The Unseen Costs of Tax Cronyism: Favoritism and Foregone Growth

8/12/2019 The Unseen Costs of Tax Cronyism: Favoritism and Foregone Growth

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A PUBLICATION OF THE AMERICAN LEGISLATIVE EXCHANGE COUNCIL

STATE

FACTOR

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alec.org

The Unseen Costs of Tax Cronyism: Favoritism andForegone GrowthBy William Freeland, Ben Wilterdink and Jonathan Williams

Executive Summary

olicymakers across the country con nue to look for the best poli -cies that will encourage more businesses to invest in their state. Aslawmakers consider tax reform, they should reference the guiding prin -ciples outlined in the ALEC Principles of Taxa on , which include fairness,transparency and compe veness.

Policymakers looking to enhance economic prosperity in their statesface two diametrically opposed strategies with respect to their taxcodes. They can embrace low, broad-based taxes with zero or minimalcarve-outs and special preferences. This approach, referred to by thispaper as the growth through markets, provides all businesses, large andsmall, with an equal opportunity to grow. On the other hand, policy -makers can embrace cronyism by providing certain businesses and in -

dustries with special targeted tax breaks and tax carve-outs. The growththrough central planning approach gives some businesses an unfair ad -vantage over others.

The stakes of ge ng this policy choice right are high. States that followthe growth through markets approach create an economic environmentthat encourages job growth, income growth, entrepreneurial opportu -nity and broadly shared prosperity.

Cronyismthe perversion of sound economic policy to create a systemthat bene ts one rm or industry at the expense of all othersis a

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serious public policy problem. Cronyism in tax policy is no excep on. Its es compe ve tax policy by precipita ng tax rate increases on the

rms not in favor with policymakers, subverts market outcomes for in -ferior economic planning, and introduces a deep tempta on for publiccorrup ons.

In the most recent year in which each state published their respec vetax expenditure reports, the sum of tax carve-outs was as follows: $228billion for personal income and businesses earnings tax exemp ons and$260.1 billion in sales tax exemp ons. This gure largely ignores target -ed tax breaks by states to individual businesses, which The New York

JULY 2014

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2 AMERICAN LEGISLATIVE EXCHANGE COUNCIL

THE STATE FACTOR

Times reports total 157,072 speci c grants to rms over the past twodecades.

Crucial to policymakers e orts to rout out cronyism in the tax code isunderstanding what it is, what it is not, why it is unsound policy, why

it should be abolished and incremental steps to ending it in state gov -ernment. A er cataloguing the nature of cronyism and establishing itspervasive problems, this report suggests the following:

1. Eliminate tax cronyism in a revenue-neutral fashion, or as partof broader tax cuts. A emp ng to close o these tax carve-outswithout decreasing tax rates elsewhere can be a devasta ng blowto rms and does li le to improve a states compe veness.

2. If tax cronyism is not completely eliminated, remove cronyismfrom the tax code and put it on the budgetary side of the scalledgermake the program budget-based, cash payouts insteadof elements of the tax code that reduce a rms tax burden. Thisincreases revenue certainty and budgetary transparency.

3. Subject exis ng tax cronyism to rigorous repor ng standards toensure transparency, and conduct a cri cal analysis of whetherthese measures are crea ng tangible economic growth over andabove their true economic cost.

Rou ng out cronyism is essen al to ensure that economic growth ismaximized and government truly operates with the publics trust. Everystate has these types of carve-outs in their tax codes to some degree,meaning that every state economy is held back, at least to some extent,from achieving their true poten al for economic growth. This guide forpolicymakers describes a path to a tax code that provides equal oppor -tunity for all and unleashes economic development based on powerfulmarket mechanisms, not inferior centralized economic planning.

Dening Tax CronyismCronyism refers to the use of public policy to bene t a speci c industry,

rm, or individual, as opposed to se ng broad and generally applicablerules and policies that apply to society as a whole. 1 It is rooted in thebelief that reliance on government planning to direct economic ac vitywill result in greater economic prosperity than free markets can achieveon their own. As economist David Henderson, editor of the Encyclope -dia of Economics, de nes it: 2

Cronyism is the subs tu on of poli cal in uence for free markets.

It comes about when government has a lot of power over pri-

vate-sector decisions and when the government o cials in powerhave great discre on over how to use it.

It is worth no ng that the prac ce of businesses u lizing exis ng taxcarve-outs to reduce their tax burden is not tax evasion. Though somehigh tax proponents like to use the term tax avoidance to suggest mal -feasance on the part of companies using tax preferences for which theyqualify, the charge is wholly disingenuous. These carve-outs are dem -ocra cally passed by lawmakers with the explicit purpose of loweringthe tax burden for select rms or industries. Fundamentally, lawmak -ers have the power to pass or repeal these provisions. Although rms

ac vely lobbying for these carve-outs (as opposed to passively qualify -ing for them) introduces a di erent moral calculus, businesses shouldgenerally not be vili ed or blamed for tax cronyism. The key issue restswith the policymakers who introduce these laws.

Moreover, general, across-the-board tax cuts done through corporateand personal income tax rate reduc ons certainly do not qualify as cro -nyism. General cuts do not favor a speci c rm or industry and conformto the general principle of sound tax policy, which holds that the meansof raising government revenue should not tax the returns of produc velabor in any formwages, investment returns and business pro ts. 3 This is because taxing produc ve ac vity lowers the real return of theproduc ve behavior and therefore results in less produc ve behaviorbeing undertaken by society.

Types of tax policy cronyism may include:

1. Targeted tax breaks or cash subsidies for speci c rms granted by

so-called economic development agencies.2. Preferen al tax treatment for rms located in a given geographic

area and mee ng numerous other quali ca ons.3. Puni vely high or special taxes on some rms or industries that

compe vely disadvantage them rela ve to other rms or indus -tries.

4. Tax carve-outs that bene t certain industries or groups rela ve tothe rest of the tax base.

Although the speci c nature and extent of tax cronyism varies fromstate to state, it is a feature of all 50 states tax codes. Similarly, elementsof tax cronyism are generally supported by poli cians on both the leand the right, though the speci c policies tend to di er. Conversely,there are poli cal reformers on both the le and right who decry thespecter of tax cronyism and call for a policy of tax neutrality.

Much of the debate about tax cronyism surrounds a central disagree -ment about the nature of economic development and the facilita on ofeconomic growth. The camps can be described as follows:

Growth Through Central Planning: Those in this camp believe that taxcompe veness is less about having generally low tax rates across theboard, and is instead about policies that a ract and assist key industriesand large rms. The hope is that many businesses and industries willcon nue to operate in a given state despite an uncompe ve tax struc -ture due to a mixture of factors not related to tax policy. Meanwhile, a

Routing out cronyism is essential

to ensure that economic growth ismaximized and government trulyoperates with the publics trust.


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THE STATE FACTOR 3

T H E U N S E E N C O S T S O F TA X C R O N Y I S M : FAV O R I T I S M A N D F O R E G O N E G R O W T H

few select rms and industries not currently residing in the state willchoose to relocate to the state if incen vized to do so. Members of thiscamp believe prudent, central government planning can maximize therevenue collected from rms currently residing in the state while com -pe ng for new rms considering reloca on or expansion.

Growth Through Markets: This camp holds that choosing to introducetax policies that are favorable to a few large rms, rather than imple -men ng compe ve tax policy for all rmswhether currently exis ngor soon to be started by entrepreneurshurts a states growth poten -

al. Government does not know which rms will provide innova on,employment growth, wage growth and tax revenue growth for thestate. Empowering government to cater to a few high-pro le rms whilenot xing underlying problems in the tax code is poor policy, as policy -makers and bureaucrats are unlikely to outperform diversi ed marketperformance rela ve to their narrow picks.

The merits of these two models will be discussed with great depth later

in this paper. But it is important to acknowledge in the context of de n -ing and cataloguing tax cronyism that the de ni on tends to be subjectto a disagreement about what the role of tax policy is. To the extent anindividual believes a tax provision has some sort of legi mate goal, he orshe is less likely to dismiss it as cronyism. That said, as a rst approxima -

on, it is fair to consider cronyism any policy that deviates from broad,neutral tax bases.

