Study: State Tax ‘Carve-Outs’ Much Bigger Than Reported

Published July 30, 2014

Cronyism or competition.

At their essence, these are the choices policymakers face with tax policy, say the authors of The Costs of Cronyism: Favoritism and Foregone Growth, published by the American Legislative Exchange Council.

Policymakers can design a tax system that treats businesses equally and fairly, with clear rules and a level playing field, or they can design a system with convoluted rules and uneven playing field. 

Convoluted rules and tilted playing fields are the norm in states across the country. Furthermore, coauthor Will Freeland says, there is a troubling lack of transparency regarding “tax carve-outs” and, in many states, no serious attempt to evaluate their results. 

‘Probably Substantially Bigger’ 

He and coauthors Ben Wilterdink and Jonathan Williams of ALEC estimate $228 billion in tax breaks from personal income, gross receipts, and other business taxes, and $260 billion from sales tax breaks in the most recent years reported by states.

But the actual carve-outs are “probably substantially bigger than reported,” Freeland said in a conference call.

“Lack of transparency is a huge issue. There needs to be much better reporting,” he added. 

He noted, for instance, 22 states don’t report exemptions from their sales taxes. Alabama, Alaska, Nevada, South Dakota, and Wyoming report nothing on the value of their tax carve-outs. Other states report “infrequent or incomplete” data, he said. 

For example, California publishes information only on large carve-outs of $5 million or more.

The authors are careful to declare not all carve-outs represent cronyism. Those that move a state toward a broad tax base with low tax rates and are applied without favoritism, such as capital expensing and exemptions for business-to-business transactions, are justified.

‘Central Planning Through Carve-Outs’ 

Williams said tax policymakers should strive for “economic neutrality” to raise revenues for the core functions of government, not tax policies that “pick winners and losers or pass the tax burden from some segments of society to others.”

The latter is happening too often, he said. Many states, for instance, offer film tax credits, which prop up an industry that makes little or no commitment to remain in a state even as other businesses and individuals shoulder higher tax burdens.

New York is advertising its START-UP NY program, in which qualifying businesses can operate 100 percent tax-free for 10 years. Williams described the program as “central planning through high tax rates and targeted carve-outs.”

More egregious still is Illinois, which has granted hundreds of millions of dollars of tax breaks to specific businesses already located in the state, including Sears Holdings Corp., CME Group, Continental Tire, and Motorola Mobility.

Weaning Off of the Teat

Wilterdink said carve-outs for specific businesses “are skewed very much toward large firms, particularly in Illinois, where the legislature was called into special session” to approve tax breaks for Sears Holdings and CME Group.

He said he does not blame businesses for “taking advantage of things that are offered. The problem is when states have uncompetitive tax systems overall like Oregon, Illinois, Maryland and New York. They struggle to keep businesses, and feel they have no choice but to offer these generous tax carve-outs.” He said they need to “move away from emergency, ad hoc tax carve-outs and have low taxes for everyone.”

Williams noted inconsistencies in such policies, saying, “even while these liberal states say taxes don’t matter for growth, they tacitly do say this” by handing out targeted tax breaks. They’d do far better to simplify their tax systems and keep tax rates low for everyone, he said.

In their report, the authors write, “Cronyism in tax policy . . . stifles competitive tax policy by precipitating tax rate increases on the firms not in favor with policymakers, subverts market outcomes for inferior economic planning, and introduces a deep temptation for public corruption.”

Internet Info

“The Unseen Costs of Tax Cronyism: Favoritism and Foregone Growth,” American Legislative Exchange Council: