In a recent interview with KWGS, tax reform task force co-chair Senator Mike Mazzei argued:

The folks that really should be displeased with our tax reform are not individual taxpayers at these low income levels, but the corporate folks that are going to lose a lot of their special interest breaks that have helped them subsidize their profit margins. When you asked about winners and losers earlier, those are the folks that are going to lose in this style of tax reform.

This claim is false. Based on the task force’s own numbers, broad-based tax preferences make up more than two-thirds of the funds targeted for elimination. That’s why Sen. Mazzei’s plan would raise taxes for a majority of Oklahomans. It’s why the real losers under this plan are not corporate special interests; they are families with children and low-income seniors.

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Ken Miller is State Treasurer and a member of the the Task Force for the Study of Tax Credits and Economic Incentives.  This originally appeared as an article in the November Oklahoma Economic Report and is reprinted with permission. For an earlier blog post on tax credit reform by Task Force co-chair David Dank, click here, and see this piece laying out OK Policy’s position.

Critics contend that if politicians are good at anything, it is studying something to death. While this legislative interim has been full of task forces and studies, many promise to be more than just simple academic exercises. True, some are meant to garner attention for a favored issue. Others are meant to bolster an opinion. And some are honest undertakings in search of good policy.

And there are some with elements of each of the above. Facing a December 31 report deadline, the Task Force for the Study of Tax Credits and Economic Incentives is preparing final recommendations.

It is this task force member’s hope that rhetoric and ideology will play a subordinate role to sound policy and economic reality. The task force recommendations can impact our business climate for years to come and must take into account the competitiveness of states in attracting industry and economic growth.

There is unanimity among task force members that all incentives should meet the three-way test of public purpose, consideration and controls.  The panel has concluded the state grants too many tax incentives, many of which need to expire, and that all incentives need stricter controls, accountability and sunset dates.

There is no such unanimity on the issue of transferable tax credits, which can be sold to a third party when the original recipient does not earn enough taxable income. Only one other state, Iowa, has recently considered eliminating tax credit transferability.  The recommendation, made by a similar task force, was not adopted by its Legislature.

As with all incentives, the criteria should boil down to a cost-versus-benefit analysis.  If our Legislature determines that an economic benefit, like infrastructure improvement or job creation, is worth a predetermined cost in tax revenue, it is difficult to understand in concept why it matters which company claims the tax credit after the three-way test has been met and the induced benefit received by the state.

It has been argued that it matters because among the largest purchasers of tax credits is the insurance industry, whose remittances are earmarked for pension funding. However, such logic is just as flawed as saying that the state income tax rate cannot be lowered because its remittances are earmarked for education. Also perplexing is why the secondary market for credits has been met with demagoguery by those who usually favor mutually beneficial voluntary exchange.

Although no new transferable tax credits have been granted in the last seven years, certainly there were poorly structured ones allowed in the past. But there have been beneficial ones as well. Facts fail to confirm the claim that all transferable tax credits, regardless of structure, are inherently bad. Everyone is entitled to their own opinion, but not their own facts and it is the latter that is currently missing from an informed decision.

Another area of divergent thought relates to accountability.  Some task force members want the State Auditor’s powers expanded to judge an incentive’s worthiness.

Others are not yet convinced the case to grow government and spending has been made, or if it is even an appropriate use of the Auditor’s office. The Tax Commission seems the more appropriate agency for such determination and is already auditing most incentives.

Further, if three-year sunset provisions are implemented, it seems wasteful for taxpayers to fund additional annual or biannual audits on expiring incentives. Facing sunset, the beneficiary will have to make the case for extension to legislators who stake their reputation with each push of a button.

Should it be determined existing audits are not enough, the panel should consider having tax credit beneficiaries pay the cost of outside independent audits. It bears remembering the courts provide the ultimate remedy for violations of the constitution and public trust.

Like those that have gone before it, this interim has seen its share of studies with varying degrees of worth. With well thought-out recommendations and proper legislative follow-through, the incentive task force will help breathe new life into job-creating tax reform, better budget prioritization and a stronger Oklahoma economy.

