How to Restructure Economic Incentives that May Be Otherwise Worthless
by Kelley Rendziperis, on Jun 26, 2017 4:08:44 PM
The main objective of economic development organizations is to entice companies to invest in a specific site or region to help create jobs and increase tax revenue within their respective local and state jurisdiction. As a result, the value of economic incentives can often be incorrectly calculated by economic developers or inflated to make a site or region appear more appealing. Therefore, it is important that you carefully evaluate the value and your ability to utilize economic incentives since they can greatly influence site selection decisions.
As a partner at Site Selection Group specializing in location advisory and economic incentive services, I have encountered these types of issues many times. This is an issue we work hard to prevent when working with our clients from the outset; however, when companies come to us after the fact, there is little that we can do.
Economic development agencies do not purposely deceive companies when they compute the value of an economic incentive package. The problem typically lies in their lack of knowledge regarding the intricacies of a company’s direct and indirect state tax liability, as well as their respective state’s tax structure. To avoid such issues, governmental entities should consider how they can be more flexible in the economic incentives they offer. This article addresses various approaches by states to help companies realize the economic incentives that they have earned.
Transferability can significantly increase the value of tax credits
Frequently companies are granted job tax credits, whether statutory or discretionary, which are available to offset state income tax liability. However, many companies ultimately find that they either do not have a significant annual state income tax liability or the liability is well below the job tax credits generated. An example is a service company which may have generated a large job tax credit by creating hundreds of jobs, but based on the apportionment methodology and sales factor sourcing rules of the state, the company does not incur a large income tax liability. In such instances, a company is left with a credit that it cannot use. Thus, locating in a state in which an economic incentive has an enhanced transferable feature is a huge benefit to a company.
Different transferability models can help you monetize economic incentives
“Transferability” can have several different meanings in this context. The key is simply that an economic incentive has the ability to be monetized. Some approaches to transferability are as follows:
1. Use against alternative tax bases: One way to generate flexibility is to make a credit transferable to more than one tax type. Georgia added this feature to its job tax credit for certain designated projects, such that if the job tax credit cannot be fully utilized against income tax, it can be used to offset payroll withholding. Similarly, Florida’s Qualified Targeted Industry tax credit can be used against several different tax bases.
2. Refundable: Perhaps the most favored tax credit is one that is refundable. States account for tax credits in their budgets and thus are expecting a company to use the credits they generate. If they cannot offset their liability then the state will refund the excess credit.
3. Carryforward: Many tax credits already have a carryforward provision, but based on the specific credit perhaps a way to be more flexible is to extend carryforward provisions for a longer period or until the credit is fully utilized.
4. Intercompany transfers: Another form of “transferability” is to be able to transfer it to other related entities within the corporate structure, such as limited partnerships.
5. Saleable: Finally, to the extent a company cannot utilize a credit, making a credit saleable to a third party allows for the company to recognize approximately 90% of the value it would have if it could have made use of the credit itself. As mentioned above, presumably a state has budgeted for these credits, so allowing them to be saleable and used by a third party should not result in any unexpected revenue loss to the state.
Creation of new legislation to make your project eligible for economic incentives
Oftentimes a state may not have any economic incentive programs to compete with other states under consideration for a significant project. This creates a situation in which a state must have the ability to be flexible and adapt quickly. In such instances, a state may create and pass legislation targeted at desired investments. For example, in 2013, Illinois and Iowa were in a bidding war over Cronus Chemical and the construction of a $1.2 billion fertilizer production facility. Iowa could offer approximately $35 million in incentives, but Illinois needed to pass legislation to be able to compete with its own economic incentives valued at approximately $30 million. Illinois needed to be able to designate Cronus as a high-impact business and thus be eligible for financial incentives, such as a waiver of sales tax. Upon the passage of these measures, Illinois did, in fact, win the project.
A current example is the passing of Senate Bills 242, 243 and 244 known as the “Good Jobs for Michigan” proposal. This measure would create incentives for companies looking to relocate or expand in Michigan. The economic incentive would be a reimbursement of withholding for companies who either create a minimum of 500 jobs in the state with an average annual wage that is equal to or greater than the prosperity region average wage or 250 new jobs if the business proposes to pay an average annual wage that is equal to 125% or more of the prosperity region average wage. This economic incentive is said to have been crafted to lure Foxconn Technology Group to create 5,000 jobs and invest $4.2 billion in Southeast Michigan.
There are several other examples of state legislatures passing bills specifically targeted at high profile projects. In most instances, the final bill that is adopted is very narrowly defined to limit the state’s financial exposure. For instance, Michigan’s Good Jobs for Michigan proposal would cap the amount of incentives available, as well as the number of recipients. Being open to the idea of drafting targeted legislation allows states to be flexible and compete for truly impactful projects.
Proponents of economic incentives will favor any flexibility a state or local community can offer, such as the recommendations above, to make economic incentives realizable to the bottom line and thus improve the overall return on investment of a project. After all, these are financial inducements that are committed to and promised by the granting authorities which a company relies on in committing to a site or project.
Opponents of economic incentives will suggest that “corporate welfare” measures should not occur and that such economic benefits should be available to all corporate citizens by reducing taxes across the board. However, the purpose of economic incentives, by definition, is to incentivize certain behaviors such as inducing capital investment and job creation. One may argue that if economic incentives did not exist that such activities within targeted industries would not occur in a particular location.
Please contact me at firstname.lastname@example.org for any questions or if you need help maximizing the value of economic incentives.