Ruling Threatens State Tax Incentives

One of states' favorite tools for luring companies and jobs is in peril. The use of lucrative state tax breaks to keep or attract corporate employers is under attack in the courts, threatening what Ohio Gov. Bob Taft (R) recently described as a "core piece" of his state's economic strategy.

In a ruling expected to be appealed to the U.S. Supreme Court, the federal appeals court in Cincinnati struck down in September part of a $281 million state and local tax incentive deal that Ohio officials brokered in 1998 with automaker DaimlerChrysler .  Lawsuits challenging similar corporate tax incentives now are pending in at least three other states, with another suit on the horizon in North Carolina.

In an attempt to stop courts from stripping states of a key economic development tool, U.S. Sen. George Voinovich (R-Ohio) on May 18 introduced legislation to explicitly grant states the power to offer tax incentives for economic development.

Voinovich was Ohio's governor when the state cut a deal in which DaimlerChrysler agreed to replace an aging Jeep assembly plant in Toledo. In exchange for agreeing to invest in new equipment and machinery at the updated plant, DaimlerChrysler was exempted from property taxes for 10 years and was allowed to claim a credit of up to 13.5 percent on its state corporate income taxes.

The U.S. Court of Appeals for the 6 th Circuit found that Ohio's tax credit program violated the Commerce Clause of the U.S. Constitution because it penalized companies that want to develop business outside the state.

The ruling affects not just Ohio but also Kentucky, Michigan and Tennessee in the court's district. But similar tax incentive programs nationwide could come under threat if the country's highest court were to agree to hear the case.

"It certainly casts a dark cloud over incentives all across the country," said Peter Enrich, a Northeastern University law professor who argued against Ohio's tax incentive program before the 6th Circuit.

Fueled by the Ohio challenge, similar lawsuits now are pending in Minnesota, Nebraska, and Wisconsin. A lawsuit also is being threatened in North Carolina, where the state's largest-ever tax break package recently was awarded to computer-maker Dell .

If the Supreme Court were to affirm the appeals court ruling, 40 states' tax incentive programs could be called into question, according to a May 13 letter from Virginia Gov. Mark Warner (D) and Arkansas Gov. Mike Huckabee (R), the chairman and vice chairman of the National Governors Association.

The letter declares NGA's support for Voinovich's proposal in Congress, saying it would "restore certainty, enhance state sovereignty and promote economic health in the states."

A coalition of business groups and state officials also is calling on Congress to pass the legislation. "It shouldn't be the federal courts that dictate state tax policy. It should be the states," said Kevin Thompson, legislative counsel for the Council on State Taxation , which has organized the coalition.

Supporters of tax incentive programs like Ohio's argue that they are a critical economic development tool for states, which have suffered job losses and increasingly have to compete globally to attract and retain companies.

Opponents consider the tax breaks to be corporate welfare and say that states are engaged in a race to the bottom, dangling ever-larger carrots in front of companies as they compete against each other to lure businesses. The result is states have to rely to a greater degree on personal income tax, sales taxes and other revenue streams, critics say.

A fresh debate now is raging in North Carolina, where just weeks after the 6th Circuit's ruling the General Assembly -- at the prodding of Gov. Mike Easley (D) -- granted Dell $225 million in tax incentives over 15 years.

In exchange, the company agreed to build a computer manufacturing plant in the Piedmont Triad -- an area hard-hit by the movement of manufacturing jobs overseas -- creating at least 1,500 jobs and investing $100 million over the next five years.

"The fact of the matter is that we're not just competing against Texas and Virginia," said Dan Gerlach, Easley's senior policy adviser for fiscal affairs. "We're competing against Ireland, Scotland, India and China. ... We have to do something in a global economy to ensure that we still have a manufacturing base in this country."

Easley's office estimates that the Dell facility will bring $743 million in net revenue to the state over the next two decades. But former state Supreme Court Justice Robert Orr is poised to challenge the constitutionality of the deal on behalf of a yet-to-be-named group or person.

Orr, who said he plans to file the lawsuit sometime in mid-June, claims that the Dell deal violates provisions of the North Carolina Constitution that restrict state taxing authority to efforts that directly benefit public interest and that bar lawmakers from handpicking private entities to receive special treatment from the state.

"The state can't selectively pick who gets a tax break and who doesn't," he said in a phone interview. "If we're subsidizing people to create jobs, then everybody who creates a job should have the opportunity to benefit from that."

The lawsuit, which Orr said he plans to file in state rather than federal court, also will contend that the package extended to Dell violates the U.S. Commerce Clause, citing many of the arguments used by the 6th Circuit panel to strike down Ohio's tax incentive program.

Lawsuits already filed in other states include a challenge to Minnesota's JOBZ -- or Job Opportunity Building Zone -- program, on the grounds that it provides a tax break to select companies at the expense of other businesses and residential taxpayers.

In Wisconsin, the state Supreme Court is considering a constitutional challenge to a 2001 law that provides property tax exemptions to Midwest Airlines and Air Wisconsin , both based in that state.

A federal lawsuit challenging Nebraska's oldest and most widely used tax incentive program for large businesses could be rendered moot if the state Legislature adopts a proposal that would re-vamp the state incentive program.