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?

Tax expenditures and oversight

The GAO released a report today - Tax Expenditures: Opportunities Exist to Use Budgeting and Agency Performance Processes to Increase Oversight (GAO-16-622). It looks at the estimated $1.23 trillion annual cost of special tax deductions, exclusions, credits and preferential rates AND how there is basically no oversight of these costs relative to discretionary budget items. Apparently, OMB and federal agencies were to review tax expenditures (there are over 150 of them) to see how they help agency goals. So far, only 11 of 169 expenditures were addressed representing less than one-third of the total cost.

I have not yet read all of the 55 page report, but the exercise sounds somewhat futile because many expenditures likely don't fit into any agency goals.  For example, what federal agency supports not only ownership of a vacation home, but also having a mortgage on it?  Does the Department of Education's goals include making sure couples with up to about $180,000 of income can get a $10,000 scholarship (American Opportunity Tax Credit) for a child?  Seems to be contrary to the underfunded Pell grant program designed to help those in need pay for tuition.

The GAO website includes a nice infographic reproduced here. Too bad it is not part of any effort to increase government finance literacy among the public. I think it would be easier to broaden the tax base if more people knew of the costs of some of these tax expenditures and the minority of taxpayers who benefit from many of the more costly ones.  Helpful information would include how, for example, the annual $80 billion for the mortgage interest deduction might be used more widely to help more taxpayers.   [Data shows that only 1/3 of individuals itemize and that the mortgage interest deduction primarily helps higher income individuals buy a more expensive home. Also home ownership rates in the US are similar to UK and Canada that don't have this deduction (see p 27 of this JCT report.]

What do you think?

http://www.gao.gov/products/GAO-16-622

What about accountability? California solar energy property

Photo from EPA's Solar Energy website.

In June 2014, California enacted S 871 (Chapter 41, 6/20/14) . It "extends the sunset for a solar tax exemption for new active solar energy systems on new construction.  This bill extends the exemption through 2023-24, and extends the sunset through January 1, 2025." Under this rule, the construction or addition of an "active solar energy system" is excluded from being classified as "newly constructed." Thus, it will not increase the owner's property taxes. On August 8, 2014, the State Board of Equalization issued a letter to county assessors about the extension and the modified text of R&T Section 73. Guidelines from BOE on the exclusion can be found here (Nov. 2012).

The exemption is allowed per Section 2(c) of Article XIIIA of the California Constitution which allows the legislature to "provide that the term 'newly constructed' does not include an of the following: (1) The construction of addition of any active solar energy system." Apparently this special rule was added by the voters as Prop 7 in 1980 (per BOE memo of 9/23/13).

In 2013, California enacted three new tax incentives to encourage business activity in the state (California Competes income tax credit, New employment income tax credit, and a state sales tax exemption for certain R&D and manufacturing equipment). The first two, have significant accountability measures associated with them. For example, the California Competes credit is obtained through a competitive bidding process where the taxpayer must prove to a 5-member panel that they indeed will be increasing investment in California. The employment credit requires timely application to the Franchise Tax Board and an increase in the number of full-time employees compared to a base year. For both of these credits, the taxpayer's name and tax benefits are made public. These all have expiration dates as well. [See my chart below for a quick review of these provisions, as well as the links at the start of this paragraph.]

The property tax exclusion for active solar energy systems also had an accountability measure. That measure was the expiration date.  That is, when the exclusion approached its expiration date, it would be examined to see if it was achieving its stated purpose in a cost-efficient manner.

I can't find any data from BOE or the legislative analysis of S 871 on the data.  While common sense might tell us that the measure is appropriate because solar energy equipment should be encouraged to reduce reliance on other forms of energy, particularly those that use a lot of scarce water or generate greenhouse gas emissions, it would be good to see the data.

From the data, we ideally should be able to answer the following questions:

• What is the cost of the exclusion relative to the cost of the solar energy equipment?
  
• Has the exclusion caused an increase in installation of such equipment?
  
• How does California's use of solar energy equipment compare to states with no incentives and those with other incentives?
  
• Who is installing the solar energy equipment?  This data should be examined looking at industry, income levels, location, etc.?
  
• Might a different incentive be better at broadening the use of solar energy equipment?
  
• Why don't all property owners take advantage of this incentive?

Often, the necessary data to examine the effectiveness of a tax incentive is difficult to obtain. The enacting legislation should include a mandate that specific government agencies collect the data and funds should be allocated to be sure that happens. S. 871 does not include such a mandate and likely the earlier enacting bills also did not include the mandate.  Much of this data is likely fairly easy to obtain.

In February 2012, the legislature held a joint hearing on the subject of accountability of tax measures. I testified at that hearing and my testimony covered reasons for accountability measures and suggestions on how to implement them.