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Photo by flickr user zeuxis.pixelsurgery used under a Creative Commons license.

An idea floating around in the tax reform debate has been to swap tax credits for a reduction in the top income tax rate. That’s one of the motivations behind the tax credit task force, which has looked at reigning in a number of business and economic development tax credits.

Oklahoma also provides another kind of credit, directed not to favored industries, but to all taxpayers below a certain income level. Some lawmakers seem tempted to eliminate these as well. They should think again.

The largest of these credits is the Sales Tax Relief Credit. Oklahoma is one of the few states that charges sales tax on groceries at the full rate. The credit is meant to offset the impact of that tax on low-income Oklahomans, who spend a larger portion of their incomes on basic necessities. It provides $40 per person to tax filers below an income cap ($20,000 for individuals or $50,000 for households with dependents). In 2009, it was claimed on almost one-third (32.3 percent) of all of the tax returns filed, and it benefited more than 1 million Oklahomans.

Similarly, the Low Income Property Tax Relief Credit is meant to help low-income seniors and people with disabilities who, because they often live on fixed incomes, can be disproportionately harmed by rising property taxes. The credit is available to anyone who is over 65 or totally disabled with incomes less than $12,000. It refunds property taxes that exceed 1 percent of household income, up to a maximum of $200. In 2009, this credit was claimed on 1,402 returns for an average benefit of about $160.

The Oklahoma Earned Income Tax Credit (EITC) is meant to provide an incentive to work, as well as offset the effect of highly regressive payroll taxes. Oklahoma’s EITC provides a 5 percent addition to what filers receive from the federal EITC, which is the largest poverty-fighting program in the United States. The EITC provides critical income support to those moving from unemployment to low-wage work. According to the Census, it lifted 5.4 million people above the poverty-line in 2010. The Oklahoma EITC was claimed on 307,253 tax returns in 2009, for an average benefit of about $104.

Finally, the Child Care Tax Credit/Child Tax Credit helps families pay for child care they need in order to work or look for work. The state credit can be claimed for 20 percent of the federal child care credit, which provides as much as $2,100 to cover expenses related to the care of a child or adult dependent. Families also have the option to instead take 5 percent of the federal child tax credit of $1,000 per child, so those who don’t pay out of pocket for child care can still receive a benefit. It is available to households with incomes up to $100,000. Unlike the other credits on this list, it is nonrefundable, which means it cannot be returned as cash after tax liability has gone down to zero. In 2009, this credit was claimed on 362,470 returns for an average benefit of about $80.

The tax credit task force has not specifically discussed these income-based credits, but some state leaders have indicated they would favor eliminating them in exchange for further reductions to the top rate. One proposal by Governor Fallin’s task force on economic development would eliminate all of the income based credits in order to pay for reducing the top rate.

This would be a serious mistake. A family of four with two children making $30,000 a year would lose at least $422 from the elimination of these credits ($160 from sales tax relief credit, $162 from state EITC, and $100 from the child tax credit). Meanwhile they would receive nothing at all from a reduction in the top rate, since they have only $14,600 in taxable income and the top rate kicks in above $15,000. The state would not even realize much of the expected savings from eliminating these credits, since many Oklahomans would be pushed further into poverty and reliance on other forms of government assistance.

These broad-based credits perform a completely different function than those going to special interests. Like the income tax bracket structure itself, they are designed to counteract regressive sales and property taxes so that everyone pays their fair share. Eliminating these credits to pay for a reduction in the top rate (which disproportionately benefits the already wealthy) could not even be fairly characterized as a tax cut. Instead, it would be a tax shift from the poor, who already pay more of their income in state and local taxes, to the already wealthy. We should watch out for any purported tax cut ideas that shift more costs onto low and medium-income Oklahomans.

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Aragon’s idea would be an effective and efficient use of public dollars based on a simple premise: the state identifies a public good and directly provides it. Contrast that with an obesity-fighting idea from a few years ago, when Sen. Mike Mazzei proposed a tax credit to reimburse 20 percent of the cost of health club memberships. This would have been more expensive than simply opening up schools and limited to those who could afford 80 percent of a health club membership. In addition, a substantial part of the credit would be wasted on those who would have joined a health club without it.

Sen. Mazzei’s tax credit was not made law, but it is emblematic of a common problem in public policy. Because we have stigmatized direct government action in many areas, we look for workarounds that are less efficient than if the state just went ahead and provided the service. This creates gaps in both efficiency and accountability.

Another example is how the state has encouraged rehabilitation of historic buildings. Lawmakers decided this was in the public interest, so they created a tax credit. However, because the credits were transferable, recipients sold many of them at 80 or 90 cents on the dollar. The buyers likely had no relationship to the rehabilitation project, so a significant percentage of the money was immediately wasted.

A more straightforward way to accomplish this goal would be to provide grants for the restoration. The state could collect proposals for projects and award funds based on merit and need. That type of program is more likely to be attacked by critics of public spending, but if lawmakers believe a program is worthwhile they should not be afraid to stand by it. Tax expenditures may be safer politics, but at a large cost.

Tax credits are not the only inefficient back door used for public goals. Privatization can create a similar problem. In some situations, a private company will have specialized skills that the state needs to contract for, and certainly some activities are more appropriate to the private sector. However, we can’t always assume privatization is more efficient.

A prime example is support services in public schools. In an attempt to respond to complaints about under-funded schools without actually putting more money into schools, one lawmaker suggested privatizing food, medical, janitorial, and transportation services, as if that would free up money for the classroom.

Yet if we think it through, it’s not clear how privatization would help. We haven’t introduced more competition, as there’s still only one buyer — the school district. Privatization would in fact add more bureaucracy, since instead of simply hiring janitors, the schools will be hiring janitorial companies with their own layers of management (not to mention a profit margin taken off the top). One study that reviewed hundreds of federal contracts found that public employees were less expensive than contractors in 33 of the 35 occupational classifications.

Contracting with private companies or monkeying with the tax code are complicated workarounds compared to directly providing a service. The most efficient way to achieve public goals is usually to keep it simple.

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Consumption Tax: A tax that applies to purchases of goods and/or services by individuals and businesses. These taxes include general sales taxes, which apply to retail sales, and special excise taxes on alcohol, cigarettes, and gasoline.

Gross receipts Tax (GrT): A tax on the total gross revenues of a company, regardless of their source. A gross receipts tax is similar to a sales tax, but it is levied on the seller of goods or services rather than the consumer. Applies to the sales made by companies at every stage of the production process, including manufacturing companies, wholesalers, and retailers.

Tax Base: The amount subject to tax. If all the consumers in a state purchase $1,000,000 in coffee each year, then the tax base for a coffee sales tax would be $1,000,000. However, the tax base does not have to be expressed in terms of money. If coffee was taxed by the pound, then the tax base would be the number of pounds of coffee sold.

 

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Rep. David Dank is co-chair of the Tax Credit Task Force. This is his 0pening statement to the Task Force’s meeting of November 9th. It is reprinted with permission and has been edited for length as indicated by [...] The full unabridged statement can be seen here. A column presenting OK Policy’s recommendations for tax reform that previously appeared on Oklahoma Watch can be seen here.

[…] The very first question we need to ask today is who we are representing here []

I think the only valid answer is, The Taxpayers.

Not the special interests who have benefited from many of these tax credits… and certainly not the few who have manipulated this system for personal gain.

I think we should also make a second thing clear today [] We are not against business. We don’t oppose growth. We believe that government policy can help create jobs. We don’t think all credits or incentives are bad.

What I think most of us believe after all we have heard here is that far too many tax credits and other incentives enacted in the past were created for the wrong reasons, and in the wrong way.

Many were enacted virtually in secret.

Some had no checks and balances.

And as we know from reading the Attorney General’s opinion, a number of them were and are constitutionally infirm, which is really another way of saying they were simply illegal [..]

I know you have heard me refer to the culture that ruled this Capitol for too long… the ‘go along to get along practices’ and the ‘special deals’ slipped into legislation ten minutes before adjournment [..]

The simple truth is that a few of these tax credits are like the huckster who took a bucket of manure, covered the top with an inch of honey and sold the whole thing as a full bucket of honey. It wasn’t until the sucker got home with it that he found out what he had actually bought.

Well, the report we will issue by December 31 is a golden opportunity to reverse that culture and to shine some much-needed light on the public business we do here, all the way to the bottom of the bucket. I trust we will take advantage of that opportunity.

I said that today’s business should address the criteria we will apply to draft our report and draft some legislation. Let me propose some possible criteria, and then I will ask the members to add their own.

• First of all, I believe that we must end forever the creation of tax credits or other incentives that are transferable. Taxpayer dollars should never be traded around to the highest bidder in a shell game like some we have seen. Any tax credit should at minimum benefit only the recipient.
• Second, no tax credit or other incentive program ought to be enacted or changed by legislation created and introduced in the final days or hours of any legislative session [..]
• Third, any future tax credit needs to come wrapped in a clear and accurate fiscal impact study. We can no longer afford to enact tax credits with unknown future costs to the state budget. Tell us what it will cost from year to year.
• Fourth, any future credit must be designed to create or save jobs. That is the only acceptable reason for a tax credit in the first place, because that is the only way any tax credit will actually help build wealth and return the initial investment to the state. Economic growth is job growth. That has to be the central goal of any tax credit worthy of our consideration.
• Fifth, whenever a business comes to ask asking for our help to grow jobs, we need to look at all of the alternatives before we even utter the words ‘tax credit.’ We have discussed several times the job sustaining provisions of the Quality Jobs Act, as well as other state programs that can help keep people at work. A tax credit should be our last, not our first, resort.
• Sixth, the State Auditor should be required to thoroughly audit every tax credit, beginning in the drafting stage and continuing on a year to year basis. The Auditor was elected by the people to oversee how public dollars are spent, and this is one area that has cried out for oversight for a long time. We will never have the transparency and accountability we have spent the last few months talking about until we have a trusted authority examining these programs.
• Seventh, I firmly believe that we can no longer afford to enact open-ended tax credits. We are coming out of a severe budget crisis, but there will always be another one somewhere down the road. Any future tax credits need to have enforceable caps and limits.
• Eight, on that same theme, all future tax credits should be subject to sunset provisions. The Legislature should periodically examine and be required to re-certify any tax credit. Frankly, I am surprised that we did not turn up a tax credit for the makers of buggy whips that had been on the books since the delivery of the first horseless carriages in 1907 or so. No tax credit should be granted eternal like, and sun-setting will address that problem.
• Ninth, I believe we need to curtail the granting of tax credits on what has become virtually an automatic basis. Each project or separate credit needs to be subject to examination and individual approval. Without that we get projects like pizza parlors in buildings that just happen to qualify for a historic preservation credit.

Finally, I would encourage you all to remember where we started today. Our first obligation here is to the taxpayers. In the end they have paid for every dollar in tax credits granted by the State of Oklahoma, since a dollar lost to a tax credit, whether it is worthy or not, always winds up either coming out of the pocket of an individual taxpayer or leaving that taxpayer a dollar short in state services that didn’t get funded [..]

Now I would be anxious to hear your input…

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The Oklahoma legislature has struggled for decades with the best way to encourage capital investment in Oklahoma. Many ideas have been tried with varying degrees of success. The problem is that once the ideas are launched by the legislature, usually as tax benefits under Oklahoma’s tax code, they are all but forgotten. Tax benefits included credits against tax liability, deductions against income and, in some cases, direct payments from the State. No real processes exist to critically evaluate these programs and eliminate those that are not working. The result is that the least effective of these initiatives stay on the books and end up costing the state hundreds of millions in lost tax revenues.

The Rural and Small Business Tax Credit programs are one of the prime examples of bad tax policy run amok. The legislature launched these programs a decade or more ago with the stated purpose of encouraging venture capital investment in Oklahoma. The structure created was very complicated, with entities called Capco’s serving as a sort of investment pool where investors would make investments and receive hefty tax credits in return. The Capco would then invest the investor funds, perhaps along with borrowed money, in qualifying rural or small business ventures.

The problems started almost immediately as smart lawyers figured out loopholes and ways to provide tax benefits which in some cases exceeded the amount invested. With such lofty investor returns at the expense of state tax revenues, investors quit paying attention to the merits of the underlying investments, as they literally had nothing to lose. In one highly publicized case, the investors took their credits and no investment was even made. The State was left totally holding the bag.

The first major overhaul of the Rural and Small Business Tax Credits was undertaken in 2006. The intent was to close the loopholes and ensure real investments were taking place. However, by 2008, lawyers had figured out another loophole by utilizing nonrecourse financing and meaningless guaranties to pump up the amount of tax credits being taken. Again, the statutes were amended to close the loophole.

By 2010, the dollar amount of Rural and Small Business Credits being issued was growing dramatically. The problem now was that virtually any investment in a small business or in rural Oklahoma would qualify. Suddenly, assisted living centers and other types of projects that would easily qualify for traditional financing started claiming the credits. Why shouldn’t they? The State was offering free money to all takers. Absolutely no mechanism existed to ensure these credits were being used in a manner that would bring more revenue into the State than it cost. In fact, one of the last deals that got in under the wire before the legislature placed a moratorium on the credits was a small employer in Southeast Oklahoma that was bringing at most 35 jobs to the community. In return for those 35 jobs, the cost of the credits to the State was projected to be around $10 to $12 million. That is a cost of over $285,000 per job!

Clearly, the Rural and Small Business Tax Credits are not the answer to encouraging investment in Oklahoma. What is the answer?

A “good” tax benefit is one that creates jobs in Oklahoma. The Rural and Small Business Tax Credits met this criterion but they were also abused and cost the state millions more than they produced in new revenues. In addition to creating jobs, then, it seems that a “good” tax benefit should meet the following criteria:

1. The benefit should be transparent. The public has the right to know who is taking advantage of these benefits, just like they have the right to know how the legislature is appropriating their tax dollars.
2. There should be accountability. People that take advantage of state tax benefits should be held responsible if they do not engage in the activity that is required to produce the credit.
3. There should be a front-end cost-benefit analysis to ensure that there is a reasonable probability that the issuance of the tax benefits will eventually bring in more state revenues than the cost in terms of lost revenues.
4. There should be a clawback of the cost of the benefits if the entity receiving them does not hold up its end of the bargain and fails to do what it has promised.

The Oklahoma Quality Jobs Program is an example of a “good” incentive program. It meets all of the criteria set forth above and has been very successful in attracting good jobs to Oklahoma. It is an incentive based on actual new jobs created. However, Oklahoma also needs an investment-based incentive to successfully compete with other states for capital and encourage additional capital investment in Oklahoma. However, to be effective the incentive must meet all of the criteria set forth above.

The opinions stated above are not necessarily those of OK Policy, its staff, or its board. This blog is a venue to help promote the discussion of ideas from various points of view and we invite your comments and contributions. To see our guidelines for blog submissions, click here.

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If the Oklahoma Legislature were to invest tens of millions of your tax dollars in start-up companies located out of state, how would that make you feel?  That’s basically the question Representative David Dank asked the Oklahoma Capital Investment Board (OCIB), a state public trust, during the August 25^th joint House/Senate hearing on state tax credits.

As co-chair of the Task Force for the Study of State Tax Credits and Economic Incentives, Representative Dank has held several hearings to review the effectiveness of state tax credits and incentives that are collectively costing Oklahoma hundreds of millions of dollars each year. One tax credit program that is drawing special scrutiny is OCIB.

The Oklahoma Legislature created OCIB in 1985 to attract private sector investment in Oklahoma start-up companies.  As conceived, the idea was to have the state invest in venture capital funds, whether located in Oklahoma or other states, and rely on the investment expertise of these venture capital funds to invest these dollars in Oklahoma companies.

The business model is a little more complicated.  OCIB borrows money from banks and invests these loan proceeds in the venture firms.  Banks are willing to make the loans because OCIB pledges tax credits issued by the state of Oklahoma to the bank as security for the loan.  So long as OCIB pays the loan back, the tax credits would not be sold.

OCIB thought these venture firms would earn a positive return on OCIB investments and use the profits from the investments to pay down the loan.  But things did not work out that way.  By 2005, OCIB had borrowed $31 million while the investments were worth $13.6 million.  So, OCIB had to sell the tax credits off to pay down the debt.

Who buys the tax credits? Businesses and wealthy investors who owe Oklahoma taxes.  Instead of paying state income taxes, they buy the credits from OCIB and reduce their tax bill dollar for dollar.  Since inception, OCIB has sold $27.5 million in tax credits.  That has a direct effect on the state budget.  Oklahoma has $27.5 million less to spend on core services – like roads and bridges, health, education, and public safety.

It’s an open debate on whether Oklahoma should directly invest in fledgling Oklahoma businesses.  Many states support new ideas generated within the state thru direct investment – in places like universities and institutions of higher research.  And there certainly would not be adequate capital for basic research and development without public sector involvement. Others point out that states directly favoring some types of business activity over others interferes with the allocation of capital in the private sector and raises borrowing costs for everyone else.

In fact, the authors of this article have friendly disagreement on the subject.  But we do agree on one thing – it’s simply wrong for states to gamble away tax dollars on out of state companies or to directly subsidize economic growth and job creation elsewhere.  That’s not what the people of Oklahoma elected their State Legislature to do.

Yet, that’s the vast majority of OCIB activities.  About 85-90 cents of every dollar invested by OCIB is invested in a start-up company located outside Oklahoma.  One company is actually located in Canada!

The reason the majority of OCIB capital is invested outside Oklahoma is because the venture firms are investing the vast majority of their capital elsewhere.   According to the 2006 Audit by the Oklahoma State Auditor and Inspector, the 18 venture funds that OCIB invested in sent $939 million out of state and only $26 million in state.  That’s less than 3 cents out of every dollar.

OCIB would have us believe that there is a shortage of capital in Oklahoma.  The reality is that capital is abundant.  What there is a shortage of in Oklahoma are good ideas worthy of investment.  Certainly, there is a role for the Oklahoma Legislature to play in supporting the generation of creative ideas that grow jobs and increase economic activity.

That role might best be described as investments in human capital – in the health and education of our citizens – and investments in our public infrastructure, the roads and bridges and highways upon which the great engines of commerce churn.

When tax credits reduce state dollars for core services in Oklahoma to fund investments made outside of Oklahoma, we have to conclude that OCIB – well-intentioned as it may be – is simply a failed experiment that has become too costly for the state.  We hope the Legislature can work to minimize losses in the future and bring OCIB to a gracious end.

The opinions stated above are not necessarily those of OK Policy, its staff, or its board. This blog is a venue to help promote the discussion of ideas from various points of view and we invite your comments and contributions. To see our guidelines for blog submissions, click here.

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Tax expenditures are a widely utilized policy tool, with each legislative session seeing the introduction of dozens of bills calling for new or expanded tax breaks for individuals and businesses.  Proponents of most specific tax break proposals tend to make the argument in their favor on one or both of the two following grounds:

• Tax preferences are instruments for accomplishing worthwhile public purposes. If policymakers agree, for example, that encouraging individuals to save for a college education is a worthy goal, then allowing a tax deduction or deferral for some or all of one’s contributions to a 529 College Savings account may be the appropriate policy tool.  Tax policy can also be used as a way to target assistance and benefits to groups deemed worthy of support, because of such factors as age, income level, disability, military service, or occupation. Providing assistance through the tax code is often seen as a more effective, less expensive, and politically more palatable mechanism for providing support than operating a government spending program.
• Tax preferences are needed to encourage economic development.  Oklahoma, like other states, has adopted a plethora of tax credits, exemptions, and incentive payments that support certain kinds of economic activity. Tax preferences are generally justified as worthwhile when targeted to economically risky endeavors, emerging companies and sectors, export-oriented companies, and companies that will create high-paying jobs. In some cases, the explicit argument is that in a world of mobile capitol and competitive localities, businesses will locate or move elsewhere in the absence of incentives.  As long as other jurisdictions are offering incentives, failure to “play the game” is tantamount to unilateral economic development disarmament.

Yet if tax expenditures can serve a necessary and justifiable means to accomplish certain public policy goals, they also raise serious problems and concerns, which include:

• Hidden Expenditures. Tax expenditures are largely invisible.  Unlike direct spending programs, tax expenditures do not require annual appropriations or legislative review.  Even with greater disclosure in recent years, it remains hard to get consistent and reliable information about the cost and beneficiaries of tax breaks.
• Efficiency. While incentives are intended to get an individual or business to do something it would not otherwise do, it is often hard to establish whether a tax advantage makes a decisive difference in influencing behavior.  Good Jobs First, among the most vocal critics of state incentives policies, emphasizes that, “A mountain of evidence suggest that development subsidies are often abused by companies that would have done exactly what they did anyway.”In many instances, only a portion of the total cost of an incentive will produce an incremental increase in the behavior being promoted; the remainder is “wasted” as a pure subsidy or giveaway. This is also true of tax breaks intended to influence individual behavior: for example, at least some of those claiming a tax credit for first-time homebuyers would have purchased a home irrespective of the tax break.
• Accountability. While tax incentive programs are generally created as a way to promote specific public goals, such as capital investment or the creation of high-paying jobs, there are frequently weak accountability provisions to ensure that goals are met.  Many incentive programs impose few, if any, requirements that companies must meet to qualify for benefits, provide little ongoing monitoring or auditing, and rarely include oversight provisions or sanctions that can be imposed on companies that fail to uphold their commitments. As a result, some states have adopted “clawback” provisions as a component of incentive programs that require companies to refund all or part of their incentives if they fail to meet specified job or investment targets, or leave the state after receiving incentives.
• Neutrality. Tax neutrality is the widely recognized principle that tax policies should “not interfere with the natural flow of capital toward its most productive use.” The practice of offering preferential tax treatment to certain individuals, businesses, and organizations rather than others tends to substitute political choices for market decisions in the allocation of resources.  In many cases, there does not appear to be any clear or consistent reason why some economic sectors or activities are granted preferential tax treatment while others are not.  These provisions can create competitive differences between similarly-situated firms and individuals. For instance, two waste recycling firms operating in the same county may be subject to different tax treatment based on one having received tax incentives to relocate, while the other has not.
• Equity. While certain tax expenditures, such as the standard deduction or the earned income tax credit, provide preferential treatment for lower-income individuals, many of the largest tax expenditures, such as deductions for home-mortgage interest, pension contributions, and college savings, primarily benefit upper-middle class Americans. This is because many lower-income families do not have income tax liability against which to claim deductions, or do not have sufficient income to allocate to preferential forms of spending.  A study by the Urban Institute-Brookings Institute Tax Policy Center found that households in the top fifth of income received twice as much benefit from federal tax expenditures as did households in the bottom fifth.In Oklahoma, data supplied by the Oklahoma Tax Commission revealed that some 72 percent of households claiming a tax deductions for contributions to the state’s 529 college savings program in 2005 had annual income over $75,000, a group that represents  just 14 percent of total Oklahoma households (see the Chart on page 6 of this issue brief).
• Fiscal Impact. The fiscal impact of tax expenditures is significant. Nationally, the Tax Policy Center study calculated the cost of tax expenditures claimed by individuals at $760.5 billion in 2007, more than the total budget for either national defense or non-defense discretionary spending. The total cost of tax expenditures for which the OTC was able to determine the cost  exceeded $5.6 billion in 2008, which was not much less than that year’s  total appropriated state budget ($7.1 billion). This total is revenue that is unavailable to sustain public services in Oklahoma or to lower tax rates. More significantly, perhaps, the cost of particular tax expenditures is generally unlimited. Typically, deductions and credits can be claimed in unlimited amounts so long as the credit’s eligibility criteria are met. If an exemption or incentive proves popular, it can have a large and unanticipated impact on the budget. An example cited in a recent national report is of an Arizona tax credit for vehicles that can run on alternative fuels; the credit was expected to cost $3 million to $10 million per year but ended up costing $680 million in its first year.In Oklahoma, when businesses uncovered a way to exploit a loophole in the Venture Capital Tax Credit, the cost of the credit soared from $2 million to $66 million in one year.

