This is the third in a 3-part series on tax reform in Washington state. You may also want to read Part 1, "Olympia: So many bills, so little tax reform," and Part 2, "Olympia: Breaking up with a tax favor is so hard to do."
From Tax Incentives, Washington State Tax Structure Study, Alternatives Subcommittee Paper, April 18, 2002.
“The issue of whether tax incentives achieve their stated purpose remains an open question. There are limited means to determine who benefits from tax incentives and if they are effective in creating jobs. Washington law requires the Department of Revenue to prepare a periodic compilation of the reduction in revenues from all tax incentives and exemptions. A few other states have enacted programs that require firms to publicly disclose information on the amount of their tax savings and on the creation of jobs and goal attainment.
Studies that examine the effectiveness of tax incentives have conflicting and inclusive results. Academic studies show small, if any, impact on growth. There are studies involving interviews or surveys showing that for individual firms tax incentives are working to create jobs in the communities in which they locate.”
Let’s start with this premise: Once a tax break is enacted, it’s difficult to modify or eliminate. What's more, analyzing the effectiveness of a tax break – the benefits versus the costs – is a problematic exercise. At least this seems to be the conclusion of many economists and others who have closely studied the use of tax breaks by states to stimulate their economies.
Individual tax breaks on the books need to be carefully reviewed using an improved set of evaluation criteria, yes, but the whole idea that they are an effective way of fueling economic development and growth also requires a much closer look.
If this is true, we need to find new approaches. Here are a few suggestions in the category of personal opinion. Several will require legislative action.
1) Business incentives need to be grouped and given review priority.
Currently, the Citizen Commission puts together a 10-year plan for reviewing all tax exemptions. Health industry tax exemptions are slated to be reviewed next year under this plan.
While it’s certainly appropriate to submit health preferences to an early review — the cost of health care is a major policy issue — there are also numerous business incentives that may or may not contribute to the state’s economic condition that also should be reviewed without delay.
2) A new evaluation factor should be added for determining need among companies that receive tax credits.
House Bill 2532 tried to address this issue in the context of the high-tech R & D credit. But it got unduly complicated by involving contributions to the Opportunity Expansion Program for the purpose of increasing slots leading to degrees in high demand areas such as computer science.
The credit is clearly not needed by well-established firms with the means to invest in R & D. Several firms could be cited, but Microsoft serves as an example. At last count Microsoft had $53 billion available for investment. It should be possible to draw a line somewhere between zero and $50 billion, above which a firm is able to fund R & D without taxpayer assistance.
3) Statutory restrictions on what can be reviewed should be removed, especially the manufacturing machinery & equipment (M & E) exemption and the small business credit.
Currently, tax exemptions for small businesses and manufacturing firms that invest in machinery and equipment aren't subject to review at all. Both are used heavily, and both were the subject of bills in the last legislative session expanding the preferences.
The M & E sales tax exemption has a significant cost. And the cost of the small business B & O credit could increase even more since both candidates for governor support its expansion. Rob McKenna supports a plan that was embodied in Initiative 1098, which would increase the credit to $4,800 a year, at an estimated additional two-year (2013-14) cost of $520 million.
Allowing these preferences to be reviewed is not taking a position on their merits. It simply means that their cost-effectiveness should be understood. Does the M & E exemption help fund robotic equipment that, although increasing productivity, actually reduces manufacturing jobs? Would it be better to focus the small business credit on start-ups?
4) All newly proposed preferences should have a clearly stated objective and should be assigned an expiration (sunset) date.
This would ensure that benefits will be weighed against costs, and that inevitable changes in the business environment that affect the need for a tax break can be reviewed in a timely manner.
5) A new effort should be made to reform aspects of the state’s tax structure that invite enactment of ever more tax preferences.
A place to start is with the B & O tax, which is replete with preferences in the form of exemptions, deductions, credits and differential rates. The Department of Revenue 2012 Tax Exemption Study lists 176 preferences with a total cost to the state of $7.7 billion in the current biennium. Of these, 113 fall into the “business incentive” category with an impact of $1.7 billion. The state actually gives back more in breaks than it retains from B & O tax receipts. For every $1.00 than goes into the general fund, $1.19 is lost through the preferences. Shifting from a tax on gross revenues to net revenues would make most if not all of these unnecessary.
6) The usefulness of the 'fiscal impact' measure should be reconsidered, and similar newly proposed metrics should be carefully thought through before they are adopted.
Currently, the state benefits of tax preferences are assessed using a number of factors, including "fiscal impact" which tries to measure the total impact of the preference on the state economy. This has, however, proven difficult to assess, and the results have not been encouraging. Newly proposed metrics such as rate of return and net benefit analysis may be equally hard to compute. This is implied by the Joint Legislative Audit and Review Committee's (JLARC) review of both the R & D sales tax exemption and the B & O credit, and by a separate study of the credit by the Upjohn Institute.
JLARC found the results of the R & D incentives to be “mixed.” It concluded: “The B&O tax credit resulted in an estimated one-time employment growth of 454 jobs with an average cost per new job of $45,000 and an estimated increase of new earnings per job of $25,000. In addition, while beneficiaries made R&D expenditures in Washington, it is not clear how much of this spending occurred as a result of the tax credit.”
Although Upjohn’s report is technically complex, its conclusion is summarized by this statement:
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