More Special Tax Incentives for Kentucky

January 16, 2006

Each year, many states add loopholes, or “tax incentives”, in their tax code for specific business sectors or specific companies, under the guise of promoting “targeted” economic growth. The latest comes from the state of Kentucky via today’s Lexington Herald-Leader:

This year, it’s a proposed sales-tax exemption on straw, wood shavings and sawdust. Last year, it was tax breaks on biodiesel fuel, pay-phone receipts and biotechnology products.

Every year, Kentucky lawmakers create new tax-law loopholes for businesses, adding to a long list of existing tax breaks that are intended to spur economic growth. The price tag: $571 million annually, according to one recent analysis.

However, legislators have no idea whether most of that forgone revenue actually creates or retains jobs as intended.

The article mentions three specific problems with these tax loopholes: foregone revenue, little economic growth, and little oversight of the policies.

“A lot of money is spent each year with very little scrutiny,” said Justin Maxson, president of the Mountain Association for Community Economic Development. “If legislators had a better understanding of how much is going uncollected, they might make different choices.”

The Berea-based community-development group recently made its own analysis, finding that 80 percent of the state’s business-tax breaks have no evaluation or reporting requirements. (Full Story)

The emphasis on little oversight in this specific case is justified. Little oversight of tax policies like these will lead to distortions in the decision making process. Specifically, the costs-benefit analysis that is required for these policies will have huge information gaps. The policymakers are unable to assess the true costs (i.e. foregone revenue and economic distortions), nor are they able to assess the true benefits (i.e. economic growth and higher employment goals). Obviously those special interests who are the beneficiaries of such policies may prefer the status quo, even if it is leading to policies that are not in the public interest.

The best tax policy that states can promote would not include these targeted tax policies for specific industries or companies, but rather a policy that taxes all industries equally and with a low rate; thereby promoting investment across the board and not distorting investment decisions.

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