Guest Blog (Tom Adelson, Scott Meacham & Preston Doerflinger): Oklahoma tax credit is subsidizing out-of-state businesses

Senator Tom Adelson is a state senator from Tulsa. Scott Meacham is the former State Treasurer and former director of the Oklahoma Office of State Finance. Preston Doerflinger is the current director of the Oklahoma Office of State Finance.

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.