he political climate for state business incentive programs is changing rapidly, in large part due to the Charlotte Cuno et al. v. DaimlerChrysler et al. court case.
Cuno involves two Ohio business incentives: the Corporate Franchise Investment Tax Credit (ITC) and the Personal Property Tax Exemption. In Cuno, the court determined that the ITC discriminated against interstate commerce (violating the Commerce Clause) by influencing an investment in-state versus out-of-state. The property tax exemption was not discriminatory because the exemption offset potential future taxes versus existing taxes.
Following Cuno, other lawsuits are in motion. Olson et al. v. Minnesota et al involves two Minnesota business incentives: the Job Opportunity Building Zones (JOBZ) program and the Biotechnology and Health Sciences Industry Zone program.
In preparing to write this article, I re-read current literature on the above cases. I have one primary observation:All current information is written from either a legal, political, or state think tank (read special interest) viewpoint.
My perspective is meant to be more practical.
With state business incentive programs the law is not often black and white. Because of this, a series of sometimes conflicting court decisions make up the body of law.
In relation to the current Cuno case, Walter Hellerstein, the Francis Shackelford Professor of Taxation at the University of Georgia School of Law, in May 2005 testimony before a U.S. House subcommittee, summed up the U.S. Supreme Court options as:
- Do nothing and face decades of litigation,
- Address only Cuno, or
- Legislate broadly on state tax incentives.
Every action has a reaction. Regardless of which option the Supreme Court takes, the economic development profession will continue to come up with new business incentives to recruit and retain industry.
To put the issue in perspective, taxadvantagegroup uses a database of federal and state incentive programs. At this time, there are over 2,500 completely different programs documented, 632 of which are tax credits. Of the credits listed, approximately 53 percent offset income tax. So from a practical standpoint, the structure of business incentives might change based on what Congress decides to do, but business incentives as a tool for economic development will not disappear. In the short run, uncertainty has been created in the market, which is never good for investment decisions. In the long run, states’ incentive programs will continue to evolve to meet the needs of business.
Congress has the power to regulate state taxation of interstate commerce. The Economic Development
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Act of 2005 (“the Act”), introduced by U.S. Sen. George Voinovich in May 2005, has been written in order to nullify Cuno. The legislation would make it clear that any State may provide tax incentives for economic development.
Generally, this is positive; however, drafting legislation that has no unintended adverse effects is never easy. In reading the Act there are still tax incentives that might not be protected. Just two examples: tax incentives that are dependent upon State residence of an individual; and tax incentives that require use of in-state services, (i.e. funds being deposited in in-state bank accounts, use of in-state labor for film production).
Will Congress decide what an incentive is? In my opinion, any difference in the tax code from one state to another that provides an opportunity for a company to increase profit (or decrease loss) is an incentive. Is the federal government going to regulate apportionment formulas, net operating loss carry back and carry forward rules and income throwback rules?
If we again consider that there are over 2,500 separate and distinct business incentive programs, it is obvious that although Congress may override Cuno, a great deal of ambiguity might still exist.
Special-Interest Information
Much of what is reported in the press cites state think tank reports. Daphne Kenyon authored an excellent article in the October 25, 2004, edition of State Tax Notes concerning the history and political affiliation of state think tanks and the usefulness of their research. There are ninety-four state think tanks that are affiliated with three overall umbrella groups, one conservative and two liberal. Kenyon identified only two of those 94 that are politically neutral: the Rhode Island Public Expenditure Council and the New Hampshire Center for Public Policy Studies. Therefore, when reading public information about business incentives, it is always important to determine what bias might exist.
Following are a few special interest excerpts:
John P. James, a shareholder in the law firm representing the plaintiffs in Olsen v. Minnesota, stated, “Tax giveaways are undermining the moral authority of the tax system.”
Michael Mazerov, senior fellow with the Center on Budget and Policy Priorities, the liberal umbrella organization for the State Fiscal Analysis Initiative (SFAI) stated, “Corporations have become adept at pitting states against each other,” and “even if the tax credits … were replaced dollar-for-dollar with other … types of economic development assistance … the likely replacements … usually are more transparent to the public.”
Timothy Bartik was cited in Mazerov’s report: “Entitlement tax breaks, compared to discretionary tax breaks, do not allow the advantages of being selective…”
On one issue nearly all can agree: The tax code undermines itself. It’s a mess, and needs to be simplified. However, it’s a broader issue than Arizona’s Defense Contractor Credit versus Florida’s Defense Contractor Refund.
Statutory tax credits serve a purpose. Statutory credits most benefit existing industry and small- to medium-sized businesses. These are the companies that do not always have either internal or external resources to separately negotiate each economic development project they face.
Who creates job growth and wealth across the country each year? Existing industry and small- to medium-sized businesses. Who would the elimination of statutory tax credits harm? Existing industry and small- to medium-sized businesses
Special interest reports often use inflammatory and condescending language. These groups would be more effective to acknowledge that state executives are smart, competent professionals instead of conveying that states are being taken advantage of and that states need to be saved from themselves.
Executives Do In This Environment?
Managing business risk is the key corporate mantra of the decade. Business incentives, in addition to creating project benefits, create tax and financial risk. Therefore it is and always has been a matter of dotting the “I”s and crossing the “T”s. A key to managing any risk area is to document and improve processes. This is also true for a company’s business incentives process. There are three main phases to any business incentive project: identification, negotiation and/or implementation, and compliance. Companies need a coordinated incentive program with a documented process for each phase. Following are a few suggestions to manage risk during the negotiation and /or implementation phase:
- Require specific signature authority for issues related to key risk areas.
- Required specific carbon copy guidelines to ensure that all risk management professionals (i.e. tax, treasury, legal, public relations, and others) stay in the loop.
- Require standard Memorandum of Understanding (MOU) language.
- Before the first external negotiation/implementation meeting, draft a “white paper” listing all the information that should be made public. Each internal and external team member can use this throughout the negotiation or implementation phase.
- In addition to the MOU, have a team member document all external negotiation/implementation meetings, i.e. who was present and what was said.
- If thinking about abusiness location in a Cuno state (6th Circuit — Kentucky, Ohio, Michigan, and Tennessee), include language in the MOU that allows for substitute programs of an equal value should Cuno be upheld.
- If thinking about locating in a state that has become known for disallowing statutory tax credits on any basis that can be conceived, include language in the MOU that clearly covers your eligibility for statutory tax credits.
- If a location makes the short list from any state listed in #6 and #7 above, then do not use 100 percent of the potential statutory incentive amount in your financial modeling.
- Make your decisions based first on the best operational site and second on the strongest financial site.
Remember that every action has a re-action. Depending on what either Congress or the courts decide related to state business incentives, states can and will find a way to compete against each other to create and to retain jobs and investment.
Although most of us do not have control over what Congress or the Courts do, we do have the ability to educate ourselves about business incentives and how to manage business incentive risk. As a corporate real estate executive, keep your eye on the details of the deal. Focus on getting the best operational site at the lowest financial cost, while managing risk. 
Tammy C. Propst is the President of taxadvantagegroup (tag), an economic development and business incentive consulting firm. Prior to tag, Tammy’s experience included serving as the Partner-in-Charge of KPMG’s Business Incentives Group and leading the international recruitment efforts of a government agency.