As States Slash Budgets, Business Tax Breaks Survive

Two months ago, as Missouri lawmakers were wrestling with a $500 million budget gap and their legislative session was winding down, Governor Jay Nixon implored them to pass comprehensive reforms to the state’s tax credit programs for businesses and other organizations. Growth in tax breaks was “rapid and unchecked,” he said . And although tax credits often are touted as tools to create jobs and grow the economy, Nixon argued that sustaining funding for education was more important for economic growth in the long run.

“Every dollar we spend on tax credits is a dollar that isn’t available for K-12 schools to invest in teaching, reading, math and science,” he said. “Every dollar we spend on tax credits is a dollar that isn’t available for our community colleges to invest in training nurses, mechanics and lab techs. Every dollar we spend on tax credits is a dollar that isn’t available for our universities to invest in educating the next generation of teachers, doctors and engineers.”

“The value of tax credits,” Nixon went on, “must be weighed against their cost to our classrooms, our colleges and other vital state services.” Nixon’s proposal and a handful of others spurred a lot of conversation in the Legislature about curbing the growth of tax credits and keeping only the ones proven to create jobs. But none of them passed.

Lately, however, Nixon has been taking a new line on business tax breaks. Ford Motor Company is restructuring its operations in ways that threaten the continued existence of an auto plant near Kansas City that employs 3,700 people. Nixon has convened legislators for a special session to consider adding up to $150 million in new tax incentives to entice Ford to retool the factory for new product lines instead of sending jobs to other plants in Kentucky or Michigan. Ford is discontinuing production of the Ford Escape and Mercury Mariner, two of three vehicles manufactured at the plant, and without new products to manufacture, auto suppliers scattered throughout the state may also face layoffs and possible extinction. The special session began before the 4 ^th of July holiday and continues this week.

Governor Nixon argues that these incentives are critical to preserving Missouri’s century-old auto industry and would help position the state as a leader in advanced manufacturing. But to some observers, the special session is evidence that Missouri has forgotten all about its discussions about the efficacy of business tax breaks. “In the vacuum of a special session, when you have to move quickly, it undermines the work that Missouri has been doing on broader tax credit reform,” says Amy Blouin, executive director of the nonprofit Missouri Budget Project.

Missouri is not the only state that seems to be of two minds when it comes to business tax breaks. Iowa and Colorado also recently stopped to reexamine their tax-incentive programs, in hopes of keeping the ones that pay proven dividends and getting rid of the ones that some would call corporate welfare. But those states, too, are finding that controlling the growth of business tax breaks is easier said than done-especially when thousands of jobs seem to be on the line.

In Iowa, it was a scandal in a tax credit program targeted at the movie industry that propelled a comprehensive study of the state’s tax credit programs. Based on a report by a Tax Credit Review Panel appointed by Governor Chet Culver, Iowa eliminated $115 million worth of tax credits. The Legislature suspended the film tax credit for three years and established a regular annual review process for all tax credits. Still, nonpartisan experts at the Iowa Fiscal Partnership called these moves mere “baby steps.” The Partnership was disappointed that legislators ignored the Panel’s more aggressive recommendations and questioned whether the estimated savings actually would be achieved.

Similarly, in Colorado, the Legislature this year managed to pass 11 bills eliminating or suspending tax credits and exemptions for businesses. The move is expected to save the state more than $100 million in the 2011 fiscal year. Gone are exemptions restaurants enjoyed for the cost of purchasing take-out containers; breaks farmers received for purchasing insecticides and bull semen; and incentives bulk mailers had enjoyed for printing coupon booklets.

But House Majority Leader Paul Weissmann, a Democrat who supported many of the measures, says the Legislature missed a chance to take a more deliberate and far-reaching approach. He says the exemptions targeted for elimination were chosen based on two factors: the amount of savings they could contribute to solving the near-term budget crisis and the likelihood that legislators could stomach the politics of getting rid of them. Left out of the discussion was any data about the efficacy of some tax breaks versus others in promoting job creation or economic growth.

“We give out tax credits like candy,” says Weissmann, who sponsored an unsuccessful measure that would have required regular review of all tax exemptions. “And then once they are in law we never look at them again.”

The search for data

Part of the problem states are encountering with business tax credits is that good data on which to base decisions is hard to come by. In Missouri, that’s a problem that budget analysts keep running into. “The general assembly is making all kinds of decisions without real or accurate information,” says Missouri State Auditor Susan Montee. “You’re guessing on a whole bunch of this.”