So, where is the data to support that the solar exclusion for property taxes is best meeting the goal, which I presume is to increase the use of solar energy in California?

What do you think?

Accountability and Tax Incentives

If a company planned to spend a chunk of money on a new advertising campaign, we'd expect that measurable goals would be set. Articulation of the goals would enable the company to determine if the campaign was successful. And we'd expect that data would be collected to enable the company to determine if the goals were met. If not met, the campaign would likely be canceled, or modified and retried.

We rarely see this approach used for tax incentives (special tax credits, deductions or exclusions). Sometimes even the goals are not specifically articulated.  California has done it both ways, usually without the goals specified or data required to be collected.  In 1993, the manufacturing investment credit (MIC) was enacted. The enacting legislation stated that the MIC would expire at some later point if there was not at least a 100,000 increase in manufacturing jobs. In contrast, in 2013, new incentives were enacted (such as the new employment credit) without specific goals set. While a lot of information on the use of these incentives will be made public, no specific goals were stated, so the information cannot be used to see if the incentives were successful.

I notice that a recent report from Maine on a review of its tax expenditures notes this problem - lack of data and useful measures.  Specifically:

"Lack of useful data. The Task Force did not have adequate data to evaluate most tax expenditures. While the biennial MRS tax expenditure report forms an excellent starting point for review of tax expenditures, it does not in many instances contain the kind of information necessary either to evaluate the effectiveness of a tax expenditure or to provide the kind of information necessary to determine the fiscal impact of the repeal or reduction of a particular tax expenditure. Estimates of fiscal impact in the report are frequently based on economic assumptions and modeling rather than specific experience. Identifying and gathering such information is an enormous task which awaits the development of a process for on-going evaluation." (Dec. 2013 report of the Tax Expenditures Review Task Force, page 10)

I believe the business approach for being strategic as to spending should also be used by governments (whether for new direct spending or spending through the tax system). That is, the goals for any incentives should be articulated and data needed to perform the measurements should be required to be collected.  What do you think?

Problems with state tax incentives

A report released in December 2012 by the Pew Center on the States (Avoiding Blank Checks - Creating Fiscally Sounds Tax Incentives) points out the risks many states take in enacting tax breaks with the hope of changing behavior to benefit the state. Such incentives include tax credits for hiring workers, income tax credits for filming in the state or energy incentives.

The report includes examples of incentives that grew tremendously, causing budget problems for the state. For example, a high wage jobs credit in New Mexico cost $9.8 million on year, but $48 million the next. Unless the credit led to a tremendously broader tax base, how is the state to afford the unchecked incentive?

States can place caps on the dollar amount available for the credit, encouraging taxpayers to change their behavior quickly to better ensure they will get benefit of the incentive before it is all used up.

Key recommendations Pew has for state lawmakers:

"Ensure that policy makers understand the budget implications of proposed incentives; and Manage the size of tax incentives by setting limits on their annual price tag."

Here are my suggestions for how states can better utilize tax incentives and control their costs:

The following questions can help improve the effectiveness of proposed tax incentives. To illustrate each question set, it is applied to a made-up proposal to provide a credit to students who prepare to teach STEM topics (science, technology, engineering and math).
 

1. Jurisdiction's Goals and Strategy: Have the jurisdiction's economic, societal and environmental goals been identified and articulated? To help determine if the purpose of a tax incentive is appropriate, it must be judged by how well it helps the jurisdiction meet its goals. Thus, such goals need to be articulated. In addition, answers should be provided as to why the tax incentive is the necessary and desired way to help achieve the goal and why alternative uses of the funds would not be better.

Example: What is the state goal that will be advanced by the tax credit? How will the credit help the state meet the goal – what is the connection between the program and the goal?

2. Tax System Relevance: (A) Does the tax system hinder the state's achievement of the goal such that modification (the addition of special rule) is needed to help the state meet its goals? OR (B) Would the tax system be an effective and appropriate vehicle for delivering the benefit? What are the pros and cons of using the tax system to provide the incentive compared to alternative means (such as a grant)?

Example: It is unlikely that there is any tax system feature that hinders students preparing for STEM topics. Thus the question is whether the tax system is an effective and appropriate vehicle for delivering the benefit. Arguably, it is not because the state tax agency would have to gather information on the student's courses and major. Also, unless refundable, the credit would only be obtained if the student had a tax liability. In addition, the credit would not be delivered when needed, that is, when tuition is due. A grant program could better deliver the benefit, assuming the benefit is needed to help the state meet its goals.

3. Tax Policy Considerations: Principles of tax policy, including equity, simplicity, neutrality and efficiency, minimum tax gap and transparency should be considered in the design of the tax expenditure.

