Time to End The War between The States

Time to End The War between The States

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State and local budgets have been devastated by the Great Recession. Hundreds of thousands of teachers, police and firefighters have lost their jobs.

Yet states continue to dole out billions of dollars annually in subsidies to attract businesses, often in largely meaningless competitions with neighboring states. Last year, for instance, Kansas convinced AMC Entertainment, the national movie theater chain, to move its headquarters from downtown Kansas City, Missouri to the suburbs on the other side of the state line. The state gave AMC $47 million to aid the relocation, even though it created no new jobs for the greater Kansas City metropolitan area.

Yet governments on both sides of the state line lost out in the switch. While Missouri saw its income tax revenue decline, Kansas failed to collect. Instead, the state allowed AMC to continue deducting payroll taxes from its employees’ paychecks without turning it over to the state treasury – a subsidy program designed to create new jobs.

“The practice of redirecting large portions of the state personal income tax withholding deducted from paychecks means many workers are, in effect, paying taxes to their boss,” wrote Philip Mattera, the lead author on a new report by Good Jobs First, a non-profit advocacy group that opposes state and local tax subsidies to business. The group documented 2,700 companies benefiting from 22 such income tax diversion programs in 16 states, costing those state and local governments $684 million a year.

This is just the latest tax scam in the escalating jobs war between the states that has been going on since at least the mid-1970s, when some cities and states began offering property and sales tax abatements to attract or hold footloose manufacturing firms. In the succeeding decades, the industry emoluments – perhaps a better word is bribes – have proliferated like ornaments on a Christmas tree.

Tax-increment financing, enterprise zones, preferential income tax rates, franchise fee exemptions, you name it. If a state or local government taxes it, they are willing to forgive the levy if you, Mr. Job Creator, promise to add jobs.

It’s now universal. What began as a desperation measure by Midwestern and Northeastern manufacturing states hemorrhaging jobs to the South is now offered everywhere and with ever-rising intensity in a weak economy. 

How well is it working? Most states have no idea. Another new study out this week from the non-partisan Pew Center for the States found half the states make no effort to evaluate the impact of these industry subsidy programs. Just 13 states had adequate evaluation programs and another dozen made half-hearted efforts, the study found.

“Deciding whether to make these investments, how much to spend, and which businesses should receive them involves policy choices with significant implications,” said Jeff Chapman, Pew’s senior researcher on the study. “When states forgo revenue by offering economic development tax incentives, they have less money to spend on education, transportation, health care, and other critical services.”

Of course, from a national perspective, the whole strategy is meaningless, a zero sum game. Companies have to locate somewhere if they want to be in the U.S. And if the competition is with a foreign location, it’s hard to imagine that state and local taxes, which are only a few percentage points of total business costs, will make a difference compared to, say, the cost of labor in Bandung, Bangladesh or Bangalore.

Ditto for why a BMW or Mercedes Benz locate their assembly plants in South Carolina and Mississippi, respectively. They locate there because labor is much cheaper than in Detroit or California, not because they get a local property tax break.

Yet think what it does to other businesses in the states giving away special tax breaks. They still have to pay their property, income and sales taxes to support local schools, roads and other public services because somebody has to. Yet those services must also be provided to the families of the employees who staff those new factories and office buildings as well as to the businesses themselves.

Think what that means if the existing business is in the same industry as the new one getting the tax break. They must pay higher taxes to subsidize their competitors.

The solutions offered in the reports by the non-profit groups didn’t really address this fiscal madness. Good Jobs First wants employers to create a line on every employee’s paycheck that states how much he or she is paying to their employer instead of to the taxman. The Pew Center on the States wants states to apply a critical eye to their proliferating programs to determine which ones are effective and which ones are not.

A better idea is to simply remove the federal tax subsidy that incentivizes the zero-sum bidding war. Any business that gets a state or local tax break compared to their similarly situated neighbors should be required to declare that as federally taxable income.

Politically unrealistic? No more so than corporate tax reform itself. The issue is likely to get raised during next year’s reform debate, where “loopholes” will need to be removed to lower overall rates. Existing businesses that pay their state and local taxes could lose that deduction – it’s a major tax expenditure for corporations as it is for individuals.

Yet those businesses who get special state and local tax breaks won’t lose anything even though they will still benefit from the lower rates. That hardly seems fair or worthy of the word “reform.”

spent 25 years as a foreign correspondent, economics writer and investigative business reporter for the Chicago Tribune and other publications. He is the author of the 2004 book, The $800 Million Pill: The Truth Behind the Cost of New Drugs.