Exceptions to Tax CronyismStepping beyond the general de ni on, there are discrepancies in whatmany choose to categorize as cronyism. Cronyist carve-outs are o encompared against a broad, neutral and economically sound base from

a public nance perspec ve. However, tax measures that a empt toachieve the proper tax base are in no sense cronyist. Addi onally, taxmeasures that seek to advance an -poverty policy in a neutral fashionlikely should also be excluded from cronyist considera on.

Business and Investment: Getting the Tax Base RightBusiness-to-business transac ons are one glaring example of so-calledtax carve-outs that empha cally do not t the de ni on. States thatu lize the sales tax vary in the degree to which they exempt busi -ness-to-business transac ons. As the Council on State Taxa on (COST)has noted, taxing business-to-business transac ons leads to distor on -ary tax pyramiding, where value is taxed mul ple mes along the pro -duc on chain, which increases the e ec ve rate of taxa on unevenly

on nal goods.4

First, this is problema c because as COST notes, Asales tax on business inputs is an addi onal cost of doing business inthe state, which companies must either a empt to pass on to their cus -tomers or reduce their economic ac vity in the state. Second, becausethe tax compounds on itself as it moves through addi onal stages ofproduc on, it distorts economic ac vity and disadvantages rms downthe produc on chain, as well as products with many stages of produc -

on and inputs. As such, exemp ng business-to-business transac on isnot cronyism but simply an economically appropriate way to establisha tax base.

There is a narrow category of business exemp ons that should also beexcluded from the category of tax cronyism beyond business-to-busi -ness transac ons. Research and development, accelerated depreci -a on, and full expensing of business capital investment, for example,are tax exemp ons that allow businesses to deduct legi mate business

expenses from their taxable earnings. Moreover, though they do tend tobene t companies that more heavily engage in research and develop -ment or capital investment, the idea is to incen vize all rms to investmore robustly in expansion. These policies are equally available to all

rms that choose to invest. They essen ally do not discriminate againstrms or industries, and instead advance the broad and neutral goal of

enhanced economic growth and innova on through research and devel -opment and capital investment of any form by enterprising rms. Mostnotably, they largely cannot be considered a form of economic planning.

Along these same lines, although the so-called preferen al rate on in -vestment income (capital gains, interest income and dividends) is some -

mes considered a tax carve-out, it should be excluded from this cate -gory. As with research and development, accelerated deprecia on, and

full expensing of business capital, the lower rate on investment incomeis available for all taxpayers and exists for the legi mate purpose of in -cen vizing increased investment. This investment has massive dividendsto all of society in terms of innova on, business hiring and wage growth.Moreover, much of the the investment income generated by corporateen es for the their equity holders has already been taxed under busi -ness income taxes. As such, the lower rate on capitol income serves tocorrect this double taxa on.

Anti-Poverty ProgramsSome exemp ons that assist low-income individuals are di cult to labelas cronyism. The earned income tax credit and child tax credit are two

key examples. Both of these credits do not clearly bene t any rm or

industry rela ve to the rest of the tax base. They do, indeed, narrowthe base and bene t a speci c class of individuals, but they are clear -ly a ma er of social assistance and have no par cular exigent policyobjec ve such as economic growth, promo ng alterna ve energy, oradvancing home ownership. It is true that there is disagreement amongeconomistspar cularly those with a strong free-market, limited-gov -ernment orienta onon the prudence of these credits rela ve todirect cash assistance or greater reliance on private charity for socialassistance. These bene ts, like most policy objec ves, are best tackledthrough the spending side of the scal ledger, not the tax code. But giv -en that they dont t the mold of cronyism, they will be set aside for thepurpose of this paper.


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Charitable income tax deduc ons and charitable en es tax-free sta -tuses, rightly constructed, belong in the same category as the earnedincome tax credit. Structure is the key issue in deciding whether apar cular charitable deduc on or tax-free charitable status is cronyist.Properly structuring charitable status means avoiding gran ng tax ex -

emp ons to organiza ons and the en es funders if the organiza on isfor all intents and purposes a business and in compe on with for-pro ten es in the marketplace. 5 Instead, these organiza ons must have astrictly charitable purpose. Given this proper structure, these tax ex -emp ons also fall into the category of social assistance and thereforeare largely not cronyism. Any taxpayer, regardless of status, can takeadvantage of the credit as it suits his or her nancial situa on. Similarly,any truly charitable en ty can qualify to bene t and can enhance socialwell-being broadly without falling under the cronyist label. Last, like theearned income tax credit, some can take issue with whether the credit isthe op mum means of achieving a given social policy, but it also is truethat it is largely not cronyism if properly implemented.

Not all exemp ons from the tax base designed to help low-income ci -zens deserve excep on from the cronyist label. Exclusions of goods andservices that are not business inputs largely provide unjust enrichmentto speci c industries, distort consumer behavior by changing a er-taxprice di erences between consumer purchases taxed di erently, ando en arbitrarily bias the prospect of business success between rmsand industries that largely provide the same nal consumer value. Al -though these exemp ons are o en jus ed as helping low-income indi -viduals, be er policies such as direct cash assistance, the earned incometax credit and keeping taxes low generally can be er assist low-incomeindividuals without crea ng economic distor ons or picking winnerindustries or rms. Given these sales tax exemp ons favor speci c prod -ucts, rms and industries rela ve to the rest of the tax base, they are

appropriately considered cronyist tax policy.

With these few excep ons established, it should be noted that the ex -cep ons largely make the rule. Nearly every exemp on in the code thatdoes not narrowly seek to construct the appropriate tax base from aneutral perspec ve should rightly be considered cronyism. This includesnumerous popular deduc ons and metaphorical sacred cows. As ageneral rule, if paying a tax entails more than providing an income orpro t gure, property value or cost of goods purchased, that tax likelyinvolves cronyist tax carve-outs.

Tax Cronyism in America: The Figures

Given the broad and unwieldy nature of tax cronyism in America, it isdi cult to se le on a speci c gure or even determine a rela ve es -mate for how much in cronyist tax carve-outs are realized each year ineach state. This issue is further compounded by poor repor ng of taxcarve-outs and a general lack of transparency regarding tax cronyism.

On the federal level, exemp ons in the personal and corporate incometax code are me culously scored and recorded annually by the JointCommi ee on Taxa on (JCT). The JCT goes through the totality of thecorporate and personal income tax codes, acknowledges all tax expen -ditures (the economic terms for carve-outs in a taxes base) rela ve to

the base and provides a line item score for each item it de nes as acarve-out. This includes items that are not o en considered tax carve-outs but certainly should register as such (the exemp on for employersproviding health care bene ts, for example), and carve-outs that areperhaps not true exemp ons (the preferen al rate on investment

income, for example). In addi on to the individual line item costs, thetotality of tax carve-outs in both the personal and corporate income taxcode is totaled in sta c format. Ideally, these gures would be calcu -lated dynamically because these credits have interac ons between therelated taxpayer quali ca on for credits and behavioral e ects, thus itis not strictly correct to sum the individual line items. But, given that

gures for aggregate es mates of tax carve-outs accoun ng for dynamice ects are not provided, sta c gureswhich serve as es mates onlyare the most useful data available. In the 2014 Fiscal Year, the sum ofTreasury Department es mates for corporate and personal income taxcarve-outs is $158 billion and $1.146 trillion, respec vely. 6

Unfortunately, the 50 states repor ng on these tax expenditures in the

personal and corporate income tax, along with the sales tax or otherstate taxes, o en does not come close to the repor ng of the JCT at thefederal level. The reports vary widely regarding which taxes the stateuses to calculate carve-outs, what credits are excluded (and their cri -teria for exclusion), how o en the reports are issued and whether theyare even issued at all. A diverse array of policy organiza ons have be -moaned the poor repor ng and the general lack of transparency, includ -ing the American Legisla ve Exchange Council (ALEC), the Tax Founda -

on, the Cato Ins tute, the Center for Budget and Policy Priori es andthe Ins tute for Taxa on and Economic Policy. 7 As such, it is tough to geta solid gure from most states, let alone a total gure for all the states.

Figure 1 (see pages 6-9) a empts to look at the most recent year of tax

expenditures in all 50 states. It is worth no ng that these gures arenot strictly comparable between states. Some states exclude many tax -es from analysis en rely. States have di erent types of carve-outs thatthey include and excludefor example, Arizona includes a credit valuedat $703.00, whereas California excludes repor ng on all credits valuedat less than $5 million. Some states tax expenditures are on scal yearcalendars and some are on standard calendar years. The most recent

year available di ers widely, and some states have no recent reportsat all, or worse s ll, have never issued a report. Figure 2 details thosestates with irregular or severely incomplete repor ng.

Figure 2: States with the Worst Repor ng on Tax Carve-Outs

Source: ALEC research based on available tax expenditure reports

No Report Infrequent or Incomplete

Alabama Arkansas

Alaska Hawaii

Nevada Missouri

South Dakota North Dakota

Wyoming South Carolina

Virginia


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THE STATE FACTOR 5


Therefore, these numbers are baselines for the purpose of consideringthe extent of carve-outs in the respec ve states tax codes. They arelimited to the quality of state repor ng, which is frequently poor. Theyshould be considered as gures for one year, not comparable to otherstates, and with all appropriate context and caveats. That said, the most

recent year of data provides a rela ve baseline of what states pay incarve-outs. This paper a empts to o er as much informa on and ap -propriate caveats as possible to provide analysis and details of statesrepor ng standards. This includes what taxes are not included in theanalysis, the criteria for not repor ng a speci c exemp on, whether theexemp on of services from the sales tax base is included and whetherfederal tax conformity is included. Federal tax conformity is the cost oftax expenditures created by the federal government for federal corpo -rate and personal income taxes with which states choose to conformtheir own tax codes. Property tax exemp ons are not included becausethey are inconsistently treated as state or local taxes. This data can beseen in Figure 1.

There are a few caveats related to Figure 1. For all gures that includethe expenditure total as a percent of total state expenditures, the taxexpenditure year is matched to the appropriate scal year. If the ex -penditure report is a calendar year and revenue is based on the scalyear, the average of the two revenue reports that the expenditure re -port overlaps is taken. Most importantly, as noted above regarding thefederal report, aggrega ng credits in sta c fashion without accoun ngfor interac ons in dynamic form is not accurate, so these gures arees mates. This paper does not a empt to exclude the tax exemp onsargued in the previous sec on are not true tax carve-outs, or make anyother adjustments. Instead, the analysis simply totals the results of eachstates own self-repor ng, without altera on due to incomplete and in -consistent repor ng. Please review Figure 1 table notes for addi onal

context and explana ons.

Summing the extent of tax expenditures in each state in the most recentyear the state reported those expenditures yields the following totals:$228 billion for personal income and businesses earnings tax exemp -

ons and $260.1 billion in sales tax exemp ons. These gures are sub - ject to the previously men oned repor ng shortcomings.

Figure 1 also details whether the state documents the policy ra onalefor various tax carve-outs and whether the state conducts a perfor -mance review. An addi onal transparency issue from which tax carve-outs su er is the lack of performance repor ng. Tax carve-outs o enhave no clearly stated goal. For those that do have a goal, the goal is not

associated with clear metrics to evaluate how well the credit accom -plishes that goal, nor do states engage in regular analysis to determinehow well carve-outs are accomplishing their stated goals. Moreover,even when analysis is conducted, it o en su ers from numerous awsof economic analysis. This paper was therefore unable to chronicleperformance of tax carve-outs by state as part of its analysis. The PewCenter on the States has a seminal report on the topic, tled EvidenceCounts, that chronicles the speci c issues and shortcomings across thestates with painstaking detail. 8

States # of Grants to Companies

Alabama 1,732

Alaska 50

Arizona 2,430

Arkansas 489

California 2,696

Colorado 324

Connec cut 293

Delaware 681

D.C. 44

Florida 1,804

Georgia 261

Hawaii 416

Idaho 253

Illinois 1,941

Indiana 1,339

Iowa 2,132

Kansas 808

Kentucky 3,196

Louisiana 2,930

Maine 4,840

Maryland 260

Massachuse s 1,479

Michigan 11,747

Minnisota 1,032

Mississippi 1,202

Missouri 2,552

Montana 60

Nebraska 590

Nevada 457

New Hampshire 400

New Jersey 7,335

New Mexico 183

New York 52,132

North Carolina 1,760

North Dakota 619

Ohio 3,321

Oklahoma 6,933

Oregon 10,027

Pennsylvania 5,506

Rhode Island 597

South Carolina 255

South Dakota 195

Tennessee 143

Texas 2,649

Utah 3,504

Vermont 601

Virginia 1,126

Washington 10,528

West Virginia 308

Wisconsin 903

Wyoming 9

Source: The New York Times

Figure 3: The New York Times Analysis of Targeted Business Incen ves


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THE STATE FACTOR

StateYear of MostRecent Report

Individual Income TaxExpenditures

ITE Budget %Corporate, Gross Receipts andFranchise Tax Expenditures

CTE Bud

Alabama No Report

Alaska No Report

Arizona FY 2013 $255,280,000 0.87% $12,222,189,124 41.72%

Arkansas CY 2012 $79,365,533 0.38%

California FY 2014 $34,717,000,000 15.23% $5,753,000,000 2.52%

Colorado CY 2011 $684,126,000 2.29%

Connec cut FY 2013 $409,800,000 1.46% $313,000,000 1.11%

Delaware FY 2013 $120,200,000 1.31% $5,220,000 0.06%

Washington, D.C. FY 2012 $840,319,000 8.75%

Florida FY 2014 No Income Tax N/A $1,565,500,000 2.24%

Georgia FY 2014 $8,274,000,000 20.14% $458,000,000 1.12%

Hawaii CY 2011 $184,900,000 1.63% $101,100,000 0.89%

Idaho FY 2015 $398,194,000 5.50%Illinois FY 2013 $4,354,000,000 6.55% $518,823,000 0.78%

Indiana FY 2009 $19,384,906,976 75.37%

Iowa FY 2010 Not Reported N/A $255,000,000 1.45%

Kansas CY 2012 $1,729,383,826 12.01%

Kentucky FY 2014 $3,374,300,000 13.14% $417,100,000 1.62%

Louisiana FY 2013 $1,961,388,192 6.61% $1,841,371,401 6.21%

Maine FY 2013 $1,178,634,662 15.11%

Maryland FY 2014 $1,944,900,000.00 5.26% $227,400,000 0.62%

Massachuse s FY 2013 $13,877,200,000 23.01% $2,734,700,000 4.54%

Michigan FY 2014 $7,814,300,000 16.03% $911,000,000 1.87%

Minnesota FY 2014 $5,569,700,000 15.57% $770,100,000 2.15%

Mississippi FY 2013 $1,197,978,000 6.17% $103,902,000 0.54%

Missouri FY 2011 $6,599,100,000 28.57% $1,081,900,000 4.68%

Montana FY 2010 $619,958,000.00 10.25% $25,260,098 0.42%

Nebraska CY 2012 $1,640,232,000 16.61%

Nevada No Report

New Hampshire CY 2013 No Income Tax N/A $28,821,000 0.58%

New Jersey FY 2014 $5,941,800,000 11.41% $5,135,500,000 9.86%

New Mexico FY 2012 and CY 2012* $705,695,900 4.98%

New York FY 2010 $21,668,400,000 16.81% $2,315,000,000 1.80%

North Carolina FY 2015 $2,328,400,000 4.53% $872,800,000 1.70%

North Dakota CY 2012 Not Reported N/A Not Reported N/A

Ohio FY 2013 $1,894,700,000 3.25% $416,900,000 0.72%

Figure 1: Total State Tax Expenditures in Most Recent Available Year


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THE STATE FACTOR 7


es Taxpenditures

STE Budget %Sales Tax ServiceExemp ons?

Federal TaxConformity?

Exclusion Rule Policy Ra onale?PerformanceEvalua on

2,107,810,000 41.33% Yes No No notable exclusions No No

t Reported N/A No NoCredits only. No deduc ons,exclusions and exemp ons

No No

1,887,000,000 5.22% No Yes Expenditures less than $5 million No No

514,810,000 5.08% No No No notable exclusions No No

710,900,000 13.19% Yes Yes No notable exclusions Yes No

Sales Tax N/A N/A No No notable exclusions Yes No

41,096,000 7.72% Yes Yes Expenditures less than $50,000 Yes Yes

2,089,000,000 17.28% Yes No No notable exclusions No No

609,000,000 16.09% Yes Yes No notable exclusions No No

t Reported N/A No NoCredits only. No deduc ons,exclusions and exemp ons

No No

098,982,000 28.98% Yes No No notable exclusions No No502,000,000 5.27% No No Expenditures less than $1 million No No

t Reported N/A No No No notable exclusions No No

376,227,000 36.15% Yes No Expenditures less than $1 million Yes Yes

701,237,181 39.59% Yes Par al No notable exclusions No No

982,772,000 19.41% Yes No No notable exclusions Yes No

663,450,562 8.98% Yes YesExpenditures less thanunspeci ed threshold

Yes No

847,112,454 23.69% Yes Par al No notable exclusions Yes No

098,300,000 5.68% Yes No No notable exclusions No No

6,951,900,000 61.28% Yes NoMajor tax categories (property,excise, fuel and others) No No

6,038,396,000 53.41% Yes Yes No notable exclusions No No

851,500,000 16.36% Yes YesTaxes subject to alterna vetax and expenditures less than$50,000

No No

235,270,839 6.36% Yes Yes No notable exclusions No No

880,500,000 12.47% Par al Yes Major components of sales tax No No

Sales Tax N/A N/A No No notable exclusions Yes No

061,561,000 41.12% No No No notable exclusions Yes Yes

Sales Tax N/A N/A NoMajor tax categories (property,excise, interest on dividends andothers)

No No

669,100,000 18.56% No Yes No notable exclusions Yes No

Sales Tax N/A N/A No Expenditures that were "toodi cult" to calculate Yes Yes

0,487,000,000 8.13% No Yes Expenditures less than $100,000 No No

378,600,000 6.57% No Yes Expenditures less than $100,000 No No

14,685,500 11.95% Yes NoEs mates for sales tax expendi -tures less than $5,000

No No

852,300,000 8.33% No Yes

Expenditures less than $1 million,expenditures derived from statecons tu ons and expendituresrelated to taxes with analterna ve tax

No No


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THE STATE FACTOR 9

es Taxpenditures

STE Budget %Sales Tax ServiceExemp ons?

Federal TaxConformity?

Exclusion Rule Policy Ra onale?PerformanceEvalua on

726,301,805 29.76% No No

Expenditures less than $25,000without "high accuracy"es mates and expenditures

with under 5 occurrences

No No

Sales Tax N/A N/A Yes Expenditures less than $100,000 Yes Yes

090,900,000 11.92% Yes No Expenditures less than $100,000 Yes No

032,449,500 13.19% No YesExpenditures with "no reliabledata"

No No

052,364,706 13.69% No No No notable exclusions No No

557,800,000 20.85% Yes No No notable exclusions No No

5,985,000,000 37.13% Yes YesExpenditures less thanunspeci ed threshold

No Yes

66,947,978 5.29% Yes NoExpenditures for which data is"not available"

No No

60,100,000 11.52% No YesExpenditures for which data is

"not available"No No

77,500,000 1.02% No NoMajor tax categories (property,excise, interest on dividends andothers)

Yes** No

761,006,500 22.78% Yes N/AExpenditures that exist in orderto prevent double coun ng

Yes No

933,490,000 9.12% Yes YesExpenditures less thanunspeci ed threshold

Yes No

278,371,000 7.93% No YesExpenditures less thanunspeci ed threshold

No No

on is to develop a tax policy that is as least intrusive, burdensome anddistor onary as possible. Tax carve-outs for speci c industries or busi -nesses are opposite to these goals and some of the most basic maximsof sound tax policy.

The ALEC Principles of Taxa on , adopted with input from legislators,members of the private sector and public policy experts from aroundthe country, outline seven guiding principles of sound taxa on, includ -ing that specialized carve-outs in the tax code violate the principle ofeconomic neutrality. This principle states that:

The purpose of the tax system is to raise needed revenue for core

func ons of government, not control the lives of ci zens or micro -

manage the economy. The tax system should exert minimal impact

on the spending and decisions of individuals and businesses. An ef -

fec ve tax system should be broad-based, u lize a low overall tax

rate with few loopholes and avoid mul ple layers of taxa on through

tax pyramiding. 10

By se ng a general tax rate and then immediately exemp ng or givingpreferen al treatment to certain businesses or industries, the tax basefor the general tax rate becomes smaller. With a smaller revenue base,states must con nually raise tax rates to get the desired amount of reve -nue. The result is increasing tax rates on a shrinking tax base. In prac calterms, this means that businesses or industries that are not the favored

few end up paying more taxes so that other businesses or industries canenjoy a lower tax bill.

The types of businesses and industries that have the poli cal clout, con -nec ons and lobbying resources to secure these preferen al tax dealsare generally very large rms. Meanwhile, individuals and smaller busi -nessesthose not favored by policymakerscannot a ord such gen -erous deals.

Case Study: BoeingA notorious example of this occurred when the state of Washington of -fered Boeing, a mul na onal company that reported almost $87 billionworth of sales in 2013, about $8.7 billion worth of tax and other speci cbene ts to build a new line of aircra wings in the state. 11 These bene ts

An effective tax system should be broad-based, utilize a low overall tax rate withfew loopholes and avoid multiple layersof taxation through tax pyramiding.


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THE STATE FACTOR


took the form of an aeronau cs industry tax credit that was designedspeci cally with Boeing in mind. This tax bene ts package included tax -es of all sorts, one of which was Washingtons Business and Occupa onTax (B & O Tax). This is a type of gross receipts tax, which means thatthe tax is levied on a companys gross revenue rather than net revenue

(pro t) on which a tradi onal corporate income tax is levied.

Addi onally, in the hope Boeing might decide to move its produc on ofaircra wings out of Washington, other state policymakers met to passtargeted tax carve-outs to en ce the rm to move to their states. Oneegregious example of this was in Missouri, when Governor Jay Nixoncalled a special session for lawmakers to pass a special tax carve-outagreement in an e ort to lure the company to Missouri. Ironically, thisspecial session was called shortly a er Gov. Nixon vetoed a small butbroad-based income tax cut for Missourians. 12

Despite crea ng an environment with higher tax rates on a shrinkingnumber of people and industries, special tax carve-outs can also be

somewhat of a hypocri cal policy for some states. O en, some willclaim that taxes dont ma er to crea ng economic growth or a ract -ing businesses and people. But while doing so, these same states makeevery e ort to extend special tax favors to companies and industriesthat relocate to their state.

Case Study: New York StateA textbook example of this hypocrisy is the state of New York. The Em -pire State ranked dead last in the most recent edi on of Rich States,Poor States: ALEC-La er State Economic Compe veness Index . Italso has the highest marginal corporate income tax rate in the na -

on and the second highest marginal personal income tax rate. Butdespite New Yorks refusal to acknowledge that taxes ma er to eco -nomic growth, Governor Andrew Cuomo and the state legislaturehave developed a plan to grow the economy: create specialized tax

carve-outs for industries and exempt them from one of the worst taxclimates in the country by se ng up Empire Zones. The Empire Zonesare speci c geographical areas that require would-be businesses tolocate there and meet the zones many eligibility requirements. Theserequirements are laid out in a 64-page document and administered by

the New York Department of Taxa on and Finance. 13

Apparently the irony in providing generous tax carve-outs needed tofoster new businesses in one of the worst tax policy climates is lost onthe states lawmakers. Meanwhile, average New Yorkers will con nueto pay much higher tax rates than the rest of the country so that thesespecial businesses and industries can be exempted.

