When states “target” tax breaks, the little guy gets caught in the crossfire. That’s the conclusion of a terrific new study on why special tax favors to special friends of the government hurt state economies and corrode good government. The paper, by the free-market think-tank Mercatus Institute, is the best distillation of the case against luring businesses with special tax favors.
The study describes how big companies skillfully play state politicians for subsidies. It shows how Wal-Mart has received at least 260 special tax breaks worth over $1 billion. It describes the $370 million in North Carolina subsidies to Apple to create a whopping 50 jobs — $7.4 million each. These come at the expense of small companies who pay full-ride on their tax bill as they lack the lobbyists and clout to play the system.
It discusses how the only way states can make a case for their special breaks is to ignore opportunity costs. States assume that money spent to lure a well-connected company would otherwise be buried or something, generating no economic activity. As the study says, “Labor and capital are scarce resources and they are rarely left idle.” It’s a point Tax Update readers may be familiar with.
The study notes how the subsidies hurt the companies who don’t get the benefits, even if they are not direct competitors of the corporate welfare recipients: “When new companies receive extra money to invest, they raise the price of capital and drive up wages, which imposes an additional cost on unsubsidized companies in the state.” This refutes the fallacy that “Smith’s tax credit doesn’t cost Jones a cent.”
They also point out how targeted tax breaks create a crony culture in statehouses. The study cites the example of Texas (citations omitted, emphasis added):
As companies direct more of their resources to securing special benefits, they need more people who can lobby or who have other rent-seeking skills. There is already a whole industry of “location consultants,” some of whom demand a commission of up to 30 percent on the subsidies that they can negotiate with local governments. Consultant G. Brint Ryan in Texas is a good representative of this industry. Texas allocates corporate benefits exceeding $19 billion per year, more than any other state. Ryan realized the profit opportunity in serving as a consultant to companies seeking to obtain these benefits. He has since secured benefits for ExxonMobil, Samsung, and Wal-Mart, among others. Ryan also illustrates the importance of having political networks for securing targeted benefits. In 2012, the Texas legislature set up a commission to evaluate the impact of state investments in development projects. Ryan, who donated more than $150,000 to the campaign of the state’s lieutenant governor, was appointed to the commission by the lieutenant governor.
The same dynamic is playing out in Iowa, as the economic development bureaucracy has spawned a cottage industry of attorneys and consultants to tap into taxpayer funds.
What should states do? The report says:
Four policy implications for state governments follow from our analysis:
– Allow for current targeted benefits to expire, and abolish state programs that grant them on a regular basis.
– Make sure that targeted benefits cannot be granted by individual policymakers on an ad hoc or informal basis
– Broadly lower tax rates to encourage company investments and obtain a more efficient allocation of resources.
– Cooperate with other states to form an agreement about dismantling targeted benefits.
Sounds a lot like The Tax Update’s Quick and Dirty Iowa Tax Reform Plan.
Joe Carter, How Enterprise Zones Lead to Cronyism
Jason Dinesen has Yet Another Post About Regulation of Tax Preparers. “Preparer regulation is a bad idea. ”
Kay Bell, Tax moves to make in June 2014
Robert D. Flach has your fresh Tuesday Buzz!
Andrew Lundeen, The Common Misconception about the Lower Rate on Capital Gains and Dividends (Tax Policy Blog):
What is not easily seen is that the $100 that Mr. Buffett earns in dividends has already been taxed at the corporate level. In fact, Mr. Buffett’s $100 didn’t start at $100, it started as $153.85.
To receive his $100 dividend payment, Mr. Buffett must own shares in a corporation, which we will call Company A. Company A earned $153.85 in profits on Mr. Buffett’s behalf. This $153.85 is then subject to the federal corporate tax of 35 percent, or $53.85.
The corporation pays the $53.85 to the federal government on behalf of Mr. Buffett and then passes the remaining $100 to him in the form of a dividend. This is the $100 we discussed earlier, on which, Mr. Buffett pays $23.80 in dividend taxes.
Warren Buffett knows this. But raising individual rates helps keep down those small guys whose businesses report their taxes on the owner 1040s — and, incidentally, makes it easier for Warren’s insurance business to sell tax-advantaged products.
Jeremy Scott, Camp Waves the White Flag (Tax Analysts Blog). “Camp tried to reform the tax system — and failed.”
Martin Sullivan, Corporate Expatriations: More Deals Are Likely (Tax Analysts Blog). ” It is unlikely that any known or yet-to-be-made-public deals will be slowed by Democrats’ efforts.”
TaxProf, The IRS Scandal, Day 390
TaxGrrrl, John Daly Relied On Tax Records To Figure $90 Million Gambling Losses. “Despite tens of millions of dollars in gambling losses, Daly doesn’t seem to regret his behavior, saying, ‘I had a lot of fun doing it.'”