Are Business Tax Incentives Good Tax Policy?

While Kansas has made strides to become more transparent about its business subsidies, including the passage of a 2019 transparency law about subsidy recipients, Kansas lawmakers still have more to do to ensure tax incentives programs are working to benefit the state and its local communities.

Tax incentives are often ineffective, primarily going to bigger companies at the expense of alternatives that could help local and small businesses thrive. Only with greater transparency and accountability can lawmakers determine which tax incentives programs are working and which programs are ineffective silent spenders of taxpayer dollars.

Tax incentives are created by policymakers to encourage certain behaviors among individuals and businesses. For instance, business tax incentives are often used as economic development tools, with the assumption that providing these tax breaks to businesses will entice the company to move to the locality, increase its capital investment, and/or create new jobs. The hope is that supporting these businesses will generate additional tax revenue in the process. Unfortunately, the presumed benefits of these tax subsidies do not always come to fruition.

Kansas is not the only state to rely on business tax subsidies, but these subsidies have increased in recent decades, although the growth has tapered since 2000. There are different types of business tax subsidies, but job creation tax credits and property tax abatements account for more than 70 percent of the tax subsidies handed out in the states. These incentives cost governments $70 billion per year.

In fiscal year 2022, Kansas received $806 million in corporate income tax, while passing a bill (SB 347) that originally allocated $1.3 billion in tax incentives over the next several years, although the final estimated amount was approximately $800 million.

Kansas Action for Children believes the answers to practical questions about taxes — like how high or low should they be, who should pay and how much, and what should be taxed — flow from strong and longstanding principles about tax and equity. These are broadly recognized as the foundation of a system that works. Tax incentives often violate the principles describing good tax policies.

1. ADEQUACY

A tax system needs to pay for the services necessary to promote economic growth and education, support basic needs, and provide for many other important functions that contribute to a thriving community. Both short- and long-term adequacy are critical.

Kansas taxpayers contribute to the services from which they benefit, while business tax subsidies let corporations off the hook from contributing to the services that improve communities. When Nevada handed out a billion-dollar break to Tesla in 2014, the local school district and county government saw a loss of revenue in the following years (between 2017 and 2021), with the school district losing $90 million that went to Tesla’s tax abatements, while the county government lost $77 million. Meanwhile, Tesla received media attention for a $37.5 million donation, a small portion of their tax abatements and the budget hole it caused.

Lawmakers must ensure the benefits of tax subsidies actually flow to the communities in which the businesses operate. Even if the business receiving the tax subsidy creates tax revenue, lawmakers must weigh that revenue with the potential increase in public spending (especially if the tax incentive is predicted to create population growth). Research shows the additional spending costs due to incentive-related population growth can eat up 90 percent of the tax revenue created by the incentive. The “cost” should not just include the amount of tax incentives, but also secondary costs, like public spending cuts. A cut to public spending, like cuts to public education, can place costs on the community in the long-term. It is estimated cutting K-12 education spending by 10 percent will decrease students’ future wages by 8 percent, costing the community in future economic growth.

2. FAIRNESS

Tax incentives are complex. Due to their complexity, they are more likely to unfairly reward wealthy Kansas businesses that have tax preparers and other resources to help them reduce the amount of taxes they may owe. It also leads to prioritizing businesses that seek to make large investments or create large numbers of jobs. They create an environment where the wealthiest can further reduce their taxes, while lower-sales Kansas businesses’ tax rates stay the same.

Small and local businesses are not often the businesses receiving tax subsidies. A Good Jobs First report studying 14 states (including Kansas) found large companies received 70 percent of subsidy deals and 90 percent of the dollars. Specifically in Kansas, large companies received 81 percent of Promoting Employment Across Kansas (PEAK) award deals and 95 percent of the monies.

Lessons from other states illustrate the potential risk for Kansas with similar incentives. Large, successful corporations often receive subsidies and fail to contribute to the localities that support them. As mentioned above, Tesla was able to lobby for a large tax incentive deal ($1.3 billion) from Nevada in 2014, which had long-lasting consequences for other areas of public spending.

Earlier in 2022, Kansas found itself in a competition with Oklahoma for an unnamed company, later revealed to be Panasonic. As a result of this competition, Kansas authorized a substantial offer with the APEX bill (SB 347), which was taken up by Panasonic, a foreign company not currently located in the state.

Those who implement tax incentive programs are more likely to want to do deals with big businesses with big job impacts, as the approval process often takes as much time in a deal with 10 jobs as it does for a deal with 100 jobs created. Given limited resources in approving deals, it makes sense their attention goes to big businesses. However, this prioritization leaves out the vital small and local businesses across the state.