The Failure of Central Economic PlanningSe ng aside the issue of grossly devia ng from generally acceptedprinciples of sound tax policy (i.e., securing the broadest possible baseand the lowest possible rate), the issue of speci c tax carve-outs can

be reduced to two di erent views on how best to achieve economicgrowth: growth through markets vs. growth through central planning.In a classic essay, The Use of Knowledge in Society, economist Frie -drich Hayek argues strongly that no one person (or group of people)could ever match the level of knowledge that is held by all the individualactors in the market. Knowledge is decentralized, and for this reason,it is more e cient to make use of local knowledge to make economicdecisions rather than trying to centrally plan an economy. On this topic,Hayek is famous for claiming that the curious task of economics is todemonstrate to men how li le they really know about what they imag -ine they can design. 14

Even before the arguments regarding economic e ciency begin, the

disagreement between the growth through markets and the growththrough central planning camps starts at the most basic level of whatthe tax code should or should not be used to achieve. Generally, thegrowth through markets camp would agree that the tax code shouldbe used only to raise revenue for the necessary core func ons of gov -ernment and should do so in a way that impacts people, decisions andbusinesses as li le as possible. Conversely, the growth through centralplanning camp sees the tax code as a policy tool to incen vize certainindustries, punish others and direct the overall economy to a speci cpreferred outcome.

Apparently the irony in providinggenerous tax carve-outs needed tofoster new businesses in one of the

worst tax policy climates is lost onthe states lawmakers.


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THE STATE FACTOR 11

The prac cal problem with the growth through central planning ap -proach, as Hayek pointed out long ago, is simply that policymakers andexperts cannot direct the economy with the precision they imagine, andcertainly not without the unforeseen consequences and tradeo s thato en are ignored. For instance, the higher tax rates on the unfavored

industries and businesses will hamper overall economic growth. A studyfrom Chris na Romer, formerly the head of the Council of EconomicAdvisers for President Obama, and David Romer, Chris nas husband,found that for each one percent increase in taxa on, real GDP was low -ered by two to three percent. 15 This assessment coincides with the vastmajority of economic evidence that lower taxes mean more economicgrowth. 16 The lost economic growth due to ar cially higher taxes on ashrinking tax base to prop up the tax carve-outs for favored industries israrely men oned as a cost.

Another problem with the growth through central planning approach isthe assump on that policymakers have some special knowledge aboutwhich industry or business is best suited to be located in a speci c state,

rather than the business or industry knowing itself. Ar cially crea ngpolicies that encourage rms to move can result in a misalloca on of re -sources. When resources are misallocated by government interferenceand the tax treatment of similar rms is di erent, market distor ons arecreated. Certain goods become cheaper than they would be otherwise,disrup ng price signals for the rest of the market. Some rms remainpro table when they otherwise would not, crea ng a class of rms thatare heavily dependent upon government to con nue. The existence ofthese market distor ons can have wide e ects through the economybecause the prices, supply and/or demand for certain goods or servicesare ar cially disrupted and distorted. 17 These distor ons are the un -seen costs of tax carve-outs.

The idea that planned economies are superior was proven false longago as part of the Soviet era Socialist Calcula on Debate within theeconomics eld. 18 But the prevalence of speci c tax carve-outs is aconcession to the basic assump on of planned economiesthat pol -icymakers know what is best. They understand which industries andbusinesses will drive economic growth, which industries and businessesshould be located where and, most importantly, that any tax carve-outis certainly worth any corresponding cost to the economy. There is nogood evidence to support these assump ons.

Create a Level Playing FieldThe cost of the growth through central planning approach can be mea -sured by the destruc on of the level playing eld for all compe tors in

the market. It becomes much more di cult for smaller, mid-size andnew rms to compete with the larger and more poli cally connect -ed rms in this scenario. These smaller rms cannot e ec vely lobbyfor comparable tax carve-outs rela ve to their larger compe tors. Taxcarve-outs o en create a culture that emphasizes reloca on of busi -nesses from other states and a bias toward larger-sized rms. They canalso crowd out unsubsidized compe tors and can even lead to the com -pulsory funding of a rms compe tors.

The en re purpose of economic development departments through -out the states is to lure businesses to come to their state. There is no

problem informing companies of op ons and bene ts that a certainstate can o er, but o en the economic development department willo er special deals that create carve-outs to the tax base to a ract spe -ci c rms. By giving tax carve-outs to newly relocated compe tors, thedeals o en make it cheaper for relocated businesses to operate than

the rms that were in the state originally. Ideally, neither new nor ex -is ng rms in a state would have any tax advantage over each other.

Complemen ng the culture of business reloca on, a larger- rm bias isalso present in the tax carve-out strategy. Bigger businesses from other

states are be er targets for incen ve packages than smaller businesseslocated out-of-state. But the advantage of large businesses goes evenfurther. Large businesses are able to a ord the lobbying e orts neces -sary to gain and maintain the speci c tax carve-outs they enjoy, whilesmaller and mid-size compe tors o en cannot. One famous exampleis a Utah State University study that tracked over 200 companies thatreceived money from the Troubled Asset Relief Program (TARP). Theauthors found that for every dollar spent on lobbying during the veyears before the TARP bailout, rms received between $485.77 and$585.65 in TARP support. 19 While this is a federal example, and datais di cult to come by on the state level, in general, larger rms thatcan a ord to in uence policymakers can enjoy a greater amount of taxcarve-outs and other government privileges.

Addi onally, tax carve-outs given to larger rms reduce the cost of do -ing business for these rms overall. This means the smaller rms arele to compete with large compe tors that have lower tax rates. Having

rms compete against one another in the market is the cornerstone ofthe economy, but it only works if there is a level playing eld in whichall compe tors know the rules and are treated equally. But the crea onof tax carve-outs speci cally intends to treat them di erently, perhapseven causing some rms to go out of business that otherwise would nothave failed. This e ect serves to crowd out the businesses and indus -tries that did not get the favorable tax carve-outs.


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THE STATE FACTOR


For this reason, the ALEC Principles of Taxa on , which can be viewedin Appendix A, make clear that the tax system should not be used tobestow special favors on any par cular group of taxpayers. These typesof carve-outs violate the principle of equity and fairness in the tax code.By trea ng rms di erently for arbitrary and poli cal reasons, the gov -

ernment is essen ally picking winners and losers through the tax code. 20 Specialized tax carve-outs deviate from the premise of a fair and equalplaying eld for all and can open the door to misuse.

Close the Door to Rent SeekingThe focus of this paper is on cronyism, speci cally state tax cronyismin the form of preferen al tax carve-outs given to various favored busi -nesses and industries. While this paper considers all these special carve-outs (with the excep on of a few caveats outlined at the beginning) to

be cronyist in nature, they open the door to real corrup on. EconomistDavid R. Henderson begins his paper, The Economics and History ofCronyism, with a ng anonymous quote, When you leave the honey jar open, expect ants. 21

While it is true that many of these specialized tax carve-outs can becreated based on the best of inten ons, it is equally true that many ofthem do not necessarily come from the best inten ons. When poli -cians and unaccountable agencies are given the power to strike specialdeals with businesses that can save them extremely large amounts ofmoney and give them a compe ve edge, the door is certainly open forless-than-appropriate deals to take place.

Clearly, businesses see a growing opportunity to work with governmentsat all levels to increase their compe ve edge. In 1973, only 14 percentof Fortune 1,000 companies had people with government service ex -perience on their boards; since 2002 it has been over 50 percent. 22 Despite the occasional shocking story of outright gross corrup on, thepower that tax carve-outs can have on businesses and their rela onshipwith government o cials can o en be overlooked. But when the gov -ernment has the power to skew the rules in favor of certain industries orbusinesses, they have an incredible incen ve to get increasingly friendlywith those making the decisions about who gets special tax treatmentand who does not.

However, businesses should not bear the blame for these speci c taxcarve-outs, or at least not all businesses are equally to blame. Thereis a signi cant di erence between rms that ac vely lobby to re-writespecial rules that hamper compe on and create barriers to entry fornew rms entering the market and rms that simply use the carve-outs

that exist to decrease their tax liability. Businesses have every incen veand legal right to use the carve-outs that are available to them. The realproblem is not that businesses are ac ng in their own ra onal self-in -terest, but rather that the tax system they are a part of is fundamentally

awed. The focus of reform should not be demonizing responsible busi -nesses ac ng in a legal and ra onal way, but rather on xing the prob -lem that results from favoring certain industries or businesses throughspecialized carve-outs in the tax code.

