Iowa Fiscal Partnership / Areas of Research / Budget / Amid Plans to Relax Limits, Business Tax Credits Grow
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Amid Plans to Relax Limits, Business Tax Credits Grow

Accountability Gap: Little Evidence Required to Demonstrate Effectiveness
IFP Backgrounder By Heather Gibney, Iowa Policy Project

Calls for reform of business tax credits followed Iowa’s scandal in the management of subsidies to the film industry.1 Little reform resulted. Now, just three years later, those calls for new limits have given way to Governor Branstad’s proposals to relax limits on spending through the tax code on business subsidies, mostly outside the budget process, and outside the view of Iowans. Tax credits are a significant part of the state’s subsidies to businesses, reflecting considerable political pressure to support tax credits as part of the normal state course of supporting business. The Governor’s recent deal to Egyptian fertilizer company Orascom is a prominent example, as over $100 million in tax credits2 were part of the $200 million in subsidies offered — illustrating, if nothing else, that whatever restrictions exist on the use and awarding of tax credits, they are not hindering their use.

Iowa is projected to spend $224 million on an array of business tax credits this fiscal year. Tax incentives and direct financial assistance are intended to support business growth by encouraging economic development, investments in new facilities, research, and job creation — new activity that would not have otherwise occurred. Whether these incentives accomplish those goals or are cost-effective remains largely unknown. Yet they continue to grow. Table 1 shows how much the state has spent on the 20 business tax credits for the past three fiscal years, and the projected spending for this year and next.

Table1-credits2010-14While General Fund revenue has increased since the end of the recession, credits have grown more quickly. Credits more than doubled from FY2005 to FY2012 while General Fund revenue increased by 28 percent during that same period. As a result, total business tax credits increased as a percent of General Fund revenue — from 2.1 percent in FY2005 to a projected 3.44 percent by the end of FY2013.3 (Figure 1.) Fig 1 tax credits grow as share of revenueThe continued growth of Iowa’s business tax expenditures is largely the result of new or expanded credits, increased spending without accountability, sizable uncapped credits, limited review of credits, and no required authorization by the General Assembly.

Iowa has two categories of tax credits: automatic and awarded. Awarded credits require an application and a specific award for a taxpayer to claim the credit. The total amount of awarded credits may also be capped or uncapped. (Table 2) Capped credits must not exceed a certain dollar amount in any year. Automatic credits may be claimed by any eligible taxpayer, with no specified limit on the amount of claims.4

Several Iowa Business Tax Credits Have No Cap on Cost, and Happen Automatically

Business credits don’t require annual authorization or scrutiny by the General Assembly to evaluate their specific value or public purpose once they have been established, as do appropriations for program expenditures or state grants.5 This can lead to excessive or unexpected spending through the tax code when credits are used to a far greater extent and for different purposes than originally intended. Even when the credits meet the criteria originally set, they may go to businesses that would have grown and developed without them. 6

In FY2012 businesses claimed $136.7 million in uncapped credits and $70.8 million in capped credits — a considerable increase from the $70.9 million in uncapped credits and $33.5 million in capped credits spent in FY2005. Governor Branstad is proposing an increase in the global credit cap for the FY2014 budget. Six economic development credits are under the global cap, currently $120 million, which the Governor wants to raise to $185 million — reversing one of the few reforms actually passed in 2010.7 These credits are all awarded by the IEDA.8

The six credits are:
• Enterprise Zone Program
• High Quality Jobs Program
• Redevelopment Tax Credit
• Venture Capital Tax Credit-Innovation Fund
• Venture Capital Tax Credit-Qualified Business or Community-Based Seed Capital Fund
• Assistive Device Tax Credit

The Governor’s proposal estimates this change would reduce General Fund Revenue by $1 million in FY2014 and $3.9 million in FY2015, with the majority of the potential $65 million annual impact on the General Fund to occur in fiscal years after FY2015.9 The Governor is also recommending raising the cap on the Endow Iowa Tax Credit from $3.5 million to $4 million. This change is estimated to reduce General Fund revenue by $200,000 in FY2014 and $400,000 in FY2015.

