Why the state keeps giving out foolish tax breaks

Job growth is lagging, but we keep giving out tax incentives to encourage the hiring of workers, regardless of whether the measures actually work or not. One culprit: the silo effect.

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Washington State Capitol

Job growth is lagging, but we keep giving out tax incentives to encourage the hiring of workers, regardless of whether the measures actually work or not. One culprit: the silo effect.

Men and women are struggling to keep a job and house their families. ... We need to provide retraining to unemployed workers whose jobs no longer exist. ... Jobs are the way out of the recession, especially in one of the hardest hit areas — the construction sector. ... Education, the number one duty of the state, is the key to the jobs of tomorrow. ... We need to encourage every student to “complete to compete”— complete an AA, bachelor’s or advanced degree so he or she can compete for the jobs of tomorrow. ... Jobs are the way out of the recession.

- Gov. Christine Gregoire's 2011 Washington State of the State Address, Jan. 11, 2011

The Great Recession has sent state economic policy makers back to the drawing board. With the state’s unemployment rate still at or above 9 percent after two years, considerable effort is going into strategies for economic development and job creation.

In the just-ended legislative session, there was much talk about jobs and the role of state government in stimulating the economy, but little positive action. And, as The Seattle Times reported, the budget cuts, especially across post-secondary public education and training, may have set back progress.

Building a new economy is of major concern to state leaders. Yet, to use a currently popular term, too much of this effort continues to demonstrate the "silo effect" — people working for that goal in one agency while ignoring similar efforts by others. This is clearly the problem when programs that directly finance economic development are compared to programs that use tax incentives for the same purpose.

In 2008 the Washington Economic Development Commission (WEDC) inventoried state-funded economic development programs as a part of developing a strategy for statewide economic growth and vitality. The survey found 143 programs managed by 42 organizations, with a total program expenditure of slightly more than $3 billion annually. State operating budget funds contributed the largest share (42%), followed by federal funds (35%) and state capital budget funds (22%).

Almost half of these programs provide direct assistance amounting to $2.2 billion to individual people or organizations, usually companies. The largest number of programs was under the management of the Department of Community, Trade and Economic Development (now the Department of Commerce), while the Department of Social and Health Services (DSHS) managed the largest amount of economic development resources, $642 million. The large size of the DSHS share was primarily due to WorkFirst, a program designed to move people receiving welfare into employment.

The survey also looked at tax incentives to encourage economic expansion across the state. It found 38 state programs that provide tax credits, rebates, or deferrals for specific investments in targeted industries or in key development areas. The majority of these incentives are given for investment in one of three broad categories: developing physical infrastructure, purchasing and installing capital equipment within Washington-based operations, or employing or training people.

What is of interest and importance here is that the WEDC study did not provide costs for the tax-incentive programs even though the state Department of Revenue (DOR) has long published financial data on tax breaks. The annual tax expenditure cost of these programs in 2008 was at least $468 million. The exact number is higher but could not be determined by this author from publicly available data because, in some cases, three or fewer firms benefited, and the DOR does not disclose the amounts under confidentiality rules.

Tax breaks have long been a major aspect of state economic development strategy. Their genesis tends to coincide with recurring recessions.

Since the 1960s, the legislature has enacted numerous tax incentives for the purpose of stimulating manufacturing and family-wage jobs, and since the mid-1990s, the legislature has encouraged high-skill and high-wage jobs through incentives for research and development.

In 1965, a time that the state was experiencing a prolonged post-World War II recession, the legislature enacted a business and occupation (B&O) tax credit for sales tax paid on materials, labor and services used in construction of and major improvements to manufacturing facilities. This was one of the first tax preferences intended to stimulate business activity.

That incentive continues today, with new and replacement machinery and equipment exempt from the sales tax. The exemption has been expanded to include equipment used for pollution control, energy cogeneration, research and development, and testing. And it has been extended to logging and rock-crushing activities. It’s estimated that 25,000 manufacturing firms are eligible for the exemption and that these firms reduced their tax payments by $600 million in the last biennium.

In 1994 the Legislature created a B & O tax credit and a sales tax exemption for high-tech firms engaged in R & D and to stimulate the eventual manufacturing of new products. Eligible firms fall into five high-tech fields: advanced computing, advanced materials, biotechnology, electronic device technology, and environmental technology.

In fiscal year 2009, 350 firms took the credit for a combined savings of $25 million. However three-fourths of this amount accrued to just 50 firms. And in the same year 74 firms were participating in the sales tax exemption that is allowed for the construction of facilities and acquisition of equipment used in R & D and pilot-plant scale manufacturing. These firms could realize a potential annual state and local tax savings of $70 million.

Microsoft has taken both high-tech breaks. The sales tax exemption has been the most lucrative. From 1995 to 2010 Microsoft constructed or expanded 92 separate facilities that qualified for the exemption, and received a total reduction in state and local taxes worth approximately $400 million.

Over the years, tax breaks have been granted to specific industries. Most recently, the state has granted tax incentives to encourage the establishment of call centers and computer-server farms.

Some, like the package of incentives for Boeing to build the 787 jet here, are large. Others, like the chicken-bedding subsidy that garnered some recent media attention, are relatively small.

However, what is characteristic of most breaks is that they tend to be all inclusive — covering a wide gamut of firms without consideration of differences such as financial position and need. Many firms benefiting from the high-tech tax breaks have ample cash reserves available for investment. Others are in the start-up category and may need assistance to realize future growth possibilities.

Given the state’s current employment malaise and dire fiscal situation, this seems a good time to rethink state tax policy in the context of economic development policy. It’s a good time to ask important questions: What is the role of tax policy in stimulating economic development and job creation? How effective have business tax incentives been over the years? And are there better alternatives to stimulate economic growth, such as direct program expenditures?

But here’s where the silo effect inhibits the discussion.

Review of tax incentives is in the hands of the Joint Legislative Audit and Review Committee (JLARC) and an affiliate body, the seven-member Citizen Commission for Performance Measurement of Tax Preferences. The citizen commission's sole statutory role is to schedule tax breaks for review by the JLARC. Although the legislature has constrained its mandate, in the 2011 session it did give the citizen commission flexibility to group preferences for review by type of industry, economic sector, or policy area.

Both the citizen commission and the WEDC have memberships that include private sector representatives — business, labor and academic — and legislators. Both are creatures of the executive branch to some extent. The citizen commission is a 7-member body with one gubernatorial appointee. The WEDC has 24 members, 15 appointed by the governor. And they clearly have similar purposes.

In the case of the WEDC it’s to find the most cost-effective ways to stimulate economic development using all available resources, including state program and tax expenditures that amount to perhaps $1 billion annually. The WEDC is currently working on a new state-wide economic development strategy based on regional innovation clusters. The citizen commission, charged with assisting the identification of tax expenditures that work or do not work as the legislature intended, is considering a new 10-year review schedule.

But the two bodies meet separately and don’t share information that could result in common conclusions and recommendations. They should. The time is ripe.

It shouldn’t take a governor’s directive or a legislative resolution to cause these entities to work together for the purpose of redesigning and refocusing tax and budget policy that can most cost-effectively contribute to economic development and job creation.

This story has been updated since it first appeared to reflect the 2009 creation of the state Department of Commerce.


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About the Authors & Contributors

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Dick Nelson

Dick Nelson is a former Washington State legislator. He currently contributes to the public debate on state and local fiscal issues through research and commentary. As when he was in the legislature, he prefers the Democratic Party.