Example: Measures would be needed to be sure the student is actually preparing to become a STEM teacher. Issues would need to be addressed as to whether the credit should be refundable and whether a student claimed as a dependent should be eligible.

4. Budget Considerations: What is the estimated direct and indirect costs of the special tax rule? How long should the tax rule be in effect? How will the cost be controlled (such as setting an aggregate limit for a tax credit)?  Will the method of paying for the special rule hinder the ability of the special rule to meet its purpose or cause a greater detriment to the jurisdiction than would occur in absence of the special rule? Could greater benefits be derived for the jurisdiction through other uses of the funds (even if for a different purpose)?

Example: Legislators need an answer to the question – Why is this credit a good use of state resources? Data would need to be analyzed to determine how much the credit should be to serve as an incentive and an aggregate cap determined and implemented. Consideration should also be given to how the credit affects existing grant programs for higher education to be sure there is no duplication.  In addition, consideration is needed as to whether more resources will need to be directed to STEM instruction to ensure that the expected increase in number of STEM students can be served. Alternative uses of the funds should be evaluated to construct the best program to help the state meet its goal of increasing the number of STEM teachers.

5. Accountability Measures: What accountability measures should be included to ensure that the special tax rule is properly used?

Example: Consideration should be given to including a clawback measure should a student not become a STEM teacher. A sunset date should be added to ensure that the credit will be evaluated for effectiveness.

6. Assessment: What data is needed to determine if the special tax rule achieves its purpose? How and when will the data be collected? Should the enacting legislation also specify data collection requirements? Who will monitor collection and who will analyze the data?

Example: The enacting legislation should specify the data that is needed for evaluation purposes and who will collect it and how. The enacting legislation should also specify a measurable and appropriate goal, such as a percentage increase in the number of STEM teachers who utilized the credit.

More - see my testimony delivered to a California legislative joint committee in February 2012. 

What do you think? Should states even enact these incentives or instead just lower their tax rates?

Government disclosuse of taxpayer data and the meaning of transparency and accountability

Despite the timing of this post, it is not about whether Governor Romney should disclose more than one year's tax return to the public. Instead it is about a California legislative proposal (AB 2439) for the government, namely the Franchise Tax Board (FTB), to disclose for the 1,500 largest corporations that file Form 10-K with the SEC, the "name and tax liability of each taxpayer and whether the taxpayer made an election to apportion its income in accordance with Section 25128.5" (25128.5 is the election to apportion income to California using the single sales factor method).

Privacy of a taxpayer's tax data is probably viewed by most people as immutable. Internal Revenue Code Section 6103 provides that "Returns and return information shall be confidential" and no employee or officer of the government is to disclose such information. Return preparers who improperly disclose or use taxpayer information can be subject to civil (IRC Section 6713) or criminal penalties (IRC Section 7216).

Tax data includes a variety of confidential financial and for individual returns, personal data. It tells the tax agency the information they need to know.  It is useful for gathering and reporting of data by the tax agency in the aggregate, but by itself, it is likely not very helpful to others and perhaps even confusing and misleading.

The purpose of AB 2439 is to help "provide transparency and accountability in the corporation tax system."   While transparency and accountability are important principles of good tax policy, they do not mean that any taxpayer's tax data should be disclosed by the government. Instead, these principles mean that taxpayers should be able to understand their tax liabilities and the rules. It also means that there are clear and appropriate reasons for the rules and design of the tax system. It would mean that if lawmakers add an incentive to a tax system, for example, that there was data showing a need for the incentive and it is narrowly and effectively designed to meet the need. Data should be collected to assess whether it is working as intended.

If the goal is to measure whether the single sales factor (SSF) apportionment incentive is effective, knowing whether the largest 1,500 companies elected to use it and how much tax they paid to California won't tell us anything helpful. The purpose of SSF apportionment is to encourage companies to locate payroll and property in California because doing so will not increase their California tax. Thus, SSF is an economic development incentive.

The accountability data that is needed is mostly available to the FTB. It includes:

• The number of companies that elect SSF each year. They can group this data by revenue size, taxable income size, SSF apportionment factor size, and industry type.
• The number of companies that do not stay on the SSF each year (that might indicate that the incentive is not long lasting).

Additional data that would be helpful to assess whether the SSF election leads companies to locate more payroll and property in the state would be to add these lines to the tax return:

• Number of employees (full-time equivalent) based in California and elsewhere.
• Amount of property acquisitions (real and personal) in California for the year and the data on dispositions of California property.

The FTB could use that data along with other economic development data available from other government agencies to help lawmakers determine if SSF is helping economic development in the state.

