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CFED Business Incentive Clearinghouse Newsletter



The Corporation for Economic Development (CFED) has asked me to
distribute this newsletter to my network.  This is a new project and one
I think could provide some insight on how best to deal with the wasteful
incentive wars between the states.

I would welcome any feedback you may have on the newsletter. 

Charles F. Horn
State Senator
Ohio's 6th Senate District
chorn@mailr.sen.state.oh.us

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Accountability: The Newsletter of the Business Incentives Clearinghouse
Volume 1, Number 1 January 1999

The Business Incentive Reform Clearinghouse is a new project, managed by
the Corporation for Enterprise Development (CFED) and funded by the Ford
Foundation, which seeks to provide local, state, and federal
policymakers with the most current ideas for holding such incentives to
a higher standard of public accountability.  Its specific goals include:
(1) serving to strengthen the ties between policymakers and the best
academic research on incentive design, reform, administration, and
evaluation ideas; (2) create a forum for dialogue between reform
experts, research, policymakers, journalists, and the informed public;
(3) exploring new federal, state, and local reform options; and (4)
tracking the latest reform alternatives and the latest case studies of
unaccountable incentive uses.

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The Care and Feeding of the State and Local Tax Base: A Valuable Public
Asset
By Michael Mazerov and William Schweke

Supreme Court Justice Oliver Wendell Holmes said it accurately and
succinctly: "Taxes are what [we] pay for civilization."  Schoolteachers,
police officers, sanitation workers, road crews, and public health
nurses can't work for free.  Publishers can't be expected to provide
free textbooks and construction companies can't give away sewage
treatment plants.  Everything we as citizens call upon state and local
governments to do - including expanding opportunity for people and
places left out of the economic mainstream - ultimately requires a
funding mechanism.  Taxes represent 56 percent of all of the financial
resources available to state and local governments.

The tax bases of states and localities are thus valuable resources that
must be nurtured, conserved, and used efficiently, no less so than a
stand of timber or a parcel of rich farmland.  Unfortunately, a number
of longstanding flaws in state and local tax systems and a host of
recently-enacted provisions aimed at encouraging local economic
development are resulting in rapid erosion of this crucial community
asset.  Major changes in federal, state, and local tax policy are needed
to ensure that state and local tax bases will be capable of meeting the
demands that will be placed upon them in the coming decades.  

Erosion From Without

Broadly speaking, states and localities tax the incomes, consumption,
and real estate wealth of their citizens and the profits and property
wealth of businesses engaged in economic activity within their borders.
Personal income taxes, household and business property taxes,
consumption taxes, and corporate profits taxes together account for 99
percent of state and local tax revenues.  Unfortunately, technological
and economic factors are interacting with longstanding deficiencies in
state and local taxing powers and policies to erode the base of these
taxes.  Indeed, a recent study by Hal Hovey of State Policy Reports
found that many states, despite the strong economic and fiscal
conditions that currently prevail, are in great danger of falling into
structural deficits (e.g., a chronic underlying imbalance between their
revenues and expenditures) when the next economic downturn occurs.

Recent improvements and declining relative costs of transportation and
communications permit businesses to supply local markets for an
ever-wider variety of goods and services through interstate trade rather
than localized production and marketing.  For example, a searchable
Internet database can now furnish potential customers with a breadth of
information concerning product specifications and availability that
until recently could only have been provided by a large national sales
force traveling to the customers' place of business.  

The increasing ability of corporations to satisfy their customers'
market demands with little or no direct physical presence in the states
and localities where these customers are located is already contributing
to a serious direct erosion of state and local sales tax and corporate
income tax bases.  The authority of state and local governments to tax
out-of-state corporations is severely constrained by obsolete federal
law, and this problem is compounded by other tax policies that have not
been updated to take account of the explosive growth in interstate trade
and multi-state corporations.  There is only so much consumer demand and
business profit potential within a given state or locality at a given
point in time, and if the sales are made and the profits are earned by
out-of-state corporations not subject to tax, the sales tax and
corporate income tax base will be directly eroded.  Already, for
example, state and local governments lose $3-4 billion in sales tax
revenues from mail-order catalog sales.  This revenue loss is
anticipated to grow dramatically in the next several years as the
Internet expands the range of goods and services that can be purchased
from remote sellers.  

The direct loss in sales and corporate income tax revenues resulting
from the collision of accelerating interstate commerce and obsolete tax
laws is compounded by a second-round loss of local income and property
tax receipts from local merchants.  Locally based businesses are at a
competitive disadvantage as compared with both out-of-state businesses
selling from tax haven states and corporations that can take advantage
of their multi-state operations to cut their taxes.  For example, one
infamous court case revealed that Toys 'R Us was reducing its reported
profit in many states - and thus its state corporate income tax
liability - by requiring its stores to pay tax-deductible royalties to
another Toys 'R Us subsidiary especially set up in Delaware to hold its
Geoffrey Giraffe logo.  