In addition to businesses credits, some business subsidies are appropriated by the Legislature. When proposed, this kind of financial assistance for a specific program is part of the yearly appropriations process — and not included as part of capped or uncapped credits. For FY2014, the Governor proposes a $19 million cash incentive for the High Quality Jobs Program that would be allocated from the General Fund. 10

Little Progress Has Been Made Reforming Credits

A serious effort was made in 2010 to review all of Iowa’s tax credit programs and identify needed reforms. Then-Governor Chet Culver appointed a seven-member Tax Credit Review Panel, which analyzed the major provisions of each tax credit and made recommendations based on assessments of the costs and benefits, oversight and responsibility, and performance.11

The first recommendation of the panel was to provide greater transparency of tax credits by having the Revenue Estimating Conference (REC) make available the types and amounts of tax credit claims that it includes in its Tax Receipts calculation. This would allow state policy makers and the public to clearly see the impact of tax credits on the General Fund budget. Currently, the REC calculates revenues based on the information in the Iowa Department of Revenues Contingent Liabilities Report, but it does not list the types and amounts of each tax credit in its reports.

The second recommendation was to eliminate the transferability provisions of all tax credits — a provision that still remains for six credits. Recipients of certain credits whose tax liability is less than the credit can sell the credit at a discount to Iowans who do owe income taxes. This can lead to an ineffective tax credit program as it complicates the projection of revenues and the tracking of credits, and creates uncertainty about when the credits will be claimed because the entity that purchased the credit may utilize a different fiscal year than the entity awarded the credit.12 When a credit is sold, it is difficult to follow who actually benefits — the buyer may not be in the same industry as the seller, and the credit can wind up subsidizing activity that is completely unrelated to the original target and may contradict other public policy goals.13

The panel’s third recommendation was to develop an effective return on investment calculation for each tax credit. Thus far, however, only one has been fully developed — for the state’s High Quality Jobs Program.14 The process of calculating a return on investment for each tax credit is still incomplete and inconsistent. Without an effective return on investment calculation, the state cannot know how effective tax credits have been and what changes should be made.

As part of the state establishing more accountability to the taxpayers, the panel recommended a five-year sunset on all tax credits. This provision was not imposed on any credit; however, six tax credits are scheduled for repeal in the next eight years. Establishing a five-year sunset would require policy makers to affirm the value of a credit, encouraging them to evaluate each tax credit and determine whether the original economic development purpose remains relevant.

To enable the state to manage its General Fund budget more effectively, the panel recommended capping all credits. Currently, seven business tax credits have no individual cap and are not included under the global cap; this includes two of the largest credits, the Research Activities Credit and the Iowa Industrial New Job Training Program.

The panel recommended elimination of six business tax credits as not being fully used and no longer necessary because of changing economic conditions — four have been repealed. Two targeted credits that remain include the Assistive Device and Qualified Business or Community-Based Seed Capital Fund.

Overall, few of the panel’s recommendations were enacted. Subsequent attempts to curb tax expenditures have met strong opposition.

Tax Expenditure Committee

In response to concerns raised by the review panel, the Legislative Tax Expenditure Committee was created in 2010 under Senate File 2380 to provide greater oversight of tax expenditures.15 This committee is composed of 10 members of the General Assembly (five members from each chamber) appointed by the Legislative Council. The purpose of the committee is to evaluate tax credits for their original purpose and to conduct a review of all credits over a five-year period — assessing their equity, simplicity, competitiveness, public purpose, and adequacy. They also are tasked with estimating the cost of each tax expenditure every fiscal year as well as the total cost of all tax expenditures.16

To date, the committee has reviewed the following business credits: High Quality Jobs, Research Activities, and Targeted Jobs from Withholding, as well as reviewing the Fund of Funds. The committee has met twice — in the Fall of 2011 and the Fall of 2012, but has not made major recommendations for changes to any tax credits that it has examined. The Iowa Department of Revenue has prepared a number of reports on various tax expenditure programs; those have provided more in-depth information about their use.

Many of Iowa’s business tax credits are designed to promote specific businesses or benefit specific firms, which run counter to a number of fundamental tax principles related to simplicity, fairness and economic efficiency. Even conservative organizations such as the Tax Foundation argue against providing special tax exemptions and credits for specific economic activities, considering them distortions to a free market with the potential to unfairly advantage one business to the detriment of another. Further, large increases in credits for businesses results in decreased tax liability, often for the benefit of a few firms and individuals who already are economically prosperous — and this decrease in General Fund revenue available to fund education, human services, health care, workforce development, environmental protection, and other economic development programs serving the larger public. Many of the state’s vital services are still not funded at pre-recession levels and proposed increases are less than what can be expected in a time of recovery. Yet business credits continue to increase faster than revenue.