For example, in January, the Legislature’s Oversight Division released a report that tried to calculate how much tax credits are costing the state. The report said the cost has grown from $145 million, or 3 percent of related taxes in 1999, to $588 million, or 8 percent of related taxes in 2009. But this is just an estimate, the evaluation notes, because the “information needed to track the impact of tax credit programs on the revenues of the State of Missouri is incomplete and uncoordinated, and recorded in multiple systems which are not consistently compared for accuracy or completeness.”

Likewise, an April report from Montee’s auditing office found that the state often underestimates the price tag of tax-credit programs. Comparing original fiscal notes attached to 15 major tax credits to their actual impact on the state’s revenues, the audit documented $1.1 billion in unanticipated revenue losses in the five-year period that ended in June 2009. The most egregious low-balling documented in the audit came from the state’s two largest tax credit programs, one that promotes low-income housing development and another aimed at historic preservation. Developers redeemed $1.05 billion in breaks during the five-year period — $918 million more than expected.

“Tax credits have been a challenge to get our arms around in terms of trying to figure out what’s working and what’s not and their impact on the state’s economy,” says state Representative Allen Icet, who chairs the House Budget Committee. “We’re often told at the outset that the credits will pay for themselves, but it’s difficult to tell whether that’s true.”

The Missouri experience

In the complicated arithmetic underpinning Missouri’s 53 tax credit programs, addition has proven far easier than subtraction. The Oversight Division’s report concluded that growth in the programs as they’re currently structured could result in a total of as much as $857 million in tax credits issued and redeemed each year. And that’s assuming the Legislature makes no additions to the tax credit programs — which is unlikely, if recent experience is a guide.  In 2009, for example, lawmakers put a cap on the historic preservation credit, but they simultaneously expanded and modified a host of others, with an overall estimated price tag of up to $51 million for fiscal year 2011.

Even when inefficiencies are clear, capping or eliminating existing tax credits is difficult, says Montee. For example, a 2008 audit of the low-income housing tax credit found that it wasn’t particularly effective: Only 35 cents of every dollar foregone by the state actually went to the development of housing. “There isn’t anyone out there saying, ‘I’m against affordable housing,’ but there are people saying ‘we need these projects,'” she says. “It’s easier to leave the tax credit programs in place than to take them away. To take them away, you have to make people mad.”

During this year’s regular legislative session, debate over Nixon’s tax credit reform proposal and a handful of others stalled and ultimately killed most economic development-related legislation, including the Ford incentives. “A closer examination [of the state’s tax credit programs] is warranted,” says Scott Holste, a spokesperson for the governor. “At the same time, we know that Missouri wants to be competitive with keeping a strong auto industry in our state, and the incentives that are being looked at in the special session would be a large part of that.”

Holste says Nixon may pursue additional tax credit reform legislation next year. In the meantime, Nixon hopes to save $47 million by intentionally slowing down the reward of additional existing tax credits. He has asked agencies to more thoroughly analyze proposals and their promised benefits before granting credits.

Many business leaders see the 2009 closure of a Chrysler plant near St. Louis in Fenton, Missouri, as a cautionary tale. “You don’t have to look too far around Fenton to find people that are frustrated,” Ray McCarty, president of the Associated Industries of Missouri, said in a conference call with reporters. “The local economy is in shambles, and frankly the state of Missouri took a very large hit when that plant went down. We do not want to see the same thing happen with another plant, and believe the only way to really hedge against that is to encourage these companies to produce new products in the state of Missouri.”

The special session is focused on the Ford incentives and reforms to the state’s pension system the governor hopes will offset the cost of those incentives. But just days into the session, the Legislature’s focus already has expanded in scope and incorporated other economic development initiatives that stalled during the session. For example, the version of the Ford bill passed by the House last week includes incentives aimed at luring computer data centers to locate in Missouri. Also, by defining Ford as a maker of vehicles for “transportation” the House may have left room for makers of bicycles and food-vendor carts to benefit.  And while it is unclear how the legislation will evolve in the coming weeks, the version passed by the House removes the explicit link between the Ford and pension bills, lowers the price tag to $100 million and houses the incentive within an existing tax credit program.

Missouri state Representative Icet has tended to support tax credits for businesses in the past, but he voted no last week on the Ford incentives. The state has been burned by the closures of other automotive plants in the state, sometimes after awarding incentives, he notes. “Even if this passes,” he says, “there are no guarantees that Ford will stick around.”