The local toy store proprietor does not have the same opportunity to
manipulate her income tax liability that a multi-state chain like Toys
'R Us does; the neighborhood computer builder starts out with a 6-8
percent price disadvantage vis-a-vis Dell Computer because he has to
charge sales tax while Dell does not.  Lower after-tax profitability and
depressed sales for locally based businesses mean lost opportunities to
expand both physical plant and payrolls.  In turn, this results in lower
property tax and income tax collections.  True, the jurisdiction that is
home to the region's Toys 'R Us store may reap economic benefits despite
the company's ability to manipulate its state tax liability, as may the
one community lucky enough to land the mail-order computer
manufacturer's national distribution warehouse.  But if states and
localities want to derive a significant share of their economic and tax
base from viable, competitive, locally based businesses, it will be
increasingly necessary to modify their tax systems to ensure that such
businesses are not taxed more heavily than out-of-state and multi-state
businesses.  At present, the competitive playing field is very much
tilted against the locally based business sector.

Erosion From Within

The flip side of the growing ability of corporations to satisfy
nationwide demand for their products from just a handful of production
and distribution centers has been intensified state and local government
competition to attract such export-oriented facilities and the jobs they
bring with them.  Special breaks on state and local taxes have, of
course, been a principal weapon in this well-publicized "War Between the
States," to the point that they, too, constitute a major source of tax
base erosion.  The amount of state and local government tax revenue
given away has escalated steadily, with the cost per job attracted
reaching as high as $250,000 to $500,000 in some instances.  While no
nationwide survey of the cost of economic development incentives exists,
we can fairly accurately project that total state and local on- and
off-budget spending on economic development (including both good
programs and bad ones) is probably five times what the federal
government spends.  This would put the total nonfederal figure at close
to $32 billion.  And, according to our best estimates, the largest
proportions of this total are tax incentives.  Depending on the state,
they may exceed direct on-budget economic development spending by 3:1 to
8:1.  New York's state and local tax expenditures for economic
development, for example, exceed $500 million annually, or over $27 per
capita.

Since the publication of Bidding for Business: Are Cities and States
Selling Themselves Short?, the Corporation for Enterprise Development
and its allies have been working to curb the excesses in today's
business incentives "arms race" among the states.  In doing so, we
believe we have succeeded in convincing most policymakers and opinion
leaders that tax incentives are generally not good economic development
tools - especially when looked at from the national perspective.  There
is a growing conventional wisdom that such programs:

* Often reward shareholders of the recipient corporations for
economic actions the companies would have taken anyway;
* Waste scarce public dollars to affect the location of business
investments with little if any impact on net job creation;
* Sometimes destroy jobs in existing businesses by providing
substantial unfair advantages to new competitors;
* Divert the attention of policymakers from attending to the
actions that could lead to net job creation and a better business
climate; and 
* Deprive state and local governments of revenues need to finance
public services that enhance a region's attractiveness as a business
location, such as good public schools and effective retraining programs
for adult workers.

Nonetheless, we must acknowledge that our intellectual victories are not
translating into practical success.  Economic development tax incentives
continue to proliferate.  For example, the last KPMG Peat Marwick survey
of senior tax and financial exectives at 203 large corporations found
that these companies stated that such incentives were more likely to be
offered than five years ago and the number of such programs has also
grown from 450 to 600 during the year polled.

Why do tax incentives continue to proliferate despite growing skepticism
about their efficacy?  First, because when a new or expanded facility
receives a tax incentive, there is no way to demonstrate conclusively
that the investment would have occurred without it.  Second, because one
cannot undercut the logic that a tax incentive larger than one being
offered by a competing jurisdiction will tip a location decision when
"all other factors are equal."  Third, because a couple of examples of
corporate executives citing tax incentives as a factor in their decision
to locate an especially sought-after plant in a particular jurisdiction
will trump a hundred econometric studies showing no correlation between
business' state and local tax liabilities and job growth.

An Action Agenda for Preserving the State and Local Tax Base

Just as it has taken several decades to build a robust movement of
organizations and individuals committed to conserving and restoring the
natural environment, it will require considerable effort to build a
constituency to defend the "natural resources" that fuel state and local
public services.  Fortunately, a growing number of organizations are
beginning to focus on strategies and policies aimed at preserving the
state and local tax base.  The embryonic elements of such a movement can
be seen in such diverse activities as the National Governors'
Association's efforts to educate Congress about the emerging threat to
the sales tax base that tax-free Internet marketing represents and
initiatives challenging excessive property tax abatements placed on the
ballot by teachers' unions in several states.  Perhaps the most exciting
recent developments are the establishment of a full-blown project at
Citizens for Tax Justice - "Good Jobs First" - aimed at supporting a
growing local movement that seeks to attach job quality-related
performance requirements to major economic development incentive
packages granted by state and local governments, along with CFED's
newly-funded "Business Incentive Reform Clearinghouse," which intends to
create a current and comprehensive web-based library of reform tools,
ideas, and research.

