the incentive were repealed. The capital gain deduction will be evaluated based on the number of qualified realized capital gains, and the state’s return on investment (the increase in economic activity versus financial cost).
Other Reviews Getting Off the Ground
New York City and Kansas are the most recent governments to propose a review of their incentives.
Under recently enacted legislation, New York City will start auditing recipients of affordable-housing tax breaks, known as the 421-a program, for compliance with applicable rules. First enacted in 1971, the program has grown into the largest tax expenditure program in New York City, according to a 2015 report by the City of New York Department of Finance Office of Tax Policy, subsidizing most of New York City’s multi-family residential construction since that time. The incentive expired in 2016 as negotiations broke down over certain wage guarantees built in to the program, but was reinstated after a new deal was struck. However, the incentive faces continued scrutiny after a 2015 case study from Columbia University found that the program disproportionately benefits wealthy residents and developers.
Meanwhile, Kansas lawmakers are facing increasing pressure to expand review of the state’s incentive programs in 2018. Sen. Julia Lynn (R) is pushing the review as the state’s Legislative Post Audit Committee released a report finding that Kansas is falling behind other state’s incentives oversight. Lynn decried the state’s ad hoc incentive approach that left state lawmakers “unable to see the big picture,” as reported by Bloomberg BNA’s Christopher Brown in the Daily Tax Report: State (subscription required). Although Kansas has a comprehensive inventory of its state credits and incentives, it lacks any formal oversight to evaluate the data. The committee report makes several suggestions, drawing from a national state tax incentive evaluation review released by the Pew Charitable Trusts in May 2017.
Considering recent budgetary issues in several states, an evaluation and reform of tax incentives could be one way states may attempt to right their financial ship. Increased transparency may aid lawmakers' decision-making and help keep the public informed on how tax revenue is being spent or, in this case, foregone.
Continue the discussion on Bloomberg BNA’s State Tax Group on LinkedIn: What criteria should lawmakers use to evaluate the effectiveness of tax credits? Should the goal aim for fairness or an increase in economic activity?
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