The accountability question should be asked while the legislation in under consideration so it can be included in the final bill. The data should be collected and reported without taxpayer names attached. There seems to be no accountability reason for disclosing to the public the names and tax data of particular taxpayers.

I have some additional suggestions for improving accountability and transparency of California's tax system here (from testimony delivered in February 2012).

What do you think?

SB 508 vetoed - the future of accountability measures

I've discussed accountability in prior posts (such as 10/8/11 and 5/22/11 and 1/3/10) and there has been recent legislative activity in California, such as SB 364 and SB 508 both reaching Governor Brown's desk this month for signature (see 2011 posts above for information on these bills). This weekend, Governor Brown vetoed both bills as being too broad.

See Governor's veto messages for:

SB 364 (10/8/11)
SB 508 (10/9/11)

In vetoing SB 508, Governor Brown says he agrees with sunset provisions for personal and corporate tax credits, he thinks all bills should be examined to determine how long they exist rather than using a one size fits all approach.

I wish he had said more to help the legislature pass an accountability bill that he will not veto.

I wish he had said:

1. Do not be so narrow to only focus on special tax rules that come in the form of tax credits, also consider special deductions, exclusions, exemptions and rates.

2. Establish a framework that must be considered in all bills that create special rule to ensure that an appropriately tailored accountability system exists for the provision. Such a framework would get around the one-size-fits-all problem, yet would ensure that bills creating or modifying a special tax rule would have an accountability measure included with it.

In June 2009, I had an article, "Calls for Accountability: Will It Help the Overall Incentives Process?" in RIA's Journal of Multistate Taxation and Incentives. Here is an excerpt with an analogy to how businesses employ accountability measures. For the same reasons that businesses employ accountability measures to ensure they are spending their money wisely, government should do the same. The excerpt also includes an example of problems that can arise when goals and accountability measures are not included in tax incentives legislation.

"The Necessity of Accountability

While accountability often conjures up thoughts of someone looking over our shoulder or seeking reasons to deny a benefit, accountability is an important aspect in any decision for directing funds to a particular use.

Executive compensation analogy: Accountability in the incentives arena is analogous to what a business might do in designing a compensation package for an executive. Business X might use a signing bonus to entice an executive to leave his or her current job and take a new one at X. Arguably this upfront payment is risky because the executive might not work out. Yet, it is deemed reasonable due to the significance of the change X asked of the executive and the risk the executive assumed. Other incentives are likely to be performance-based, such as stock options and bonuses tied to meeting specific goals.

The executive’s compensation package is likely to include annual performance reviews, repayment of incentives for misrepresentations, and some protections for not meeting targets if due to reasons beyond the executive’s control, such as a natural disaster or an economic downturn. In designing the compensation package, X’s advisers will consider the short- and long-term goals for X and the need for accountability to shareholders.

Problems from inadequate accountability: Perhaps as frequently as the newspapers report companies leaving or moving to a state due to a package of incentives, there are reports of governments wasting funds on incentives that appear to have provided no benefit to the jurisdiction.

Lack of accountability can jeopardize incentives because with no data on use and effectiveness, the incentives are vulnerable to repeal due to the ease of arguing that their cost exceeds the benefits produced. In addition, it is important that the purpose and goals of an incentive be adequately stated up front so that accountability can occur. Otherwise, an incentive might be called into question because its supporters tout how wonderful it has been while its questioners tout that it has not lived up to its promise. For example, in California, some businesses state that enterprise zone incentives have worked effectively to stimulate the economy.[1] In contrast, the California Legislative Analyst’s Office has recommended that the enterprise zone incentives be phased out because they have not been shown to be cost effective in generating new economic activity in the state.[2] This extreme dichotomy of views likely indicates lack of sufficient data and specificity of goals to allow for effective accountability rather than an ineffective incentive.

---

[1] For example, see California Chamber of Commerce, “California Enterprise Zone Program Positive, Effective State Policy,” 5/1/08; available at the organization’s website at www.calchamber.com/Headlines/Pages/CaliforniaEnterpriseZoneProgram.aspx.

[2] California Legislative Analyst’s Office, “The 2008-09 Budget: Perspectives and Issues,” page 116, available at the LAO website at www.lao.ca.gov/analysis_2008/2008_pandi/pandi_08.pdf.

What do you think?

California Accountability Measures - SB 508 and SB 364

Several states, including California, have proposed actions and taken actions on adding accountability to the tax system. The measures usually apply to tax credits. A common approach is to place a sunset date on enacted credits to ensure that they don't remain in the law permanently and that they get back on lawmakers' radar screens, such as when the sunset date approaches. Another approach would be to include some assessment measures so that the tax agency or other government agency can measure periodically if the tax incentive is accomplishing the goals for why it was enacted. A good example of California doing this in the past was with the Manufacturers' Investment Credit (MIC). If California did not have an increase of over 100,000 jobs in certain sectors, the MIC would go away. It lasted for sometime, but then the jobs number went down and the MIC disappeared.

I blogged on a proposal in California - SB 508 in May (here). It is focused on accountability for future enacted income tax credits. That is good, but I point out that tax incentives don't only come in the form of credits and they exist in all types of taxes (not just the income tax). Thus, the bill is too narrow.

SB 508 passed in the legislature (enrolled bill / for analyses, search for SB 508 here). It is on the governor's desk awaiting signature or veto.

SB 364 also passed the legislature (enrolled bill / for analyses, search for SB 364 here). This is an odd bill. It would impose a penalty for future credits enacted, where the claimant had a decrease in employment. Governor Brown vetoed this one on 10/7/11 saying that the approach is too broad and penalties should be tailored to a credit's unique provisions. I agree. I think SB 364 would also have made the law more complicated in measuring employment and identifying which future credits would be subject to this penalty.

There is an informative California Watch article on these bills - Kendall Taggart, "Bills seek to better regulate tax breaks," 10/6/11. (Disclaimer: I'm not just saying this because I'm quoted in the article.)

Let's see what Governor Brown does with SB 508. I think if he signs it, that would be good. I would then hope that this is a trial for how to add accountability measures to income tax credits that might then be expanded to other special rules added to income, sales, property, excise or other taxes. This approach, particularly one of requiring lawmakers to state the goal for a special rule and how its effectiveness in reaching that goal will be measured, might also end up in fewer incentive provisions which would also prevent tax laws from becoming more complicated, inequitable and inefficient.

What do you think?

Rhode Island, Vermont, accountability and unified economic development reports

Rhode island enacted SB 5894 (Chapter 151) on June 30, 2011. This appropriations legislation adds some additional accountability measures for a few of its credits and other incentives, as well as modifies its unified economic development reports. The additional data to be collected by the state for some incentives are details of employees hired. Specifically:

"On or before September 1, 2011, and every September 1 thereafter, the project lessee shall file an annual report with the tax administrator. Said report shall contain each full-time equivalent, part-time or seasonal employee’s name, social security number, date of hire, and hourly wage as of the immediately preceding July 1 and such other information deemed necessary by the tax administrator. The report shall be filed on a form and in a manner prescribed by the tax administrator."

Here is the rewritten provision calling for the unified economic development report:

"42-142-6. Annual unified economic development report. – (a) The director of the department of revenue shall, no later than January 15th of each state fiscal year, compile and publish, in printed and electronic form, including on the Internet, an annual unified economic development report which shall provide the following comprehensive information regarding the tax credits or other tax benefits conferred pursuant to sections 42-64-10, 44-63-3, 42-64.5-5, 42-64.3-1, and 44-31.2-6.1 during the preceding fiscal year:
(1) The name of each recipient of any such tax credit or other tax benefit; the dollar amount of each such tax credit or other tax benefit; and summaries of the number of full-time and part time jobs created or retained, an overview of benefits offered, and the degree to which job creation and retention, wage and benefit goals and requirements of recipient and related corporations, if any, have been met. The report shall include aggregate dollar amounts of each category of tax credit or other tax benefit; to the extent possible, the amounts of tax credits and other tax benefits by geographical area; the number of recipients within each category of tax credit or retained; overview of benefits offered; and the degree to which job creation and retention, wage and benefit rate goals and requirements have been met within each category of tax credit or other tax benefit;
(2) The cost to the state and the approving agency for each tax credit or other tax benefits conferred pursuant to sections 42-64-10, 44-63-3, 42-64.5-5, 42-64.3-1, and 44-31.2-6.1 during the preceding fiscal year;
(3) To the extent possible, the amounts of tax credits and other tax benefits by geographical area; and
(4) The extent to which any employees of and recipients of any such tax credits or other tax benefits has received RIte Care or RIte Share benefits or assistance.
(b) After the initial report, the division of taxation will perform reviews of each recipient of this tax credit or other tax benefits to ensure the accuracy of the employee data submitted. The
division of taxation will include a summary of the reviews performed along with any adjustments, modifications and/or allowable recapture of tax credit amounts and data included on prior year reports."

This level of detail is unusual among states. A unified economic development report is to provide information to help lawmakers and others understand how tax incentives are being used. I think more is needed. The above description just sounds like a collection of data. Although it is more than would otherwise exist, without some analysis, it won't have much meaning.