The connection of tax expenditures to debates about budget choices is something the General Assembly and Governor must acknowledge. Tax expenditures have the same overall impact on state budget choices as do direct appropriations. Before adding new tax expenditures or raising the caps on those that exist, Iowa lawmakers would do well to return to the findings of the most comprehensive review in the last decade, that of the Tax Credit Review Panel, and address these issues anew.

[1] “Tax Credit Reform Glass Half-Full? Maybe Some Moisture,” Iowa Fiscal Partnership, March 23, 2010. http://www.iowafiscal.org/2010docs/100317-IFP-analysis.pdf
[2] “Branstad, Reynolds Celebrate Largest Capital Investment in Iowa History,” Office of the Governor, September 5, 2012.
http://www.iowaeconomicdevelopment.com/NewsDetails/5496.
[3] Author’s analysis of tax credit figures from 2005-2015 Contingent Liabilities Report, Iowa Department of Revenue.
http://www.iowa.gov/tax/taxlaw/0313RECReport.pdf.
[4] Tax Credit Contingent Liabilities Report, Iowa Department of Revenue, March 22, 2013.
http://www.iowa.gov/tax/taxlaw/0313RECReport.pdf.
[5] “Seduction: The Disaster Story of Iowa’s Film Tax Credit,” Iowa Fiscal Partnership, October 8, 2009.
http://www.iowapolicyproject.org/2009docs/091008-ifp-film.pdf.
[6] Charles Bruner, Peter S. Fisher, “Business Tax Credits and Expenditures 101: A Primer on the Economics of State Subsidies to Promote Iowa Economic Development,” Iowa Fiscal Partnership, February 1, 2010.
http://www.iowafiscal.org/100204-taxcredits101.html.
[7] Author’s analysis of tax credit figures from 2005-2015 Contingent Liabilities Report, Iowa Department of Revenue.
http://www.iowa.gov/tax/taxlaw/0313RECReport.pdf.
[8] Tax Credit Contingent Liabilities Report, Iowa Department of Revenue, March 22, 2013
http://www.iowa.gov/tax/taxlaw/0313RECReport.pdf.
[9] “Preliminary Summary of the Governor’s FY2014 Budget Recommendations,” LSA, Fiscal Division.
https://www.legis.iowa.gov/DOCS/lsaReports/BudgetAnalysis/Archives/FY%202014%20Prelim.pdf.
[10] “Summary of the FY2014 Budget and Governor’s Recommendations,” LSA Fiscal Division.
https://www.legis.iowa.gov/DOCS/lsaReports/BudgetAnalysis/Archives/FY%202014.pdf.
[11] State of Iowa Tax Credit Review Report, Department of Management, January 8, 2010.
http://www.dom.state.ia.us/tax_credit_review/files/TaxCreditStudyReviewReportFINAL1_8_2010.pdf.
[12] State of Iowa Tax Credit Review Report, Department of Management, January 8, 2010.
http://www.dom.state.ia.us/tax_credit_review/files/TaxCreditStudyReviewReportFINAL1_8_2010.pdf.
[13] Jennifer Weiner, “State Business Tax Incentives: Examining Evidence of their Effectiveness,” New England Public Policy Center, December 2009.
http://www.bos.frb.org/economic/neppc/dp/2009/neppcdp0903.pdf.
[14] Lee Rood, “Have State Tax Credits worked for Iowa?” Des Moines Register, November 16, 2011.
http://www.public.iastate.edu/~nscentral/mr/11/1118/monitor.html.
[15] Notes on Bills and Amendments: Tax Credit Reductions and Review, Senate File 2380, LSA, March 17, 2010.
https://www.legis.iowa.gov/DOCS/LSA/IntComHand/2012/IHMJD000.PDF.
[16] Background on Senate File 2380, Legislative Tax Expenditure Committee, LSA, Fiscal Division.
https://www.legis.iowa.gov/DOCS/LSA/IntComHand/2012/IHMJD000.PDF.

 

Heather GibneyHeather Gibney is a research associate for the nonpartisan Iowa Policy Project, where she focuses on state fiscal issues and their effect on working families. She received her master’s degree in Public Policy from the University of Northern Iowa and undergraduate degrees in Psychology and Criminal Justice from the University of Iowa and Mount Mercy University.

The Iowa Fiscal Partnership is a joint budget and tax policy initiative of two nonpartisan, Iowa-based organizations, the Iowa Policy Project in Iowa City and the Child & Family Policy Center in Des Moines. Find IFP on the web at www.iowafiscal.org.

 

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