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Monday, April 4, 2011

Enterprise zones and the role of the tax system

I saw an interesting article in the Daily News (San Fernando Valley) - "Local entrepreneurs thrive in enterprise zones" by Dana Bartholomew (3/26/11). I'll admit that what first came to mind is - well, if you are going to get tax credits and exemptions, won't that make it easier to "thrive"?

The article notes that "benefits to companies include a $37,440 tax credit for each worker hired, sales tax credits for new machinery, a 35 percent cut in city utility rates, reduced requirements for parking." How do you measure whether you have a going business with such subsidies? But ... many businesses (and individuals) get tax subsidies of some sort (percentage depletion, manufacturing deduction, various credits, and more). Generous ones for businesses can mask whether the business is truly a going concern. But how much does the subsidy have to be to get to that point? Certainly, a negative tax rate should call into question whether the business is viable and whether the government outlay could be more productive elsewhere. These can certainly be difficult issues to resolve.

The purpose of enterprise zones should be to encourage businesses to invest in areas where buildings may need major improvements and the workforce may need training. That sounds like a win for the state that would otherwise end up spending money to make improvements. If the state can help businesses to improve the area, should be a win for everyone. But how much subsidy should the business get? Should the state instead use the money directly for training centers and hiring people in the area to improve the area and start their own businesses?

Also, as noted in the article, some enterprise zones include affluent areas, such as the Warner Center area in Woodland Hills. That seems odd.

The article also quoted an accountant "who specializes in enterprise zones." Yes, this area of the tax law, like others, has generated a practice area! This accountant noted that "four out of seven failing clients in recent years [were] saved by zone tax incentives, many by filing amended returns." Well, claiming this tax incentive on an amended return points to a problem - how can you have a retroactive incentive? If the reason for the amended return was that the business only learned after the fact that it could claim tax breaks, then the tax breaks are not what led the business to invest. In such a case, the tax breaks just reward for something they were going to do anyway.

What about this approach:

  • removal of special tax breaks

  • lowering of tax rates

  • infrastructure spending to improve areas with low business activity

Principles of good tax policy, particularly, simplicity, certainty, neutrality and economic growth and efficiency, are better met by a tax with a broad base and low rate.

Of course, part of the problem in California now is that the talk is about removing tax breaks but not lowering the rate because we are trying to resolve a budget shortfall. I'm not convinced that the shortfall is due to special tax breaks alone, but also to an outdated tax system (such as the sales tax). But, can the state do more than piecemeal reforms in a time of budget crisis?

What do you think?

1 comment:

Stephanie Corwin - SJSU said...

The enterprise zone credit is a hot topic currently in California, as Governor Jerry Brown looks into eliminating the credits. Many feel that the enterprise zones allow California to compete against other states in drawing in businesses. However, there have been numerous studies by the Public Policy Institute of California, the California Budget Project and the Legislative Analyst's Office that show the credits are costing the state money and are not having the desired impact on increased jobs. Therefore this is not having the positive impact on the Economic Growth and Efficiency principle as we would expect.

The studies that show this is not impacting jobs are supporting the comment that these credits are not incentivizing a change in behavior. Those who are benefiting from the credit are those that had existing activity in the enterprise zones.