The tax credits should have a stated purpose and some appropriate assessment measure. For example, if it is a jobs credit, collect data on number of net jobs added by those claiming the credit, state employment changes, as well as comparisons to prior years and to other states. Did the state have higher employment increases than states not offering a jobs credit?

Vermont has been preparing unified economic development budget reports for a few years (here). Vermont's March 2011 report notes:

"It is important to have clear, attainable and measurable goals (outcomes) in order to have meaningful measures of success (performance) for relevant programs and activities. The Administration and the Legislature must work toward establishing clear sets of measureable goals for all new programs including those related to economic development. A review of the current programs and their stated goals shows that a majority of programs still have only broad goals which are often difficult to measure."

The authors note that this is a difficult task as often the outcomes are worded too broadly. To help remedy this problem, the state offered 2-day workshops on the "basics of outcomes, measures and methodology."

It's not easy. If the lawmakers say the credit is to encourage use of renewable energy, how can that be measured? How can it be determined if the credit caused created use of renewable energy beyond what would have happened without the credit?

Typically, either very broad, nonspecific goals are stated or perhaps none are stated. No company would do this. They would not try a new marketing strategy without stating the goals and how to measure if it meets their goals. The same should apply for government spending which often comes in the form of tax incentives.

What do you think?

Twitter and San Francisco proposed tax break

An item on the February 8, 2011 San Francisco Board of Supervisors agenda was the following:

"110155 [Business and Tax Regulations Code - Payroll Expense Tax Exclusion in Central
Market Street and Tenderloin Area]
Sponsors: Mayor; Kim, Chiu and Farrell
Ordinance amending Article 12-A of the Business and Tax Regulations Code by adding Section
906.3 to establish a payroll expense tax exclusion for businesses located in the Central Market
Street and Tenderloin Area. ASSIGNED UNDER 30 DAY RULE to Budget and Finance
Committee."

As reported in the press,* this amendment is to provide a 6 year payroll expense tax holiday for companies hiring new employees in the area noted above, most notably, for Twitter which is considering moving out of San Francisco.

* For example, see San Francisco Chronicle, 2/10/11 - "Tax break to Twitter makes sense."

Additional Information:

• Per the Twitter website - they have job openings - quite few are listed!
• The SF Payroll Tax Expense is described by the city as follows: "all businesses with a taxable San Francisco payroll expense of greater than $150,000 must file a Payroll Expense Tax Statement for their business annually by the last day of February for the prior calendar year (Jan. 1st - Dec. 31st). The Payroll Expense tax rate is 1.5% or .015. You calculate the Payroll Expense Tax by multiplying the business' annual San Francisco payroll expense by 1.5% or .015, the Payroll Expense Tax rate." So, this tax is on medium and large-size businesses.

Tax Policy Analysis:

• Equity: The proposal is not just aimed at Twitter but at any company that adds employees in the designated area. This makes the tax cut more equitable.
• Neutrality: The proposal violates the principle of neutrality in that it will encourage companies to locate new employment in the designated area rather than in other parts of the city.
• Accountability: Stories in the papers noted that Twitter's employee base would be growing from 200 to 2,000 over the next few years. But what if it doesn't grow that much? Of course if it doesn't grow that much, it would never owe payroll tax on a higher payroll expense amount because there wouldn't be higher payroll. But while it will likely grow past 200 employees, what if it doesn't meet some particular goal? The city would have lost the payroll tax on the greater number of employees without the benefit of having offered the tax break in the first place. For accountability, a goal and clawback provision should be included. For example, if an employer's employment doesn't grow by X% by a certain date, it must pay back some percentage of the tax savings it obtained.
• Appropriate government revenues: Does the city not need more tax revenues? It is likely considering the fact that without Twitter, it will have nothing, so keeping it and collecting payroll tax on 200 employees is better than nothing. But will the city be able to deliver services to a larger company without additional revenues? Will other tax increases or spending cuts be needed?

Tax incentives tied to competitive pressures facing jurisdictions can be difficult. Whatever city Twitter is planning to move to (I saw two different cities noted in newspaper articles), could offer some better tax break. This is what economists call the "race to the bottom" with the companies being the winners and the jurisdictions and other taxpayers often the losers.

What do you think?

Tax System Equity and Tax Expenditures .. and Stanley Surrey Explanation

On October 11, 2010, the Washington Post ran an editorial entitled "The Current U.S. Tax System Is Tilted Toward the Haves." It addresses the issue of the growing number and amount of "tax expenditures" in our federal tax system and the inequities often inherent in them.

"Tax expenditures" refers to deductions, exclusions and tax credits that result in lowered tax bills for those using them. Generally, the term focuses on special rules that are designed for some purpose other than measuring income. Typically, the special rules are designed to encourage some type of behavior, such as charitable giving. For more on this - see the statement at the end of this blog post from Stanley Surrey who invented the phrase while serving as Assistant Secretary for Tax Policy at Treasury in 1967.

