Scott Meacham is the former State Treasurer and former director of the Oklahoma Office of State Finance. He currently chairs the Oklahoma Chamber of Commerce’s Economic Development and Taxation Committee.
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:
- 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.
- 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.
- 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.
- 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.
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