Issue of the Week

The Unlevel Playing Field, or Why Discretionary Tax Breaks Are A Bad Idea

By Elizabeth Lynam

One of the ways in which political leaders have responded to the adverse effects of high state and local tax burdens is to grant dispensations to specific firms. The dispensations are granted largely through programs the State and City of New York have set up to offer property and sales tax exemptions and low cost energy. These are administered locally through the Economic Development Corporation, an off-budget entity set up to deal with firms on behalf of the City.

The largest parts of the packages offered to business are the real property tax exemptions granted to firms in New York City in order to encourage them to remain in the City or expand their operations. According to the New York City Office of Management and Budget, in fiscal year 1998, the property taxes foregone due to these special arrangements totaled over $393 million. Additional exemptions were given for state and local sales taxes imposed on purchases by the favored firms and for utility taxes to which they may have been subject.

The argument in favor of these tax breaks is that they keep in the city jobs and economic activity which otherwise would be lost to New York. Were this the case, the exemptions would then "pay for themselves" by generating revenues from income and retail sales taxes which would otherwise have been lost due to relocation.

The benefits associated with discretionary tax breaks are questionable for three reasons: 1) It is not clear that a firm would have located or relocated somewhere else without the incentive package. 2) Reducing taxes for one firm and not others in the same industry makes the playing field uneven by subsidizing one of several competitors; the favored firm may gain at others' expense without enlarging the local economy. 3) The overall tax burden in a locality does not change as a result of a few discretionary breaks; thus, the burden on those still paying taxes grows.

First, it is not clear what the firms involved would actually have done without the tax breaks. Some may move as threatened, but others might have remained or at least kept some of their operations in the city. Very often, a firm has only to assert or hint of its departure to trigger city action. In the cycle of assertion and response, the city is at a disadvantage having no way of ascertaining whether the firm really intended to relocate. It may hear reports from key actors or officials in competing localities that negotiations are underway, but without calling a company's bluff by refusing to negotiate a city will never know what would have happened without the giveaway.

To illustrate the point, Bertelsmann A.G. walked away from a $28 million incentive package in early September because it did not want to be delayed by the full environmental review the City required. The company decided to move ahead with its expansion and forgo tax breaks citing a need to consolidate employees in one location. If Bertelsmann hadn't backed out of the deal, the City would have given tax breaks to a firm that in all likelihood would have built the building anyway.

Second, the calculation of benefits typically ignores the adverse impact of the deal on firms not involved. Cutting the costs of one firm in the city gives it an unfair advantage over its local competitors in the same industry; some significant portion of its future activities may have transferred from a local competitor who would have been paying a full share of taxes. To the extent this occurs, the tax exemptions do not increase economic activity within the city.

Ernst and Young, for example, one of the largest accounting firms in the world, signed up for a $20 million incentive package this July to build a new office tower in midtown, prompting officials at PricewaterhouseCoopers to say they would seek a similar deal for their new building. New York City has a highly competitive accounting sector. If PricewaterhouseCoopers cannot negotiate a similar benefit and some of their business moves to Ernst and Young as a result, economic activity is unchanged but the city has foregone $20 million in revenue. If PricewaterhouseCoopers is given an equal deal, the City loses $40 million with no change in the volume of accounting activity.

Third, the strategy has adverse consequences for businesses in other industries and for all residential taxpayers who continue to pay a full share of taxes. The foregone revenue is made up by these other taxpayers, whose burden grows. This makes the City less competitive for nonexempt parties and takes its toll on the scale of their activities. Thus, subsidizing the activities of one firm over another worsens the overall business climate - a zero-sum game.

The need to deal with the generally high level of taxes in New York City is illustrated by Chase Manhattan Corporation's recent announcement that it was moving 3,500 jobs out of the City to cut costs. Chase didn't even bother to discuss tax breaks with the City. Officials at the company said the deal wouldn't be worth it because the cost of doing business is so much higher in the City. Instead of cutting deals for select firms, the City should be improving the climate for all businesses. Redirecting the roughly $400 million in tax breaks to improve schools and public transportation and to lower taxes across the board would serve that purpose.

In the face of similar incentives offered by other states and counties, the use of discretionary tax breaks remains contentious; some see them as essential to keep jobs, while other criticize them as giveaways. However, a more competitive and economically neutral tax system would eliminate the need for virtually all such incentives.

Elizabeth Lynam is a Research Associate at the Citizens Budget Commission


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