Challenges of using tax incentives

The federal government and probably all states have numerous tax incentives. These are usually credits that reduce the regular tax liability if the taxpayer takes the required action such as creating a certain number of jobs, investing in a designated zone, installing energy efficient property etc.

These incentives reduce tax revenues. They are usually created in the tax system as a simpler way to administer them as opposed to creating a government function to evaluate programs and make payments where warranted.

Common issues with incentives include:

• Are they rewarding behavior that would have occurred anyway such as because the action helps the business beyond its tax situation.
• Whether the incentives is property designed to target the desired behavior, or is also incentivizing behavior that is not desired.
• Often no system is set up to assess whether the desired benefits occur and what the cost/benefit of the program is.
• Sometimes there are no clawbacks in place to require the taxpayer to repay the tax savings should it turn out that they did not do what was required or they did not do it for the required time period.

The Comptroller in New Jersey recently issued a 70+ report analyzing the effectiveness of five tax incentives: [1/9/19 press release + Exec Summary + report]

1. Grow New Jersey Assistance Program
2. Economic Redevelopment and Growth Program
3. Business Employment Incentive Program
4. Business Retention and Relocation and Assistance Grant Program
5. Urban Transit Hub Tax Credit Program

The study found that the incentives were not properly managed and evaluated. The reviewers found that weaknesses in the system “resulted in improperly awarded incentives of 4179 million, overpaid incentives of $6,6 million, and over-certified incentive awards totaling $52 million, that unless corrected will result in overpayments. In addition, 2,993 jobs were not substantiated as having been created or retained.”

So, good that a review occurred. Let's see what the results of the audit are - will changes be made. But in enacting tax incentives, measures should be taken, most notably to determine the incentive is really needed, and if yes, also enact requirements for appropriate data to be collected, analyzed and reported to the lawmakers annually.

What do you think?

Yet One More Proposal for Relief of New State Tax Deduction Cap

The Tax Cuts and Jobs Act (PL 115-97; 12/22/17) limits the itemized deduction for state and local taxes to $10,000 ($5,000 if married filing separately). As with most of the individual tax changes including the lowered tax rates, this change only exists for 2018 through 2025.

Several states don't like this change, particularly states like New York, New Jersey and California with high state taxes. New Jersey enacted S 1893 on 5/4/18. It allows local governments to create funds where property owners can "donate" to the fund and get a 90% credit against their property tax. The federal benefit is that this is a charitable donation which shows up on the federal return as a charitable deduction rather than as a state tax deduction. Sounds like a good deal.  Too good to be true?

Perhaps now that a state has enacted such a law (although local governments still need to create the funds), Congress or the IRS will step in to let us all know if this works. While similar state tax credit funds have been around for a while, the state credit amount is usually lower. The problem is that if the "donor" gets a big benefit from the donation, was it really a charitable donation?

Other versions of this type of proposal are at the state level, such as California SB 227 which creates the California Excellence Fund. Donors get an 85% state tax credit. SB 227 passed in the Senate on 1/30/18 and is awaiting attention in the Assembly.

But California has one more proposal - AB 1485. This proposal has limited effect compared to other bills. This bill allows a 100% credit against an individual’s California income tax for a contribution to a charity located in California. The credit maximum is $500 ($1,000 for MFJ). No California deduction is allowed for the contribution. The stated goal is “to ensure California creates a robust and efficient tax incentive program that encourages all Californians to contribute to the charitable organizations serving their communities, coupled with accountability and transparency measures. Towards this end, California’s tax credit for charitable donations ensures that California taxpayers receive the maximum possible economic return on their investment and creates overall positive and sustained economic impacts for the entire state.” The bill’s effectiveness is to be judged by the number of taxpayers who claim the credit.

Critique: Unlike other proposals, such as SB 227, AB 1485 has a dollar limit. Also, the purpose might not be realistic because while for California tax purposes, the donor comes out even, if the individual does not itemize for federal purposes, there is no federal tax benefit of the donation. If the donor does claim a federal deduction, it's a great expenditure for the taxpayer because the benefit exceeds the cash outlay. For example, if the donor is in the 32% federal bracket and donates $1,000 (MFJ), they save $1,000 of California taxes and $320 of federal taxes - all for a $1,000 outlay!

AB 1485 provides a benefit to California taxpayers who do not itemize as they will get a tax benefit for their contribution (if to the right organization). 

How does the state pay for the likely high cost of AB 1485? Seems they will have to cut costs such as for social programs and perhaps even education. Will the donations go to charities that will make up for these cuts? I don't think so. Some of the donations will likely go to churches and public (and private) schools as they are clearly located in California. More of the donations will be make by higher income individuals as they have the money for the donations. Basically, AB 1485 allows taxpayers to use their tax dollars to decide which charity or cause to support rather than elected officials deciding where those tax dollars are needed.

The FTB likely needs to define what it means to be a charity located in California and how a donor can tell (such as distinguishing a PO Box from an actual location). Also, why not say that the charity has to provide a certain portion of its benefits to Californians (or that is qualifies for a property tax exemption in California since the charity could note that on its website and the FTB can verify that). Clarification is needed on whether a charitable contribution deduction continues for donations above $500 ($1,000 if MFJ).

Will these provisions work? What if individuals use them and then Congress or the IRS says no? I don't think it is a problem for AB 1485 as the donations are clearly to charities (although that can include governments). SB 227 which finds the General Fund is a bigger concern. It is basically replacing tax payments with "donations". It donations to the state fund are not enough, it won't affect government operations as they will still have tax dollars to meet budget needs.

What do you think?