Michael R. Press, Business Incentives Advisory, Duff & Phelps (Jun/Jul 07)
It is not at all surprising that tax exemptions were found to be important or very important by nearly 87 percent of the Corporate Survey's respondents. There are three major reasons why tax exemptions rank high on the list of site selection factors in the survey: They can have a significant impact on a company's financials; they vary significantly from place to place; and they are common - virtually every business is affected by them.
Significant Impact on Financials
Underlying the significance of state and local tax exemptions to corporate financial results is simply the comparative significance of state and local taxes to the bottom line of corporate America. A 2006 study by Ernst & Young, "Total State and Local Business Taxes," revealed that 45 percent of total state and local taxes are paid by business and that business' share was $554 billion (up more than 10 percent from 2005). Astonishingly, this figure represents nearly half of total after-tax profits for all U.S. corporations. Clearly, state and local taxes impact business profits in a significant way; thus, it is only natural that tax exemptions granted to business will be quite high on the list of concerns of corporate decision-makers.
Significant Variation from Place to Place
The second reason tax exemptions rank so high as a location selection factor is that most state and local taxes are accompanied by exemptions that vary from state to state and community to community. Thus, companies know that their location - in terms of state and local taxes and the exemptions that may or may not apply to them - will greatly affect their operating margins. If exemptions and tax rates applied uniformly around the country, they would not affect location decisions at all.
As Common as the Taxes to Which They Apply
The third reason tax exemptions are in the forefront of location decision-making is simply because they are so common. For example, the state of Connecticut's Department of Economic and Community Development website lists five property tax exemptions, 10 corporate sales and use tax exemptions, and four corporate income tax exemptions available outside the state's designated enterprise zones.
As tools for economic development, tax exemptions, broadly defined, are the most common of all incentives. Even in the United States and Europe - where highly developed economies generate tax receipts sufficient to fund generous grant programs - tax incentives form an important part of the government's policy arsenal. Virtually every tax has a set of exemptions to satisfy public policy objectives. The most common policy objectives are economic development and fairness, but they are by no means the only ones. Thus, most states with a sales and use tax, for instance, exempt manufacturing equipment, food items, and sales for resale.
• Fairness objective: Exempting sales for resale advances the fairness objective. It is widely accepted that taxing items on an ad valorem basis differentially based on the number of times they have been traded before reaching the final consumer is unfair. Taxing basic food items and medicines is deemed unfair to the poor, who spend an inordinate share of their incomes on such items.
• Economic development objective: The manufacturing exemption is intended to benefit local manufacturers, most of whom could just as easily serve their markets from a location outside the taxing jurisdiction. Manufacturing equipment is usually exempt from the state and local sales and use tax as an incentive to manufacturers to locate in a particular place and not across the county (or state) line to avoid the tax.
Although tax exemptions are not the only public policy tool to advance the economic development objective, they are, by far, the most frequently used. Why is that? Let's compare them to two other well-used economic development incentives - project grants and tax increment financing.
Project grants: Grants have the advantage of being very specific. Therefore, they are much more "efficient" from the government's perspective compared with tax exemptions, but they are much less common because they are usually tied into the budget-making process of the state or local government. Tax exemptions, on the other hand, are for the most part "self-implemented" by the corporate taxpayer, requiring far less bureaucracy than the typical grant.
Grants have to be appropriated from the treasuries of general-purpose governments and, therefore, they must compete against a full agenda of social and municipal services that the public has come to expect in return for their tax dollars. Tax exemptions are often included in what policymakers refer to as "tax expenditures." In effect, they are hidden expenditures in favor of business enterprise that escape the rigorous scrutiny of the annual legislative appropriations process.