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New state laws strengthen oversight of tax incentives

by Laura Tomaka ~ November 2015 ~ Stateline Midwest »
In the final weeks of this year’s legislative session, Minnesota Rep. Bob Barrett worked successfully to secure $100,000 in state funds for a city in his home district. The money, which came from an existing economic development program, aims to help the city lower taxes and be more competitive within the state, as well as with neighboring Wisconsin.
But as Barrett’s appropriations request made its way to final passage, he had to answer questions from colleagues. What will prevent you, the Minnesota Senate chair asked Barrett during conference committee, from coming back next year and requesting even more money?
“If this money doesn’t do what it’s intended to do, then I won’t be coming back,” Barrett told fellow legislators. “But if it works, and we [create] new jobs, new businesses, new property taxes in my area, that would be telling you that it was money well spent, and I will be coming back and asking for more.”
This same bottom-line, results-oriented approach is also behind Barrett’s support of a new law in Minnesota (part of SF 888) that calls for greater legislative scrutiny of the state’s various tax-incentive programs.
Whether it’s $100,000 for a city or millions of dollars for a business, he wants more accountability: Track how government is spending its money, and evaluate what is working and what is not.
“We give out an awful lot of money,” Barrett says, “and I want to know how well that money is being used.”
With the new law in place, Minnesota’s legislative auditor will evaluate at least one major tax incentive program each year. The auditor will also study “exclusive incentives” — those packages given to specific companies or projects. (One notable example of a recent “exclusive incentive” was the nearly $500 million in state and local subsidies for a new Minnesota Vikings stadium.)
Over the past 30 years, business incentives have become a significant part of state and local economic-growth strategies across the country. Every U.S. state, in fact, has at least one program that offers tax or financial incentives to businesses as a way to encourage job creation and growth.
In 2012, a New York Times investigation found that, collectively, state and local governments spend $80 billion annually on business-incentive programs.
“Many of these incentives operate as automatic features of the state tax code, and they don’t really get evaluated in the same way that an expenditure program would,” says Peter Fisher, research director of the Iowa Policy Project.
As long as states are competing against each other for business activity and jobs (and local governments are doing the same), these programs will be part of economic development strategies. But the new law in Minnesota reflects a trend in state legislatures across the country: Lawmakers are demanding more oversight and accountability.
Demanding results, information
According to the Pew Charitable Trusts, 17 states — including Indiana, Minnesota, Nebraska and North Dakota in the Midwest — have passed laws since 2012 requiring a formal evaluation that analyzes the effectiveness of individual incentive programs.
“It’s really been a nationwide movement to get better information about the results,” says Josh Goodman, a Pew researcher.
“[Legislators] wanted to know how many jobs these programs are creating, if there are better ways to design them, and whether they are worth the price.”
To be “worth the price,” the incentive must change the behavior of businesses — “to do something they otherwise wouldn’t have done,” Goodman says. States must also measure whether the incentives are matching the underlying goals of their economic development programs.
“What are you trying to achieve?” asks Goodman. “Are you trying to create the most possible jobs, or are you trying to create high-quality jobs that are defined by different measures? Are you targeting some specific industry for some reason?”
All of those metrics must be considered, Goodman says, when developing an evaluation program.
Nebraska, which spends a considerable amount of money on its various business incentives (see table on this page), is now in the beginning stages of implementing a new review process. Two years ago, the Legislative Audit Office said the lack of clearly stated goals in the state’s incentive programs made it difficult to evaluate results.
The Legislature responded one year later by rewriting the Nebraska Advantage Act, which had provided $130 million in tax credits and refunds to businesses between 2006 and 2012. With clearer objectives now written into the law, legislators acted this year to improve oversight.
LB 538 requires the Audit Office to review each of the state’s eight major tax incentive programs at least once every three years. Those programs include the Nebraska Advantage Act, an angel-investment tax credit, a beginning-farmer tax credit, rural development tax credits, and research and development incentives.
“Whether it’s so many dollars per job or a benefit to an employer or a benefit to the state or a community, we are trying to put some dollars on [the return coming from the incentive programs],” says Nebraska Sen. Dan Watermeier, chair of the legislative committee that sponsored LB 538.
Under Nebraska’s new law, too, the state will compare the existing programs and their results to other policy options and funding alternatives.
“We need to not only prove that the tax incentives work, but when there is a new incentive brought forward, we can use this as a baseline to show what is getting good results,” Watermeier says. “If we need to create a new incentive, then we have the background to say why, and when the public asks about the dollars that are invested, we’ll be able to answer.”
The higher level of scrutiny, he adds, will put more pressure on legislators to create sound incentive programs in the first place.

Learning from past tax incentives
In 2013, Indiana legislators eliminated nine of its smaller economic development programs, the result of a state study showing that some state incentives were ineffective and/or underutilized. The following year, Indiana lawmakers passed a bill (HB 1020) requiring that each of the state’s incentive programs be evaluated for its economic impact every five years.
This analysis must include a calculation of the return on investment, a cost-benefit comparison of the foregone revenue and shifted tax burden, an estimate of the number of jobs created, and an assessment of whether the incentives have met program goals.
“If you want to see a state that’s done a really good job in their evaluations, thinking through the whole question of what happened because of the incentive and what would have happened anyway, Indiana’s a great example of that,” Goodman says.
As Indiana Sen. Brandt Hershman noted earlier this year in an article written for Stateline Midwest, “The only way to know [whether tax incentives are working] is to be data-driven and vigilant.”
“Any tax incentive can outlive its usefulness,” he wrote of the importance of completing routine evaluations. “Policies that were once effective in encouraging growth or attracting jobs could lose their appeal due to changes in the economy.”
According to Fisher, these state evaluations should be timed to coincide with the sunset of a tax-incentive program. Legislators did this in Nebraska, a move that Watermeier says will help guide future decision-making.
“Now we know if we have a sunset coming and if we don’t like [an incentive program], we can let it sunset,” he says. “We [will] have the background to say the metrics are showing whether it’s actually effective.”
In Minnesota, Rep. Barrett says, the state’s increased scrutiny of tax incentives will allow legislators to revisit — and learn from — policies of the past.
“Too often we don’t look backward at previous laws and at whether those laws have actually accomplished the [intended] goals,” he says.
This doesn’t meant a state will “undo” an incentive or subsidy already set aside for a specific company or project. But as part of its evaluation, the Minnesota Legislative Auditor’s Office will create a report on best practices for targeted or “exclusive” incentives.
“This is a good-government effort,” Barrett says. “We are trying to do government better, more efficiently, more economically. We are trying to spend the money where it should be spent, and it’s a model that could be used in all areas of government.”

 

Article written by Laura Tomaka, CSG Midwest staff liaison for the Midwestern Legislative Conference Economic Development Committee.