Several widely accepted principles of sound tax policy can be used to evaluate business tax credits. They include:
Equity: Similarly situated taxpayers should be taxed similarly.
Neutrality: A tax should not encourage taxpayers to make economic decisions based solely upon tax consequences.
Revenue Adequacy: An adequate tax system raises enough money to pay for public services and investments.
Simplicity: A simple tax system is one that is relatively straightforward and easy to comply with for the taxpayer and relatively easy and inexpensive for government to administer.
Transparency: A good tax system requires informed taxpayers who can clearly see how tax assessment, collection, and compliance works.
Competitiveness: A competitive tax system does not impede the ability of companies to compete with those located outside the state and does not limit the state’s ability to attract new business.
Business tax credits undermine all of these principles (see Table 7.1) with the exception of competitiveness, where their impact is more ambiguous. As discussed in Section III of this
95Evidence Counts: Evaluating State Tax Incentives for Jobs and Growth.
84 report, taxes — and, by extension, tax credits — are but one of several factors considered by businesses in their expansion/location decisions.
Table 7.1: Business Tax Credits: Their Effect on Tax Policy Principles Tax Principle Effect on Tax Policy Principles
Equity Tax credits and other tax incentives undermine equity. They favor one set of taxpayers over another, and, in industries producing similar products, one set of companies over another. For example, an incentive for solar energy panels would be perceived as inequitable by producers of wind turbines.
Geographically targeted tax credits favor otherwise identical taxpayers solely on the basis of location.
Neutrality Tax credits and other tax incentives undermine economic neutrality when they distort economic decisions that would have been made absent the tax credit.For example, a business may decide to install solar power if there is a tax credit to do so, rather than insulate their building, which might be more efficient.
Revenue adequacy Because tax incentives narrow government’s revenue base — rarely with a compensating rate increase — they undermine revenue adequacy. By narrowing the tax base, tax incentives may make the tax more volatile, further undermining revenue adequacy. Tax credits (and other incentives) also “lock in” state spending regardless of economic conditions. For example, during the economic downturn in 2008, NYS could not prevent revenue losses due to tax credits without resorting to extraordinary measures. To mitigate revenue losses from the credits, the state implemented a tax credit deferral plan that, although it resulted in short-term savings, increased administrative complexity, as well as fiscal impacts in later years.
Simplicity Tax incentives undermine simplicity. Tax credits (and other incentives) make the tax code more complex for taxpayers to understand and more difficult for government to administer. The incentives also create opportunities for avoidance, e.g., a business could characterize its investment as one that qualifies for the ITC even if it would not do so but for the credit.
Transparency Tax incentives undermine transparency. Taxpayers and the general public should know that a tax incentive exists, how it is imposed, and who receives it. With few exceptions, there is limited publicly available information as to who is getting the incentives and how much each is costing the government.
In the case of negotiated credits, special arrangements made between the state and individual taxpayers are usually not revealed to other taxpayers or to the public.
Competitiveness It is unclear how tax credits affect a state’s competitive position since business location/expansion decisions are made based on several factors, including the mix of taxes and the provision of public services.
85 VII.2 Evaluating Business Tax Credits: the GAO Framework
Every year, after extensive review of the governor’s budget, the NYS legislature decides how much to allocate to education, health care, infrastructure, and other public services. Tax incentives, however, once in place are rarely reviewed as part of this process. But, unless an incentive “pays for itself,” it reduces revenues available for government to use to fund direct spending or to lower overall tax levels. This is true for the federal government as well as for NYS and other states.
The U.S. Government Accountability Office (GAO) has created a framework to evaluate federal tax expenditures that closely resembles its approach to evaluating spending programs.96 The mandate to evaluate spending programs is predicated on the Government Performance and Results Act (GPRA) of 1993 and its 2010 update. The 1993 act established a statutory framework for performance management and accountability, including the requirement that federal agencies set goals and report annually on progress towards those goals and program evaluation findings. In response to this and related management reforms, federal agencies have increased their attention to conducting program evaluations. The GPRA Modernization Act of 2010 (GPRAMA) raised the visibility of performance information by requiring quarterly reviews of progress towards meeting agency and government-wide priority goals. GPRAMA also requires that tax expenditures be included in reports where activities contribute to goals that cut across agency lines.
In response to the need to evaluate the effectiveness of tax expenditures in meeting agency and government goals, the GAO has suggested questions to be asked in assessing tax expenditures. An adaptation of these questions can be applied to the evaluation of NYS’s business tax credits.
1. What is the purpose of the tax credit?
For some credits, the purpose is clear from the enabling legislation; for others, the purpose is not clear and may need to be inferred.
Are there performance measures established to monitor success in achieving the intended purpose of the credit? Performance measures should be part of the
96 Tax Expenditures: Background and Evaluation Criteria and Questions, GAO-13-167SP (Washington, DC: United States Governmental Accountability Office, November 29, 2012).
86 enabling legislation and should be monitored annually and included in budget reviews and deliberations.
2. Even if the purpose is achieved, is the tax credit good policy?
Is the credit fair and equitable? Who benefits from it?
Are similarly situated taxpayers treated similarly?
Is the credit simple and transparent? Is there periodic public reporting of credit recipients?
3. How does the credit relate to other state programs?
Does the credit duplicate or overlap other state objectives?
Is the credit coordinated with other state activities?
Is the incentive a cost-effective way of achieving the policy goal?
4. What are the consequences for the state budget of the credit?
Are there options for limiting the credit’s revenue loss?
Can taxpayer’s eligibility be limited?
For eligible taxpayers, can the value of the credit be reduced?
Are there sunset provisions for the credit?
5. How should evaluation of the credit be managed?
What agency or agencies should evaluate the credits?
How often should the credit be evaluated?
What data are needed to evaluate the credit?