Governor Taking the Wrong Approach to Economic Development

January 27, 2016 by Mark Scott in 2016 Session, Blog, Budget and Tax, Economic Opportunity

Governor Hogan’s proposals for rejuvenating Maryland’s manufacturing industry would create an uneven playing field for businesses and set a bad precedent by exempting some businesses from paying their fair share for the services we all benefit from.

We all agree that creating more good jobs in Maryland must be a priority, especially in areas with high unemployment. However, the governor’s approach is modeled after activities in other states that have created few jobs at very high cost to taxpayers.

Governor Hogan wants to eliminate the state corporate income tax and all other state taxes for 10 years on manufacturers that set up shop in specific areas of Baltimore City, Western Maryland, and the lower Eastern Shore. In addition, people hired at these new manufacturers earning less than $65,000 per year would not have to pay any state income taxes.

The governor’s proposal is similar to other programs Maryland leaders have tried for the past three decades, with very little to show for the efforts. Currently, there are dozens of business tax credits programs available to companies that cost residents millions of dollars each year.

Of these business tax credits, about one-quarter are employment tax credits and one-half are related to economic development. Since 2000, the state has given out an average of $900,000 in enterprise zone income tax credits each year. Enterprise zones are areas that state and local officials designate as in need of investment, offering property and income tax credits to businesses that choose to locate there. From fiscal year 2001 to 2014, state reimbursements to local governments for this program totaled $131.2 million—as the state is responsible for half the cost of the enterprise zone property tax credits.

If just 10 percent of eligible companies took advantage of the manufacturing tax credit by relocating into enterprise zones, the governor’s proposal would cost the state about $20 million in lost revenue due to tax credits and an additional $52 million by exempting employees from paying the income tax, according to an analysis by the state Department of Legislative Services that used figures from 2012 to evaluate a similar proposal.

Similar zone-based programs that offer incentives specifically to manufacturers include the State Enterprise Zone Program and the One Maryland Program. Maryland also already has special tax provisions for manufacturers.

In addition to the significant loss in revenue that the state would incur, creating tax-free zones for companies and exempting workers from paying state income tax is an unproductive strategy for a number of reasons.

First, by giving very favorable tax treatment to certain businesses, the plan could harm the existing businesses that do not receive this favored treatment. This, in turn, would reduce the profitability of those existing businesses, their tax liability and, reduce the total amount of resources that the state receives and uses. It’s important to point out that money the state foregoes in revenue is money that could have gone for schools, transportation, safe communities, and other building blocks of broad prosperity.

Second, the budget cuts or other tax increases needed to offset the revenue loss would cancel any short-term stimulus. Corporate tax-cut advocates often argue that they encourage job creation by “letting businesses keep more of their money” to invest in local economies.  But, states must balance their budgets, so they must fully offset the revenue loss from corporate tax cuts through some combination of cuts in services and increases in other taxes.  Those steps would cancel out whatever boost to the state’s economy that corporations might provide by spending their entire tax cut in-state.

Third, corporate tax cuts weaken long-term growth by leading to cuts in public services. Businesses need and demand the high-quality education systems that produce skilled workers. They need well-functioning infrastructure to get their employees and supplies to their plants and their products to customers. They need police and fire protection. If states help pay for corporate tax cuts in ways that impair the quality of these services, even the tax cuts’ modest positive potential impacts likely won’t materialize.

Fourth, such tax credit programs are easy to subvert and hard to enforce. For example, companies sometimes shut down operations and immediately reorganize under a new name so that they can participate in the program.

Fifth, corporate tax cuts could reduce the overall level of economic activity in Maryland. Some of corporations’ tax savings would likely go to their out-of-state shareholders in the form of higher dividends, which is good for the shareholders but worthless to the state.

The Department of Legislative Services evaluated the enterprise zone tax credit and its application here in Maryland, and found that enterprise zone tax credits are not effective in creating employment opportunities for enterprise zone residents. Additionally, property tax and local income tax revenues will decrease in counties and municipalities in which a Maryland zone is designated, even though their infrastructure costs will rise to support the new development.

Instead of implementing a policy that could provide a minimal benefit to a small segment of the population, while being quite costly for the state as a whole, lawmakers need to focus on creating a more equitable tax system that calls upon high earners and corporations to pay their fair share in support of the public good.