Lawmakers must consider what policies — most likely not tax incentives — would best support local businesses, including small businesses and entrepreneurs.

3. RACIAL EQUITY

Equity needs to be built into fiscal policy. That means recognizing that tax policy is not race-neutral. It is important to assess fiscal policies for their impact on racial equity and to pursue policies that deliver equitable outcomes.

Tax incentives are not a magical elixir to revitalize communities, including communities that face continued structural barriers due to past and lingering racism. Communities facing these continuing barriers are often described as “distressed communities,” with Black and Native Americans being much more likely to live in such a community than their white peers due to decades of discrimination and residential segregation.

Distressed communities are those which lack jobs and neighborhoods with lower employment rates compared to their local labor market. One way to help distressed neighborhoods is to increase access to jobs, such as through better and reliable transportation, job training, and access to affordable, quality child care so parents can go to work.

Prioritizing small businesses makes better long-term sense, especially if helping distressed areas to bolster economic and business activity is the policy goal. Compared to investing millions of dollars into large corporations that already have the funds to expand their business in the state, investing in small businesses can improve distressed communities with their individual needs, which could include services like assistance with real estate and infrastructure, business consultation, and job training.

These types of investments in distressed places are estimated to cost state governments (in total) $30 billion a year, which breaks down to roughly 3 percent of state taxes [approximately $13 million in Kansas based on fiscal year 2022 numbers].

If the goal of business tax incentives is to revitalize distressed labor markets, which could also target structural barriers facing communities of color, a targeted approach would be much more cost effective.

4. SIMPLICITY

Tax incentives aren’t simple and can include complicated provisions, which increases the difficulty of enforcement.

The complexity of tax incentives creates an environment where only those who can navigate the complexity and advocate for their businesses stand to benefit (primarily wealthier and larger companies).

The proliferation of tax incentives requires the programs to be detailed to ensure they are targeted effectively. While this helps keep the cost down, it also makes the overall tax system more complex for the Kansas Department of Revenue to administer and enforce, while also failing to create a discernable positive impact on economic development. More work is needed to create a tax structure and tax policy that works to bolster economic growth across the board, not with individual business tax handouts.

5. SUSTAINABILITY

A tax system needs to be constructed in ways that avoid — as much as possible — unpredictable, large fluctuations in the amount of revenue collected each year.

Some tax incentives do not have budget caps, which means a surge of businesses who take them could cause fluctuation in revenue. One way to address cost is to eliminate refundability, which would block businesses from receiving tax incentives if they do not pay any state corporate income tax. One study states that eliminating refundability would reduce the costs of such incentives by one-third.

Another issue of sustainability is the political nature of these tax incentives, which often have short-term benefits but much longer costs. A tax incentive could have a low number of eligible beneficiaries when first implemented, but later on, the number of potential beneficiaries could increase, along with the cost to the state.

To control for this potential problem, every subsidy program should be systematically evaluated for effectiveness every three to five years by an independent agency. In addition, every program should have a statutory sunset or expiration date.

6. ELASTICITY

Ideally, the amount of revenue collected should increase as the economy expands, reflecting the increased needs of education, transportation, and many other public services. Tax incentives skim from the top and reduce money coming in at the front end.

An important question to ask is how will these policies be administered and monitored to inform future needs and continued investment?

If business tax incentives do create additional jobs, that will likely lead to increased resource use and infrastructure needs in the community. With additional jobs comes population growth, which results in greater need for public schools, road repairs, child care providers, and other public services. Lawmakers must consider these associated needs, their cost, and how to ensure the benefited business contributes to them.

Creating a surplus of refundable tax credits that have not yet been collected can lead to major fluctuations in the cost, depending on how business activity and profits change. This could lead to an increase in spending on tax incentives during times of increased economic activity, rather than an increase in tax revenue, making tax incentives the opposite of elastic, where they decrease revenue to keep up with the costs of public services.

Tax Incentives and Transparency

While Kansas has made gains in increasing transparency around tax incentives, there is still much work to be done. A recent report from Good Jobs First recognized Kansas as a state making improvements, given the bipartisan 2019 transparency law that led to an online database of subsidy recipients. Unfortunately, the law only applies to incentives given out after the law was enacted.

However, while the report highlighted the progress Kansas has made, the state still only received a score of 28.8 points (out of 100).