We would suggest that organizations concerned about the long-term
preservation of a healthy state and local tax base focus for the next
decade on seeking implementation of the following five sets of economic
development-enhancing tax policies:

* Mandatory public disclosure by corporations of their actual
state and local tax liabilities, the value of the economic development
tax incentives they receive, and their local economic activity
(including sales, payrolls, and plant and equipment investment) is the
sine qua non of achieving both corporate accountability for tax
incentives and fair taxation of businesses in general.  Only with such
information can policymakers and the public evaluate whether the cost of
tax incentives is justified by the growth of payrolls and investment and
the feedback effect on the tax base itself.  Such information is also
needed to evaluate whether existing tax policy ensures that all
corporations benefiting from state and local services are paying their
fair share of taxes and that state and local taxes are not tilting the
playing field either in favor of or against competitors.  Corporate tax
disclosure is best pursued through a coordinated national campaign that
seeks to enact it in numerous states simultaneously, since a single
state seeking to adopt such a policy would be vulnerable to corporate
threats not to locate new investments there.

* Many states need to implement a set of tax policies aimed at
ensuring that multi-state corporations have state corporate income tax
and sales tax liabilities as similar as possible to those faced by
wholly in-state corporations.  These policies include mandatory
"combined reporting" (an accounting method that treats businesses
comprised of a parent and subsidiaries as one corporation for state
corporate tax purposes) and the assertion of taxing jurisdiction over
out-of-state corporations to the limits permitted by federal law.  For
the long term, changes must also be sought in federal law that would
permit states to tax all out-of-state corporations making substantial
sales to their residents (including resident businesses).  All of these
changes are needed to ensure both that a state's tax base is not
directly eroded by out-of-state businesses (such as mail-order and
Internet sellers) and that local businesses are not placed at a
competitive disadvantage by a state's tax policies as compared with
out-of-state businesses.

* Given the range of experimentation that has already occurred for
enforcing the accountability of economic development incentive deals
through legally binding performance contracts, now is the time to draw
on best practice and draft a model for states and localities to follow.
Laws should be sought to grant citizens legal standing to ensure
compliance with these contracts and to ensure that the routine
enforcement of the contracts is not the responsibility of the state and
local economic development staff that originally marketed the
jurisdiction and arranged the deal.  Laws implementing economic
development incentives should also always include a requirement that the
programs undergo a well-financed, professional, and independent sunset
review every five years.

* Activists should seek legislation requiring the preparation of a
unified development budget, which would examine simultaneously all on-
and off-budget spending on economic development.  This is a valuable
tool, because it clarifies existing commitments and implicit priorities
(e.g., business recruitment versus workforce preparation versus
technology development), enables policymakers to better weigh
conflicting imperatives (e.g., K-12 school financing versus property tax
abatements), can help direct scarce public dollars into programs that
generate better development returns for the state, and helps educate the
public and policymaking community to the fact that economic development
involves more than business incentives and industrial attraction.

* Finally, both before- and after-the-fact evaluation of incentive
programs and special deals would be aided by developing a "certified"
cost-benefit methodology setting minimum standards for what a good
assessment should look like.  After such a model approach is developed,
efforts should be launched to encourage all states and localities to
adopt it when they are measuring net benefits and net costs per job for
varied development incentives.  Adoption of a uniform evaluation
methodology would prevent one state from offering a more extensive
location incentive package than another merely because it measured the
benefits more generously.  The effectiveness of such a uniform
methodology would also be enhanced if states competing for a particular
facility would agree to share information provided by the company
regarding such matters as the amount of capital to be invested, the
number of jobs to be created, their pay scales, etc.

We are under no illusion that these reforms will be easy to enact.  But
we are encouraged by the reform efforts, which are now organizing around
these issues.  More and more citizens are saying  "enough is enough" and
that we are wasting too much money on subsidizing companies for what
they would have done anyway.  If we can focus the degree of commitment
and resources that this agenda demands, we can build broader coalitions
between main street businesses, public employee unions, taxpayer
watchdog groups, low-income budget advocates, and many others.  By doing
so, this agenda has a realistic prospect for success.

Michael Mazerov is a Senior Policy Analyst at the Center on Budget and
Policy Priorities and William Schweke is a Senior Program Director at
the Corporation for Enterprise Development.
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For more information about the project and CFED, contact: Bill Schweke
or Matt Hull at CFED's Southern Office, 123 West Main Street, Third
Floor, Durham, NC 27701 (phone: 919-688-6444; fax: 919-688-6580).

Be sure to visit our web site for additional information about incentive
reform and alternatives to incentives: www.cfed.org.