Tax Carve-Outs Dont WorkTax carve-outs distort the market, violate the principles of sound taxpolicy, destroy the level playing eld for rms in the market and openthe door to ever-increasing rent-seeking. S ll, could some consider this

tradeo worth the cost? Except for a few anecdotes, the data over -whelmingly show that despite these high economic costs, packing thetax code with specialized tax carve-outs for businesses and industriesdoes not even achieve the goals of economic growth and job crea on. 23

When a state endeavors to lure a company into its borders using tar -geted tax carve-outs, the results can vary. Many mes, the companywould have located in that state even in the absence of state-o eredtax carve-outs. But some mes companies shop around for a good dealand are ready to relocate at a moments no ce for a be er one. If thiswere the case, the state is in a bind. Should it expand the tax carve-

While it is true that many of thesespecialized tax carve-outs can

be created based on the best ofintentions, it is equally true thatmany of them do not necessarily

come from the best intentions.


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THE STATE FACTOR 13

outs it already gave the rm or simply let it go? Too o en, states chooseto expand tax carve-outs under pressure from rms that will always beasking for more.

Case Study: Maryland

Consider the case recently in Maryland. Ne lixs hit show, House ofCards, was given a generous tax carve-out worth about $11 million forchoosing to shoot the rst season of the show in Maryland. Tax carve-outs for the second season could total about $15 million. But in spiteof these enormous tax carve-outs, the shows producers called uponMaryland lawmakers to pass even more tax credits for the show or elsethey would relocate to another state. 24 A er reaching a deal with Gov -ernor Mar n OMalley, the show will remain in Maryland to shoot thethird season, and will receive another $11.5 million in tax carve-outsthat were not originally planned. 25

Case Study: Oregon and IllinoisThe latest examples of states put in a tough spot by companies demand -

ing higher tax carve-outs just to stay in the state are Oregon and Illinois.Oregon is in talks to keep Intel in the state, o ering millions of dollarsin extra tax carve-outs. 26 Illinois passed tax carve-out deals with CMEGroup Inc. and Sears Holdings Corpora on to keep them in the stateat a cost of $218 million per year, at a me when general corporate taxrates have gone up drama cally and Oregon and Illinois are dangerouslyunderfunding their pension systems. 27

Case Study: New JerseyNew Jersey is another state that is in the limelight for its disappoin ngresults of tax carve-outs. A report from New Jersey Policy Perspec veexamines the $4 billion worth of tax carve-outs the state has given outover the past 10 years and deems the results a largely unsuccessful

a empt to spur economic ac vity. The report goes on to note that overthe previous decade, $4 billion in tax carve-outs went to only 252 com -panies and le the majority of New Jersey businesses and residents tomake up the lost revenue. 28 On a related note, New Jersey has consis -tently raised taxes on ci zens during the past 10 years, and now, facedwith a major budget shor all (par cularly due to underfunded pen -sions), the New Jersey legislature may resort to raising over $1 billion intaxes on residents and businesses yet again. 29

Overall, there are some good reasons to doubt the real-world e ec ve -ness of tax carve-outs and very li le evidence to support their con n -ua on. States do not have the advantage of seeing what the economywould be like without specialized tax carve-outs, but the evidence pre -

sented in this paper suggests it would eliminate distor ons, cut wasteand help economic growth in the long term.

There is no strong evidence that tax carve-outs are as e ec ve at cre -a ng jobs and spurring economic growth as they claim. As opposed tolower general tax rates and a compe ve business climate, specializedtax carve-outs are subject to ee ng poli cal whims and tend to target

rms that are always searching for the be er deal rather than rms thatare actually posi oned to naturally grow the economy without an ar -cial advantage. In fact, a review of the literature on tax carve-outs showsthat most empirical studies on tax incen ves nd that they have li le

or no e ect on employment or on the economy as a whole. 30

Solutions for Fixing the Tax CodeTax cronyism is a bad deal for the states. The problems are pervasive

and cannot be en rely mi gated by improved structuring and process -es. Moreover, the bene ts are weak, par cularly once it is acknowl -edged that exemp ng some businesses from the tax base while tryingto reach a given revenue target requires higher rates on the rest of thetax base. Given the high cost, few bene ts, large economic distor onand tempta on for quid-pro-quo corrup ons that come with tax crony -ism, states should reverse the trend of using them to incen vize growth.This should be done in a revenue-neutral fashion and, ideally, alongsidebroader fundamental tax reform that lowers the overall burden of tax -a on, thereby giving compe ve tax rates to all taxpayers and minimiz -ing the number of losers from fundamental tax reform.

The best op on would be to eliminate all current tax carve-outs thatdeviate from the tax base, while lowering tax rates on produc ve be -havior, such as income taxes, in a revenue-neutral or revenue-nega vetax reform package. However, this might be a poli cally heavy li formany states. Even if this op on isnt immediately achievable, there aresome concrete examples of good policy other states have adopted thatcan help to control and, eventually, reverse the problem of specialized

tax carve-outs.

Tax Carve-Out TransparencyWashingtonWashington state is one success story in a emp ng to reverse the trou -bling trend of tax carve-outs. In 2013, thanks largely to the e orts of theWashington Policy Center, the state of Washington approved a law thatadded desperately needed clari ca on to the states tax carve-outs.Speci cally, whenever a new tax carve-out is proposed, the legislaturemust include the reason for the devia on from the tax base and (insome cases) set speci c benchmarks so policymakers can review the taxcarve-out and evaluate whether it is successful and should con nue. 31

Given the high cost, few benets,large economic distortion andtemptation for quid-pro-quocorruptions that come with taxcronyism, states should reversethe trend of using them to

incentivize growth.


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THE STATE FACTOR


Transparency is key. Many people, including policymakers, are notaware of all the various tax carve-outs that hide in their tax codes, letalone what those proposals were intended to achieve. By requiringbenchmarks for success and melines for new tax carve-outs, legisla -tures can at least iden fy which carve-outs are achieving their goals and

which are not. This informa on alone is lacking in many states today.

By increasing transparency and being able to iden fy the reasons be -hind tax carve-outs and which ones are failing to meet goals, policymak -ers will have the tools they need to clean out their tax codes and morecarefully evaluate which carve-outs get included in the rst place.

This type of transparency should be applied to any proposed new taxcarve-outs moving forward and should not undermine the privacy oftaxpayers through retroac ve repor ng requirements.

The Pew Center on the States report, Evidence Counts, provides aguide for states looking to improve their transparency and obtain con -

crete evidence of tax preference performance. Further, ALEC has modelpolicy (see Appendix B) based on the Washington state experience thatcan serve as a guide for policymakers a emp ng to subject tax cronyismto sunlight.

Cash Subsidies, Not Tax Carve-OutsMichiganOne important step states can take to address tax carve-outs, par cu -larly those that involve targeted preferences to just one rm, is to putthese programs on budget. That is, make them cash payments donethrough the standard state appropria on process, not elements of thetax code or o -budget tax abatement.

One reason for this move is predictability. Many states end up essen -

ally unaware of the extent of tax credits and target preferences theyowe to rms and individuals. This introduces massive revenue vola l -ity to tax collec ons and makes appropriate budge ng, par cularly inthe context of state balanced-budget requirements, extremely di cult.Through annual appropria ons processes and cash payouts, states canbe er forecast what revenue they can expect to take in and the value ofbusiness subsidies they will pay out.

Another reason is framing. These tax carve-outs are essen ally econom -ically indis nguishable from cash subsidies; but they are framed as taxcuts, which is decep ve. Firms receiving carve-outs can claim that theelimina on of these preferences essen ally is a tax increase, and legis -lators who support tax carve-outs can frame them as tax cuts instead of

business subsidies. Moreover, having these preferences on the tax sideunderes mates the states true public expenditure.

Michigan took this important step under the Snyder administra on formany of the states targeted tax preferences administered by the Michi -gan Economic Development Corpora on. 32 This states leadership is con -ver ng these subsidies from tax carve-outs to cash payments, which issound in terms of budget integrity and poli cal framing.

