The data for this week's Monday Map comes from a component of the 2014 State Business Tax Climate Index that looks at business taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. incentives in each state.
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Many states provide tax credits which lower the effective tax rates for certain industries and/or investments, often for large firms from out of state that are considering a move. Policymakers create these deals under the banner of job creation and economic development, but the truth is that if a state needs to offer such packages, it is most likely covering for a bad business tax climate. Economic development and job creation tax credits complicate the tax system, narrow the tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. , drive up tax rates for companies that do not qualify, distort the free market, and often fail to achieve economic growth.
A more effective approach is to systematically improve the business tax climate for the long term. Thus, this component of the Index rewards those states that do not offer the following tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. s, and states that offer them score poorly.
Investment Tax Credits. Investment tax credits typically offer an offset against tax liability if the company invests in new property, plants, equipment, or machinery in the state offering the credit. Sometimes, the new investment will have to be “qualified” and approved by the state’s economic development office. Investment tax credits distort the free market by rewarding investment in new property as opposed to the renovation of old property.
Job Tax Credits. Job tax credits typically offer an offset against tax liability if the company creates a specified number of jobs over a specified period of time. Sometimes, the new jobs will have to be “qualified” and approved by the state’s economic development office, allegedly to prevent firms from claiming that jobs shifted were jobs added. Even if administered efficiently, which is uncommon, job tax credits can misfire in a number of ways. They push businesses whose economic position would be best served by spending more on new equipment or marketing to hire new employees instead. They favor businesses that are expanding anyway, punishing firms that are already struggling. Thus, states that offer such credits score poorly on the Index.
Research and Development (R&D) Tax Credits. R&D tax credits reduce the amount of tax due by a company that invests in “qualified” research and development activities. The theoretical argument for R&D tax credits is that they encourage the kind of basic research that is not economically justifiable in the short run but that is better for society in the long run. In practice, their negative side effects—greatly complicating the tax system and establishing a government agency as the arbiter of what types of research meet a criterion so difficult to assess—far outweigh the potential benefits. To the extent that there is a public good justification for R&D credits, it is likely that a policy implemented at the federal level will be the most efficient since the public good aspects of R&D are not bound by state lines. Thus, states that offer such credits score poorly on the Index.Share