Don’t forget about tax breaks—how most economic development happens in Kentucky
By Justin Maxson
Tax exemptions in the tax code and tax incentive programs, while both designed to improve the economy, are not the same thing. The differences are important and have been obscured in the recent growing public debate about economic development in Kentucky.
So what are they?
Economic Development Tax Exemptions — These are tax breaks written into the tax code for any eligible business or industry sector. For example, Kentucky gives a sales tax exemption for energy producing fuels or coal used in the manufacture of electricity. We exempt semi-trailers and trailers from sales tax. A recent report by the Mountain Association for Community Economic Development identified 45 such tax breaks which together cost the state $448 million in lost revenue in 2004 – a bit more than the entire Medicaid shortfall this year. Tax exemptions aimed at spurring economic activity make up almost 60% of the state’s total spending on economic development.
Economic Development Tax Incentives — These are company specific economic development subsidy programs aimed at job creation or expansion. These include programs like the Kentucky Jobs Development Act or the Kentucky Rural Development Act, which are administered by the Economic Development Cabinet. In 2004, $123 million in subsidies were received by businesses as projected in the Finance Cabinet’s Tax Expenditures report.
Recent public debate has tended to focus on the Economic Development Cabinet’s tax incentive programs, obscuring important issues related to the comparatively larger tax exemptions that are written into Kentucky’s tax code by the legislature.
Once passed into law, tax exemptions lose revenue to the state, year after year. They exist unless the legislature decides to remove them. So in essence, the beneficiaries of tax breaks receive funding priority year after year over other on-budget needs like education, health care or environmental protection.
Unlike tax incentives, which receive some degree of evaluation by the Economic Development Cabinet, there are no requirements to evaluate the effectiveness of most business tax exemptions. Do businesses that receive these tax breaks create more jobs? Do tax breaks foster healthier industries? No one checks, so we just don’t know.
Tax exemptions are scarcely considered part of the state’s economic development strategy or strategic plan. Considering we lose nearly $450 million dollars a year in tax revenue, policy-makers should include tax expenditures as part of an overall economic development approach.
Kentuckians need to better understand the impact of economic development tax exemptions. Surely some play a role in improving the ability of an important sector to compete and contribute to Kentucky’s economy. Just as surely, some of them are of questionable value to the public good, particularly when compared to other fiscal needs of the state.
Improving transparency, evaluation and the balance between spending on both tax exemptions and incentive programs and other economic development strategies is critical to the state’s future. We need a comprehensive approach to economic development that better coordinates all forms of state spending on economic development.
The following are some recommendations to consider as part of a wiser approach.
Create a unified development budget. Each year all economic development spending (tax exemptions, tax incentive programs and on-budget spending) should be reported to the Secretary for the Cabinet for Economic Development and the legislature in one document that summarizes the total cost to the state.
Strengthen oversight mechanisms. Require annual reports for every year a business receives tax incentives or direct subsidies, including information about jobs created, wages earned and benefits provided. Create aggregate annual reports by incentive program or tax expenditure to allow an evaluation of their effectiveness.
Reauthorize tax exemptions and incentives. Study the impact of all economic development tax exemptions and incentive programs on a cyclical schedule (perhaps review 1/3 of them every four years, so each one gets a review every twelve years). In the year following this review, the tax exemptions would either be reauthorized or ended by a vote of the legislature. This would create an opportunity for meaningful consideration of their value in relation to other budget needs.
Spend more money on other development strategies. Increase the funding for workforce development partnerships and small business retention and expansion activities including expanded business support services. Support the growth of coordinated efforts to grow Kentucky entrepreneurs. Develop pilot investments in natural resource based economic development strategies including sustainable forestry and out-door related tourism. Support significant expansion of the affordable housing trust fund.
Justin Maxson is president of Mountain Association for Community Economic Development in Berea.