Eliminate Tax Carve-Outs and Reduce RatesIt is worth men oning that some xes try to solve the problem in anega ve way. A emp ng to close o these tax carve-outs without de -

creasing tax rates elsewhere can be a devasta ng blow to rms withina given state. This amounts to a tax increase to rms that harms statecompe veness, which policymakers should avoid.

The overall goal of tax policy is to raise revenue for the core func ons

of government and to do so with as li le distor on or burden on stateresidents and businesses as possible. If tax carve-outs are eliminatedand rates for everyone are reduced, an equal playing eld is achievedand everyone is be er o . However, if tax carve-outs are eliminated andthere are no accompanying rate cuts to make up for this, the tax codewill be more fair but more burdensome and distor onary. Using theelimina on of tax carve-outs to raise revenue undermines the key goalof tax reform: improving state economic compe veness.

Conclusion

Specialized carve-outs in the tax code are distor onary and ine ec veat best, and examples of government cronyism at worst. These carve-outs run contrary to the principles of sound tax policy and the basicfairness of a level playing eld for all businesses to compete. Every statehas these types of carve-outs in their tax codes to some degree, mean -ing that every state economy is held back, at least to some extent, fromachieving their true poten al for economic growth. Iden fying and lim -

i ng specialized carve-outs in the tax code is an important policy toolthat lawmakers can use to make their business climate more fair andul mately grow their states economy without arbitrarily favoring onebusiness or industry over others.

Addi onally, iden fying tax carve-outs for elimina on can be the goldencket to fundamental tax reform. These carve-outs can be included in

any package to broaden the tax base and lower the tax rate in either arevenue-neutral way or as part of a larger tax cut package. This allowsstates to end tax carve-outs and make their tax policy climate compet -i ve and open for everyone. Lower rates, broader bases and an equalplaying eld with no favors make a recipe for economic success.


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THE STATE FACTOR 15

Appendix A: ALEC Principles of Taxation

The proper func on of taxa on is to raise money for core func ons of government, not to direct the behavior of ci zens or close budget gapscreated by overspending. This is true regardless of whether government is big or small, and this is true for lawmakers at all levels of government.

Taxa on will always impose some level of burden on an economys performance, but that harm can be minimized if policymakers resist the temp -ta on to use the tax code for social engineering, class warfare and other extraneous purposes. A principled tax system is an ideal way for advancinga states economic interests and promo ng prosperity for its residents.

The goal of American tax policy should be to raise revenue for func ons of government in a way that minimizes distor ons, so as to grow the overalleconomy and facilitate commerce.

Guiding principles of taxationThe fundamental principles presented here provide guidance for a neutral and e ec ve tax system: one that raises needed revenue for core func -

ons of government, while minimizing the burden on ci zens.

Simplicity The tax code should be easy for the average ci zen to understand, and it should minimize the cost of complying with the tax laws.Tax complexity adds cost to the taxpayer, but does not increase public revenue. For governments, the tax system should be easy to administer,

and should help promote e cient, low-cost administra on. Transparent Tax systems should be accountable to ci zens. Taxes and tax policy should be visible and not hidden from taxpayers. Changes in

tax policy should be highly publicized and open to public debate. Economic Neutrality The purpose of the tax system is to raise needed revenue for core func ons of government, not control the lives of cit -

izens or micromanage the economy. The tax system should exert minimal impact on the spending and decisions of individuals and businesses.An e ec ve tax system should be broad-based, u lize a low overall tax rate with few loopholes and avoid mul ple layers of taxa on throughtax pyramiding.

Equity and Fairness The government should not use the tax system to pick winners and losers in society, or unfairly shi the tax burden ontoone class of ci zens. The tax system should not be used to punish success or to soak the rich, engage in discriminatory or mul ple taxa on,nor should it be used to bestow special favors on any par cular group of taxpayers.

Complementary The tax code should help maintain a healthy rela onship between the state and local governments. The state should alwaysbe mindful of how its tax decisions a ect local governments so they are not working against each other with the taxpayer caught in the middle.

Compe veness A low tax burden can be a tool for a states private sector economic development by retaining and a rac ng produc ve

business ac vity. A high-quality revenue system will be responsive to compe on from other states. E ec ve compe veness is best achievedthrough economically neutral tax policies.

Reliability A high-quality tax system should be stable, providing certainty in taxa on and in revenue ows. It should provide certainty ofnancial planning for individuals and businesses.

Benets of a principled tax burdenSince taxes lower the economic welfare of ci zens, policymakers should try to minimize the economic and social problems that taxa on imposes.Ci zens then directly gain the bene ts of a low tax burden. These bene ts are summarized below:

Greater economic growth A tax system that allows ci zens to keep more of what they earn spurs increased work, saving and investment. Alow state tax burden would mean a compe ve advantage over states with high-rate, overly progressive tax systems.

Greater wealth crea on Low taxes signi cantly boost the value of all income-producing assets and help ci zens maximize their fullest eco -nomic poten al, thereby broadening the tax base.

Minimize micromanagement and poli cal favori sm A complex, high-rate tax system favors interests that are able to exert in uence in thestate capitol, and who can nego ate narrow exemp ons and tax bene ts that help only limited taxpayers and not the general economy. A fair

eld and no favors is a good mo o for a strong tax system.

Approved by the ALEC Board of Directors on June 3, 2010.


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THE STATE FACTOR


Appendix B: The ALEC Tax Expenditure Transparency Act

SummaryThe legislature nds that the states tax code includes tax expenditures enacted to achieve a variety of policy goals for the public interest. The

ul mate goal should be for the states tax system to re ect sound principles of taxa on. In order to make policy choices going forward regardingthe best use of limited state resources, the legislature concludes that it is necessary to ar culate the legisla ve intent and have measurable perfor -mance goals for each tax expenditure created.

Model Policy

Short Title.This Act shall be known and may be cited as the Tax Expenditure Transparency Act.

Section 1.(A) For purposes of this sec on, tax expenditure means a provision in the tax code that provides incen ves for par cular kinds of ac vi es or thatgives special or selec ve relief to certain groups of taxpayers. Tax expenditures are considered devia ons from the norma ve tax base. (1) Tax expenditures shall not include:

(a) deduc ons to arrive at income under an income tax; (b) exemp ons of business inputs under a sales tax; (c) deduc ons or credits used to o set a discriminatory tax or fee.

(B) For any bill introduced in either the House of Representa ves or the Senate that adopts a new tax expenditure or expands or extends an exis ngtax expenditure, the bill should include legisla ve intent provisions, establishing the policy goals, and any related metrics.

Section 2. {Severability clause}

Section 3. {Repealer clause}

Adopted by the Tax and Fiscal Policy Task Force at the Annual Mee ng, August 9, 2013. Approved by the ALEC Board of Directors, September, 30,

2013.


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THE STATE FACTOR 17

(Endnotes)1 Mitchell, Ma hew. The Pathology of Privilege. The Mercatus Center at George Mason University. March 2014.2 Henderson, David R. The Economics and History of Cronyism. The Mercatus Center at George Mason University. July 26, 2012.3 ALEC Principles of Taxa on . American Legisla ve Exchange Council Task Force on Tax and Fiscal Policy. Also see: McBride, William. What is the Evidence on Taxes

and Growth? Tax Founda on. December 18, 2012. Also see: McBride, William. Empirical Evidence on Taxes and Growth: A Response to CBPP. Tax Founda on.