• Local Impact. Tax policies adopted by the state legislature can have a large impact on the revenues available to local governments. With a few exceptions, the sales tax base for municipal and county governments is set by the state legislature, so that every new sales tax exemption adopted at the Capitol erodes the sales tax base of cities and counties across the state. On property taxes, while the Legislature cannot directly enact new exemptions, it can and does send proposals for statewide property tax exemptions to votes of the people.

As much as tax preferences can be faulted on all these grounds, incentives and subsidies will still be defended as necessary tools for states competing against one another to attract or retain investment and jobs.  But as Arthur J. Rolnick, the Senior Vice-President of the Federal Reserve Bank of Minneapolis has contended, this competition “interferes with interstate commerce and undermines the national economic union by misallocating resources and causing states to provide too few public goods.” Even if the subsidies war as a whole leaves no winners other than the companies that can wring concessions from state and local governments, states are unlikely to withdraw unilaterally. Accordingly, Rolnick is among those who have called on Congress to exercise its Commerce Clause power to put an end to  the economic war  among the states. Conservatives and libertarian supporters of free-market principles have also consistently urged states to abandon the use of subsidies as a form of economic development.

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What’s up this week at Oklahoma Policy Institute? The Weekly Wonk is dedicated to this week’s events, publications, and blog posts.

This week at OK Policy, we reported on the first meeting of a legislative task force to evaluate state tax credits and economic incentives.  The meeting made clear that it will be a long and sometimes contentious process, but that this Task Force is serious about meeting the challenge.  We blogged on Wednesday about how the recent FAA shutdown proves business taxes aren’t always passed on to consumers.

Also this week, we examined the persistence of racial disparities in the state’s unemployment rate.  Black workers in the state were unemployed at more than twice the rate (13.1 percent) of white workers (5.9 percent) in 2010.  Finally, we highlighted an upcoming workshop on hiring ex-offenders and long-term unemployed.  The workshop will be held on Friday, August 5th and will address the economic cultures and challenges that develop with long-term unemployment, as well as employer questions and concerns about hiring those with criminal backgrounds.

In the Know, Policy Notes

• A Stateline infographic shows how a federal default could affect states.
• The Infrastructurist looks at what will happen to U.S. infrastructure if the debt ceiling isn’t raised.
• The Pew Research Center shows a widening racial wealth gap; the median wealth of white households is now 20 times that of black households and 18 times that of Hispanic households.
• Massachusetts is developing “innovation schools,” which operate within the traditional school system but are allowed more flexibility, to compete more aggressively with charter schools.
• The Economix blog shows how corporate tax loopholes provide significant benefits to shareholders, at considerable cost to everyone else.

Numbers of the Week

• 120°F – Temperature in Tipton Oklahoma on June 27, 1994, the state’s highest recorded temperature to date
• 21.8 percent – Percentage of Oklahoma’s school-age children living in poverty in 2009, 8^th highest in the nation
• 608,497 – Number of people on food stamps in Oklahoma in April 2011, up 4.5 percent, or 26,446 people, from the same month last year
• 2^nd - Oklahoma’s rank nationally in job growth during the last 6 months (December 2010-June 2011).  The number of jobs in the state grew 2.1 percent
• $2,197,065 – Amount paid in restitution by criminal offenders that was distributed to crime victims in Oklahoma in FY 2010

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