The editorial raises the question as to why about 50% of the $400 billion cost of the breaks benefit the "wealthiest 5 percent of Americans?" They note two problems with "tax expenditures" -

1. The lack of transparency and accountability.
2. Equity issues because "accomplishing social policy through tax expenditures tends to award the most help to those who need it least."

The editorial refers to a recently issued report by the Corporation for Enterprise Development and the Annie E. Casey Foundation entitled Upside Down. I encourage you to read the report and I applaud these entities and the Washington Post for highlighting this issue because more people need to understand that not only do these numerous special rules complicate the tax law, but they make the system inequitable.

We'd be better off with an income tax with a broader base and lower rate. Hopefully reports and articles like this will help spread the word to more people. (I had an op ed in the SF Chronicle on this topic in April 2008.)

And, here is a history lesson on "tax expenditures" - an excerpt from Pathways to Tax Reform by Stanley S. Surrey, 1973, page 6:

"The federal income tax system consists really of two parts: one part comprises the structural provisions necessary to implement the income tax on individual and corporate net income; the second part comprises a system of tax expenditure under which Governmental financial assistance programs are carried out through special tax provisions rather than through direct Government expenditures. This second system is grafted on to the structure of the income tax proper; it has no basic relation to that structure and is not necessary to its operation. Instead, the system of tax expenditures provides a vast subsidy apparatus and uses the mechanics of the income tax as the method of paying the subsidies. The special provisions under which this subsidy apparatus functions take a variety of forms, covering exclusions from income, exemptions, deductions, credits against tax, preferential rates of tax, and deferrals of tax."

Accountability - Growing Attention, More Needed

An Associated Press story of January 2 (Babwin, "Cities, counties take back corporate tax breaks") notes how some cities are making use of "clawbacks" to reclaim tax breaks that did not yield the expected benefits for the jurisdiction.

I think this is part of what will be a growing trend amongst lawmakers and the public to ask questions about both direct spending and indirect spending that exists in the tax law (such as via special deductions, credits and exemptions).

There is another current article (1/3/10) in The Lexington-Herald Leader in Kentucky - "Tax breaks are budget loophole" by Blackford and Cheves. This story raises the question why consumers pay sales tax on DVDs but none is paid on the purchase of horses and coal. Per the article: The "state's General Fund is expected to collect about $3 billion in sales taxes during fiscal year 2010, compared to about $2.4 billion the state will forgo in sales tax breaks for horses, coal and dozens of other items."

The Kentucky article notes that a study on tax exemptions was authorized by the legislature in 2005, but never completed. It also notes that in 2008 the legislature failed to pass a bill that would have imposed sunset dates on exemptions and required public discussion on the provisions. The article notes that the dollar amount of exemptions is growing: "The money lost to tax breaks is rising about 7 percent a year as the General Assembly -- often at lobbyists' urging -- creates new loopholes in the tax laws without closing old ones."

Some states are considering or taking actions. I noted some actions in Oregon, Missouri and Florida in a 11/27/09 post. Oregon imposed sunset dates on many of its tax breaks which will require some discussion as to whether or not they should be renewed. Unfortunately, the legislators might not have the data they need to make such determinations because there was no specific call to either identify the objectives of particular breaks or call for collection of data needed to evaluate them.

Tax expenditures - deductions, credits and exemptions in a tax system that are not there for fundamental design reasons, but to provide some special benefit, are mostly hidden from lawmakers and the public. If there is no sunset date, they can remain in the tax law forever unlike line item spending that is likely to get reviewed each year. Also, these expenditures are rarely capped. Thus, unlike a budget line item, the tax expenditure can easily grow each year without offsetting revenues to cover the spending.

Ideally, special tax breaks should not be used. A tax with a broad base and lower rate best meets the principles of good tax policy. If a jurisdiction believes its economic, social and environmental health warrants some type of encouragement to some activity, it can be handled via a direct grant of funds. That allows for specific criteria for the award to be created, a dollar limit set and the public to have access to who received the funds. The tax law won't have to suffer the burden of the added complexity of special rules or their typical inequity (that is, a tax break to some is paid for by higher taxes for others).

It is great to see the news stories because that may cause the public to not only ask their elected representatives about spending in agency budgets, but also the spending that exists in the tax law. There are many puzzling tax expenditures in most tax systems and with rising budget shortfalls, it is past time to look at where that unnecessary spending can also be cut.