February 21, 2014.4 Cline, Robert; Phillips, Andrew; and Neubig, Tom. Whats Wrong with Taxing Business Services? Adverse E ects from Exis ng and Proposed Sales Taxa on of Business

Investment and Services. Council on State Taxa on. April 4, 2013.5 Freeland, William and Sullivan, Cara. Fair Business Compe on Requires a Neutral, Consump on-Based Tax System. American Legislator. July 18, 2013.6 Data calculated by the U.S. Treasury Department and published in the O ce of Management and Budgets Analy cal Perspec ves report.7 Leachman, Michael; Grundman, Dylan; and Johnson, Nicholas. Promo ng State Budget Accountability Through Tax Expenditure Reform. Center for Budget and Policy

Priori es. May 2011. Also see: Five Steps Towards a Be er Tax Expenditure Debate. Ins tute for Taxa on and Economic Policy. October 2012. Also see: Freeland,

William. A Halloween Horror Story: Tax Carve-Outs Edi on. American Legislator. October 2013. Also see: Splinter, David. Transparency for Tax Expenditures: A

California Proposal. Tax Founda on. July 2009. Also see: Kleinbard, Edward D. The Hidden Hand of Government Spending. Regulatory Magazine. October 2010.8 Evidence Counts: Evalua ng State Tax Incen ves for Jobs and Growth. The Pew Center on the States. April 2012.9 Story, Louise; Fehr, Ti ; and Watkins, Derek. United States of Subsidies. The New York Times. December 2012.10 ALEC Principles of Taxa on. American Legisla ve Exchange Council Task Force on Tax and Fiscal Policy.11 Westneat, Danny. Tax Breaks for Boeing: Were No. 1. The Sea le Times. November 13, 2013.12 Freeland, William and Wilterdink, Ben. Missouri Tax Hypocrisy. RedState. January 17, 2014.13 Parts 10 through 14 of the Regula ons of the Commissioner of Economic Development. New York State Department of Taxa on and Finance.14 Hayek, Friedrich. The Fatal Conceit: The Errors of Socialism. University of Chicago Press. 1988.15 Fruits, Eric and Pozdena, Randall. Tax Myths Debunked. American Legisla ve Exchange Council. 2013.16 McBride, William. What is the Evidence on Taxes and Growth? Tax Founda on. December 18, 2012.17 Coyne, Christopher J. and Moberg, Lo a. The Poli cal Economy of State-Provided Targeted Bene ts. The Mercatus Center at George Mason University. May 2014.18 Boe ke, Peter. Socialism and the Market: The Socialist Calcula on Debate Revisted. Routledge. 2000.19 Blau, Benjamin; Brough, Tyler; and Thomas, Diana. Corporate Lobbying, Poli cal Connec ons, and the 2008 Troubled Asset Relief Program (under review at the

Journal of Financial Economics ). Via Mitchell, Ma hew. The Pathology of Privilege: The Economic Consequences of Government Favori sm. The Mercatus Center

at George Mason University. March 2014.20 ALEC Principles of Taxa on. American Legisla ve Exchange Council Task Force on Tax and Fiscal Policy.21 Henderson, David R. The Economics and History of Cronyism. The Mercatus Center at George Mason University. July 26, 2012.22

Schweizer, Peter. Throw Them All Out. Houghton Mi in Harcourt Publishing Company. 2011.23 Coyne, Christopher J. and Moberg, Lo a. The Poli cal Economy of State-Provided Targeted Bene ts. The Mercatus Center at George Mason University. May 2014.24 Johnson, Jenna. House of Cards Threatens to Leave if Maryland Comes Up Short on Tax Credits. The Washington Post. February 20, 2014.25 Johnson, Ted. House of Cards Receives Maryland Tax Credits. Variety. April 25, 2014.26 Dondero, Russ. Intel Jumps through Oregons [sic] Tax Loophole. Hillsboro Tribune. April 12, 2013.27 Bergen, Kathy. Illinois House OKs Tax Breaks for CME, Sears. Chicago Tribune. December 12, 2011.28 DePaul, Jennifer. New Jersey Tax Subsidies Surge Doesnt Equal Economic Boom, Report Says. Tax Analysts. June 12, 2014.29 Rizzo, Salvador. NJ budget clears rst hurdles in Legislature, with $1 billion in tax hikes. The Star Ledger. June 25, 2014.30 Calcagno, Peter T. and Hefner, Frank. Unleashing Capitalism: A Prescrip on for Economic Prosperity in South Carolina. The South Carolina Policy Council. 2010. Via

Coyne, Christopher J. and Moberg, Lo a. The Poli cal Economy of State-Provided Targeted Bene ts. The Mercatus Center at George Mason University. May 2014.31 Mercier, Jason. American Legisla ve Exchange Council Considers Washingtons New Tax Preference Transparency Law. Washington Policy Center. August 13, 2013.32 LaFaive, Michael. Good, Bad, Ugly of Gov. Snyders Budget. Michigan Capitol Con den al. February 2011.


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THE STATE FACTOR


Acknowledgements

The authors recognize and express thanks to Jacob Gram and Jacob Kohlhepp, for their research contributed greatly to this project.

Special thanks are due to Chris Edwards of the Cato Ins tute; Ma Mitchell of the Mercatus Center; and Sco Drenkard, Liz Malm and Lyman Stoneof the Tax Founda on for their valuable feedback on this report.

We also thank our colleagues: Ka Siconol , Ted La erty, Bill Meierling, Ashley Varner, Molly Fuhs, Jordan Conrad, Michael Bowman and the sta ofthe American Legisla ve Exchange Council for their many e orts to ensure the publishing of this report in a mely manner.

Finally, we thank the numerous economists and tax policy researchers who provided important analyses on these ma ers that informed our ownresearch.

We hope these research ndings serve to educate America's state policymakers and members of the public interested in fair, neutral, pro-growthtax reform.


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THE STATE FACTOR 19

About the American Legislative Exchange CouncilThe American Legisla ve Exchange Council is Americas largest nonpar san, voluntary membership organiza on of state legislators. Made up ofnearly one-third of Americas state elected o cials, the Council provides a unique opportunity for state lawmakers, business leaders and ci zen or -ganiza ons from around the country to share experiences and develop state-based, pro-growth models based on academic research, exis ng statepolicy and proven business prac ces. The ul mate goal of the Exchange Council is to help state lawmakers make government work more e cientlyand move government closer to the communi es they serve, thereby crea ng opportunity for all Americans.

In state legislatures around the country, ci zen groups foster ideas, par cipate in discussions and provide their points of view to lawmakers. Thisprocess is an important part of American Democracy.

The Exchange Council and its nine task forces closely imitate the state legisla ve process: resolu ons are introduced and assigned to an appropriatetask force based on subject and scope; mee ngs are conducted where experts present facts and opinion for discussion, just as they would in com -

mi ee hearings; these discussions are followed by a vote.

Council task forces serve as tes ng grounds to judge whether resolu ons can achieve consensus and enough support to survive the legisla ve pro -cess in a state capitol. All adopted model policies are published at www.alec.org to promote increased educa on and the open exchange of ideasacross America.

TASK FORCE ON CIVIL JUSTICE

Civil Liability Predictability Fairness in Damages

Discouraging Lawsuit Abuse

TASK FORCE ON COMMERCE

Limi ng Government Mandates on Business

Transporta on and Infrastructure Employee Rights and Freedoms

TASK FORCE ON ENERGY, ENVIRONMENT AND AGRICULTURE

Energy A ordability and Reliability Regulatory Reform Agriculture and Land Use

TASK FORCE ON EDUCATION

Educa on Reform Parental Choice

E ciency, Accountability and Transparency

TASK FORCE ON HEALTH AND HUMAN SERVICES

Pro-Pa ent, Free Market Health Policy Private and Public Health Insurance Federal Health Reform

TASK FORCE ON INTERNATIONAL RELATIONS

Interna onal Trade Intellectual Property Rights Protec on Federalism

TASK FORCE ON TAX AND FISCAL POLICY

Pro-Growth Tax Reform

Priority-Based Budge ng Pension Reform

TASK FORCE ON COMMUNICATIONS AND TECHNOLOGY

Broadband Deployment Consumer Privacy E-Commerce

JUSTICE PERFORMANCE PROJECT

Recidivism Reduc on Overcriminaliza on Data-Driven Criminal Jus ce Reform


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To learn more about how the AmericanLegisla ve Exchange Council helps develop

innova ve solu ons in partnership with

lawmakers and business leaders, or to become a

member, please visit www.alec.org.

American Legisla ve Exchange Council

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Tel: 703.373.0933

Fax: 703.373.0927

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The Unseen Costs of Tax Cronyism: Favoritism and Foregone Growth

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