The same report from Good Jobs First analyzed 250 programs in all 50 states, including five programs in Kansas. Despite the 2019 policy change, there are still areas of growth. For example, only three of these programs includes transparency about the amount that is dispersed. While the 2019 law has led to disclosure about which companies benefit from the High Performance Incentive Program (HPIP), there is still no disclosure around the subsidy amount or the outcome of the program.

The report examined five economic development tax incentive programs in Kansas. They scored the programs in eight areas:

1. Project information
2. Advance notice and public participation
3. Recipient identity
4. Subsidy information
5. Job creation reporting
6. Wages/payroll reporting
7. Expenditures/investment reporting
8. Data accessibility and usability

The program with the highest score was the Job Creation Fund, with a score of 52 out of 100 possible points. The program with the lowest score was the Research & Development Tax Credit, with a score of 0.

The scores show that while some progress has been made, including in areas like project information and data accessibility and usability, there is still much room for improvement. None of the five programs had any points for advance notice and public participation or wages/payroll reporting. Only one program (Job Creation Fund) scored a single point in the each of the recipient identity and expenditure/investment reporting portions.

Are Tax Incentives Effective?

Due to the lack of transparency, there is not enough work being done to ensure tax incentives are meeting their intended goals. If the tax incentive is created to incentivize behavior, are policymakers examining whether the program meets the intention?

Some programs have been studied and do not appear to meet their goals. For example, the Rural Opportunity Zone tax incentives appear to not actually be incentivizing people to move to rural Kansas. This is not an unusual problem states are facing.

Additionally, many businesses still plan to invest in building or expanding their business, regardless of tax incentives. In Texas, 85 percent of the companies that were offered tax breaks had already planned to open facilities. And average-sized incentives only factored into the decision-making process of business location for less than one in five businesses.

A study found tax incentives were often given to companies who would have settled in that location, regardless of the incentive package. Unfortunately, “since poorer states and communities are more likely to use incentives in the first place, the end result is to undermine the resources and revenues of the places that can least afford it.” (Florida, 2017)

For other programs, there has been no research to determine whether they are successful or not. If the state is going to spend large sums of money on these programs, the least it can do is ensure the programs actually work. But the effectiveness of the programs can only be determined if the incentive deals are fully disclosed, such as the company information and owners, the number of promised jobs, the wages for the jobs, and how much investment is expected by the business.

If the company fails to fulfill what is expected, the state could require repayment. While research does not show a relationship between incentives and economic growth, if lawmakers still want to pursue these opportunities, they can, but should put measures in place to recoup state monies if the business fails to produce the agreed-upon outcomes.

Policy Recommendations

Lawmakers should not be afraid to eliminate programs that are not working or ensure accountability by creating mechanisms for businesses to return subsidy dollars if they do not meet agreed-upon outcomes. Kansas evaluates a handful of tax incentive programs but does not always act on the findings. If tax incentives will be used, lawmakers should ensure the programs:

1. Raise living standards in the communities in which they are based. Tax incentives should be required to generate good paying jobs with employer-provided health care coverage. Current residents should be the primary recipient of the jobs created — not corporations that refuse to adequately invest in the communities they are settling in.
   
   
2. Defend schools from consequences of tax subsidy gimmicks. “Property tax abatements are among the largest and longest-lasting subsidies companies receive, and they can be devastating to the budgets of local schools. We can protect education from tax giveaways by giving school boards veto power over the use of tax-increment financing and other subsidy programs that impact their budgets.” (Good Jobs First)
   
   
3. Have appropriate transparency, before and after the deal is made. Businesses should make the case before and after the deal is done. Incentive applications should include economic impact analysis, which are available for public viewing before the deal is approved.
   
   To ensure transparency, there should be a prohibition of non-disclosure agreements, which block taxpayers from knowing about potential deals. In addition, there should be advanced public notice about the debate and approval of the deals. Deal disclosures should be public, easily accessible, and multi-year.
   
   
4. Make businesses prove it. In addition, lawmakers must ensure accountability is met, which requires transparency about the tax subsidies, including public disclosure of the recipients, the anticipated number of jobs and wages, and promised community investment.
   
   
5. Put in place mechanisms to recoup money if results aren’t met. Elected officials should ensure they do not stand to lose money if the business cannot perform, which could include having the incentives distributed after the company meets the deliverables. In addition, all clawback actions must be properly disclosed.
   
   
6. Don’t leave out small businesses. Rethink how to support businesses already in the state. Rather than prioritize tax incentives, consider providing individualized services for local businesses, which research shows are more beneficial than incentives in terms of job creation.