For more:

• Nellen, CA Sales Tax Base is Too Narrow
• Nellen, CA Personal Income Tax - Too Many Unneeded Breaks
• Nellen, Op ed in SF Chronicle - 'Spending problem?' - some of it's hidden in our tax laws" (2/08)
• Nellen, "Calls for Accountability: Will It Help the Overall Incentives Process?," Journal of Multistate Taxation and Incentives (6/09) (available through RIA)
• Congressional Research Service, Tax Expenditures: Compendium of Background Material on Individual Provisions (12/08)
• Joint Committee on Taxation, Tax Expenditure reports
• Urban Institute, How Big Are Total Individual Income Tax Expenditures and Who Benefits from Them? (12/08)

What do you think? Should tax expenditures be addressed in some way? How? Which ones? How can accountability be built into the tax and law-making systems?

Temporary or Permanent - Which Is Better?

The Joint Committee on Taxation notes that 73 provisions in the federal tax law expire at 12/31/09 (JCX-20-09). These include:

• Personal tax credits allowable against AMT
• Increased personal exemption amount for AMT
• Additional standard deduction for state and local real property taxes
• Above-the-line deduction for qualified tuition and related expenses (§222)
• Exclusion of unemployment compensation benefits from gross income
• Refundable credit for government retirees
• Increased §179 expensing to $250,000/$800,000
• New markets tax credit
• R&D credit
• Add’l 50% first year depreciation
• Credit for construction of new energy efficient homes (§45L)
• FUTA surtax of 0.2 percent
• 65% subsidy for payment of COBRA health care coverage continuation premiums

While there have been numerous bills introduced that extend just one expiring provision, such as the research tax credit or the special deduction for teacher supplies, we only just yesterday, saw a bill that extends many of the provisions and is promoted as revenue neutral. That bill, H.R. 4213, introduced by House Ways & Means Chairman Rangel, is projected to cost about $30 billion but has offsets. The bill is 110 pages long! The offsets:

• Foreign Account Tax Compliance Act of 2009 (H.R. 3933 & S.1934)
• Tax carried interest as ordinary income

The bill also calls for the Joint Committee on Taxation to submit report on each extended provision by 11/30/10.

The bill does NOT include a "patch" for the individual AMT for 2010. If such a patch is not enacted, millions of individuals for whom the AMT was not intended, will owe it in 2010. It is likely that the patch will be enacted, but perhaps was omitted from H.R. 4213 due to the cost and the desire to get something passed by year end. Unfortunately, the longer it takes to enact the "patch" the more complicated taxes become for millions of individuals because they won't know what their estimated 2010 taxes will be.

Most of the extended provisions in H.R. 4213 are extended for just a year. Several have been extended many times before. So, this all begs the question - is it best to keep special rules in a temporary form so they DO get reviewed by Congress regularly or is it best to not waste the effort and problems of delayed extension and just make these provisions permanent?

The answer depends.

• Some of these temporary items were for stimulus and should not be extended unless it is clear they worked and stimulus is still needed.
• Any provision that has been extended more than 5 times should be seriously looked at to see if it should become a permanent provision. The research tax credit is a good example. Yet, since it is an incentive provision rather than a provision that defines "taxable income" it should still be reviewed regularly. But, moving it beyond repeated one-year lifes would enable the credit to be better utilized because businesses could better factor it into future R&D plans.
• Accountability measures should be created for new tax breaks and they should all likely start off as temporary. When a deduction or credit is permanently enacted, it becomes "off budget" in that Congress has no obligation to review it ever (unlike line item budget items). When new provisions are enacted as temporary measures, they need attention when the expiration date comes up. THE PROBLEM with our current federal system is that there is no accountability measure designed with new provisions that would ensure that Congress has DATA it can use to determine if the provision should be extended, modified or left to expire. States have similar problems, but some do enact accountability measures to ensure that they have DATA before it is time to consider renewal of the provision.

Here is an example of an accountability measure. The State of Washington’s reduced B&O tax rate incentive available to certain manufacturers of solar energy systems sunsets on 6/30/14. The enacting legislation included a requirement that by 12/1/13, the Department of Revenue provide the legislature with a report that notes the number of solar energy system manufacturers in Washington, the change in number, and the effect on job creation from the reduced tax rate. [Washington, SB 5111, Chapter 301, Laws of 2005 (7/1/05)]

So, Congress should include some type of data reporting mechanism for incentive provisions and they should be enacted on a temporary basis. Renewal should then depend on whether the incentive is having the intended effect. This would ensure that provisions are not extended just for expediency.

Provisions that are design features, such as the AMT patch (an inflation adjustment should have been part of the original provision), should be permanently enacted.

For more information on H.R. 4213:

• Ways & Means summary
• Text of the bill
• Joint Committee on Taxation revenue estimates (JCX-59-09)

What do you think?