Tax

In Defense of State Tax Incentives

From tax breaks to direct cash subsidies, state economic-development programs can help companies defray the cost of growth.
Scott M. SuskoJanuary 7, 2013

If your company intends to add jobs, state economic-development incentives, which can run the gamut from a straightforward tax break to more complicated programs that provide direct cash subsidies, may present a unique opportunity to offset the cost of expansion.

To be sure, the recent changes to state incentives programs across the country create a dizzying array of both opportunities and traps for businesses thinking of expanding and seeking incentives.  A threshold question for many CFOs who are thinking of pursuing incentives for their company is “Are incentives worth it?”  The simple answer is “It depends.” 

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While regulation of incentives programs is on the rise across the country, these programs continue to be powerful and well-funded tools.  Companies can only effectively evaluate the pursuit of incentives by appreciating the differences in these programs from state to state, which includes the nature of available incentives as tax credits or cash subsidies, whether incentives are tied to capital investment or job growth or both, the timing and complexity of the application process, and the political environment in each jurisdiction where incentives may be pursued.  But at a minimum, it seems that the decision to pursue incentives should not be driven by incomplete reports in the media that tell only one side of the story.

Indeed, if you pursue incentives, you should be aware of the intense criticism recently levied by the mainstream media at incentives and the companies that pursue them as seen in As Companies Seek Tax Deals, Governments Pay High Price,” in The New York Times. The criticism of state economic-development incentives, though, fails to identify recent trends in these programs and, as a result, paints an incomplete picture of this important policy issue. 

The 2012 Presidential race centered on the economy, including whether federal or state programs were more effective in creating jobs.  Now that the election has passed, the media has shifted from applauding innovative methods for job creation to criticizing state economic-development policy, particularly the use of “incentives” by state governments to induce job creation and capital investment in the private sector. 

Whether CFOs agree or disagree with the policy behind state economic-development incentives, there’s no denying the significant effort made by state officials across the country to regulate the granting of incentives in order to make the process more transparent and competitive. This monitoring also provides state governments a means to reduce the risk of awarding incentives to companies that fail to deliver on promises of job creation and capital investment.  In redesigning these programs, states are seeking to balance the quest for good jobs with the need to conserve precious revenue, all the while avoiding the appearance of picking favorites. 

The landscape for incentives has radically changed. Take New York, for example. In 2006, the State of New York awarded more than $1.4 billion in incentives to a single computer-chip manufacturer that was relocating a factory to upstate New York. This incentives package included $735 million in tax breaks and $665 million in cash; it still stands as the single-greatest cash award to a private company in the history of the United States. This $1.4 billion award was not a result of a statutory incentives program, nor is there much of a record of how state leaders developed this incentives package. The size of the award may have been a result of the fact that New York State felt it was in competition with locations outside of the United States.

Fast-forward to New York in 2011, where Gov. Andrew Cuomo established a clear framework for the awarding of incentives. New York State has consolidated its process and made it more transparent by creating 10 “Regional Councils” made up of public and private individuals who vet requests for incentives by geographic region. Now, rather than $1.4 billion being available to a single company, there was a total of $750 million available in 2012 for the entire Open for Business program. The majority of funds, approximately $500 million, came from various state-agency budgets that regulate labor, the environment, housing, and community development. The remaining funds were directly available to businesses (rather than through the aforementioned state agencies) and came in the form of cash grants up to $175 million or tax breaks up to $75 million.

New York is not alone. Massachusetts dramatically changed its Economic Development Incentive Program (EDIP) in 2010. EDIP provides income-tax credits to companies that are creating new jobs and making significant capital expenditures. The 2010 law changes to EDIP were significant in three ways. First, a $25 million annual cap was established for the amount of available tax credits under the program. Second, a “clawback” mechanism was created that allowed Massachusetts to recoup EDIP tax credits from companies that failed to meet job or capital expenditure commitments. Third, EDIP tax credits were no longer awarded pursuant to a rigid formula that was wholly dependent on negotiations with municipalities. Instead, the power to award incentives was consolidated at the state level and Massachusetts’s economic-development officials were given flexibility to award increased tax credits along a statutorily defined scale so that the Commonwealth could focus its efforts on specific industries or geographies.

Those changes made the process more competitive and gave the Commonwealth more checks and balances on the process than previously existed. Moreover, if a company fails to live up to its end of the bargain with state officials, then Massachusetts has a means to recoup the value of the EDIP tax credits that were utilized.

Similarly, in 2012 the State of Georgia used a substantial portion of its share of proceeds from the National Mortgage Settlement with major financial institutions to provide approximately $70 million of funding to its economic-development programs. One of Georgia’s economic-development tools is its Jobs Tax Credit (JTC) program. This program is very forward-thinking in that it is not limited to capital-intensive businesses (i.e., manufacturers) and is only awarded after jobs are actually created. What this means is that incentives may now be open to industries other than manufacturing and the risk of awarding incentives to businesses that do not live up to job-creation commitments is diminished. A single job under the JTC program can create $20,000 of tax credits for the business creating the employment opportunity.

It is unclear how the negative press about incentives may further alter these programs going forward. At a minimum, states will continue to monitor these programs and test their return on investment. Such is the case in Connecticut, where the governor’s office recently commissioned a taskforce on tax policy that concluded state tax credits should be realigned with the state’s long-term economic-development strategy. Moreover, there is a growing concern that seeking incentives on behalf of a company may require registration as a lobbyist. This issue was recently resolved in Massachusetts with regard to EDIP in favor of not having to report activities related to seeking tax credits from the Commonwealth. However, the Public Integrity Reform Act of 2011 in New York has created a new disclosure program called Project Sunshine that may affect the reporting of activities tied to soliciting incentives.

Scott M. Susko, a partner in the law firm of McDermott Will & Emery LLP, focuses his practice on all aspects of state and local tax matters.