Tax Analysts Blog

Messing With the Markets: Using the Tax Laws to Influence Economic Behavior

Posted on Sep 2, 2015

I shudder every time I see a state government use the tax law as an incentive for a business to do or not do something. I shudder a lot. States provide these incentives so businesses can create jobs, make investments, locate here, locate there, use specific energy sources, etc., etc. There are thousands of such laws throughout the country. Almost every one is inefficient and ineffective. I am often reminded of Bruce Springsteen's poetic verse in "Atlantic City":

      Down here it's just winners and losers, and don't get caught on the wrong side of that line.
There are a lot of winners in the state tax world but many more losers. And our leaders are picking them.

The recent Tax Foundation report "Location Matters: The State Tax Costs of Doing Business" illustrates the folly of government intervention in markets. The foundation, working with KPMG LLP, examined statutory and effective business tax rates across the 50 states. That's important, but for me, the report's most important revelation is just how unfair the state business tax system really is.

The report says that tax incentives mostly benefit new firms, while disadvantaging (I suspect greatly in many cases) established firms. This is something I have been pointing out since the Mercedes-Benz deal in Alabama. States give a company tax dollars in return for building a new plant or hiring a certain number of people. Sometimes the state gives millions of dollars, but recently it's been billions of dollars. But what of the companies that have already opened a plant, made investments, and hired workers? They often receive no state gifts. That is patently unfair. Of course, all this often provides an incentive for mature firms to go to the legislature for their own breaks. That may even things up sometimes, but it's a horrific way to run the government.

Yet, as the foundation discovered, even incentives for new firms are often laced with inequity. Some new firms enjoy lots of tax benefits because the legislature decides they should. Other new firms receive little or no government help. Again, a fifth-grader can see the injustice in this system.

The foundation emphasizes that businesses pay a lot of taxes other than those on corporate income, a point that the Council On State Taxation has been making for a long time. The states differ in their approaches to business taxation of property, sales, and unemployment. When you then take the myriad government machinations into account, you are left with a very uneven playing field across industries. For example, the report says the median effective tax rate for new retail operations (which almost never receive incentives) is 31 percent, while the median rate for new research and development centers is 11.4 percent. The median rate for a mature, labor-intensive manufacturing firm is 9.2 percent, while distribution centers bear a 26.7 percent tax burden. In my experience, the government isn't particularly savvy about deciding if Industry X should be favored over Industry Y.

The report examines seven model firms -- a corporate headquarters, a research and development facility, an independent retail store, a capital-intensive manufacturer, a labor-intensive manufacturer, a call center, and a distribution center -- and calculates the effective tax rate for each of them in each of the 50 states. There are huge differences among the states, which is to be expected. Wyoming has a lower overall tax burden than New York. But within states, the differences in what the firms pay in taxes are startling. In my home state of Virginia, new manufacturers have an overall effective tax rate of 4.3 percent, while established manufacturers pay 11.4 percent. New distribution centers pay a rate of 22.1 percent, while older distribution centers pay 35.2 percent. Why? The differentials exist because the legislature says they do. That should trouble everyone.

Read Comments (2)

edmund dantesSep 1, 2015

CT takes the opposite approach. The legislature drastically increased the
already high state corporate tax in June, notably with new limits on loss
carryforwards. For GE, corporate headquarters in Fairfield, it was a bridge
too far, as the changes meant hundreds of millions in unexpected taxes on their
sale of GE Capital to satisfy the Dodd-Frank regulators.

Accordingly, GE will be moving out, an announcement is expected by the end of
the year. Many more companies are looking at their options--and of course, no
new businesses are moving in. Your report says that CT is 44th in business
taxes, but that doesn't take the June changes into account, some of which were
retroactive.

I agree with your thinking, business taxes should be low and uniform. These
high taxes with individual carve-outs--the Malloy prescription--are crony
capitalism at its worst, an invitation to corruption.

emsig beobachterSep 1, 2015

David, while state tax incentives remind you of Springsteen's tune about
Atlantic City, these incentives remind me of Bobby Bare's song "The Winner." It
doesn't matter what the cost, as long as the protagonist comes out the winner
in the short run even if he/she/it is a winner in the long-run.

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