Question of the Month: What mechanisms do states use to review the efficacy and/or oversee the use of their tax incentives for businesses?

States, meanwhile, are feeling the fiscal and political pressure to improve disclosure in their programs that provide tax breaks and grants to businesses.

Stateline Midwest Vol. 20, No.5: May 2011

The recent economic downturn has pushed states to find ways of attracting new businesses, retaining old ones and encouraging job creation, but at the same time, the fiscal crisis has put a premium on getting the most out of the grants and tax incentives that are offered to companies.

We have entered a new “accountability era,”professor Annette Nellen says. Perhaps the best examples of this were the unprecedented transparency and disclosure rules that allowed the public to track where federal stimulus money went and how it was spent. States, meanwhile, are being pressured to improve disclosure in their programs that provide tax breaks and grants to businesses.

“In a recession, incentives receive added attention from all stakeholders: lawmakers, businesses and consumers/voters,” Nellen, a professor on taxes and finance at San Jose State University, wrote in a 2009 article for the Journal of Multistate Taxation and Incentives.

Here is a look at some of the common strategies used by states to ensure that their investments are paying off; specific examples from the Midwest are also included.

  • Specify qualifications for a tax break/strengthen approval process — For a business to qualify for a tax break or incentive, a state often requires a company to meet certain criteria: wages paid, jobs created, health insurance and other benefits provided, capital investment made and taxes created. Nellen cites legislation passed by the Kansas Legislature in 2007 as an example of how this type of accountability often works. SB 240 provided a tax incentive for manufacturers meeting the following criteria: constructs a new plant with a cost of at least $100 million, hires at least 100 new workers, and pays higher-than-average wages. To make this more of a back-end accountability system, one idea for states is to provide the tax incentives only once the criteria have been met. Another way to ensure that the state’s goals are met is to strengthen the approval process. In Texas, for example, the governor, lieutenant governor and speaker of the House must OK all projects that receive money from the state’s Enterprise Fund.
  • Public disclosure and online accountability — One strategy increasingly being employed by states is the use of online transparency and accountability systems. These systems provide the public with company-specific information on the amount of the tax subsidy, comparisons on the number of jobs promised and the number of jobs actually created, wage levels for employees, and the company’s compliance record with various state rules and regulations. A December 2010 report by the group Good Jobs First (“Show Us the Subsidies”) singled out Illinois, Ohio and Wisconsin as having among the most robust online disclosure systems in the nation.
  • Clawbacks — These are penalties for businesses that don’t comply with the requirements of the tax incentive. According to Good Jobs First, Minnesota has an especially strong clawback law. First, all state and local subsidy agreements must contain clawback provisions. Second, the granting jurisdiction in Minnesota can recapture all or part of a subsidy, with interest, and any company that does not meet its contractual commitment can also be barred from future tax incentives.

Other common mechanisms used by states include placing sunset provisions in statute (so that tax incentive programs cannot continue without further legislative action) and the use of monitoring and performance audits.