John Edward, a resident of Chelmsford who earned his master’s degree at UMass Lowell and who teaches economics at Bentley University and UMass Lowell, contributes the following column.
Governments should be cautious when they spend taxpayer money. Elected leaders would do well to follow the lead of the Supreme Court on how to be cautious.
During a recent hearing on Beacon Hill, legislators and the Patrick administration argued over the taxpayer money spent on tax incentives. As reported by CommonWealth Magazine, “Tax breaks… are finally coming in for serious scrutiny.”
It is not clear what serious scrutiny means. Nor is it clear why our elected leaders have not already scrutinized these tax breaks. What is clear is that they should be subject to “strict scrutiny.”
The United States Supreme Court first applied the strict scrutiny standard in the 1940s. The court applies strict scrutiny under the equal protection clause of the Fourteenth Amendment in cases involving fundamental rights and legislation based on racial classifications.
The strict scrutiny standard sets a very high bar. When applied as a standard, the court considers legislation valid only if:
1. There is a “compelling state interest,” and
2. The legislation is “narrowly tailored.”
Government should apply the same standard to tax incentives. There must be a convincing argument that an incentive will benefit the common wealth. If the government targets incentives at individual companies, they are instead Picking Winners and Losers. Incentives must also be unambiguous in order to avoid loopholes through which taxpayer money will fall.
At the federal level, “carried interest” is a good example of a tax policy that does not meet the strict scrutiny standard. Investment fund managers charge a carried interest fee to clients based on any gain in the client’s investment account. Current law taxes carried interest at the much lower capital gains rate.
There is no compelling state need for this tax break. There is no persuasive evidence that it promotes investment. The fund manager is investing someone else’s money. The primary effect is that it provides an incentive to get income classified as carried interest.
The tax break is not narrowly tailored. As reported recently by Forbes magazine, when Mitt Romney left Bain Capital “he negotiated a deal that gave him carried interest in Bain funds set up for a decade after his departure–and hence a stream of retirement income taxed at low rates.” We should not allow companies to use carried interest so the rest of us have to pay for platinum parachutes.
Many Massachusetts tax policies do not stand up to strict scrutiny. One high profile example is the film tax credit. Hollywood producers and movie stars can get huge tax breaks when they film something in Massachusetts. The state spent $80 million of taxpayer money on this tax credit last fiscal year.
The film tax credit does not fulfill a compelling state interest. The state interest is the creation of jobs. Temporary jobs are created, but at an estimated cost to the state of $142 thousand dollars per job. The state gets an estimated 13 cents in new revenue for every dollar spent.
The film tax credit is not narrowly tailored. The state pays out even when the filming would have occurred here anyway. Boston-based WGBH received over $4 million in credits for filming productions locally.
A policy that promotes job creation across industries could meet strict scrutiny. A policy that promotes a targeted industry, for example alternative energy, may pass the strict scrutiny test.
However, a policy that targets a specific company does not fulfill a compelling state interest. If Governor Patrick’s administration had applied strict scrutiny, they would not have picked a loser by giving Evergreen Solar a tax break.
If the state of Rhode Island had applied the strict scrutiny standard to the 38 Studios case, they could have avoided losing $75 million in taxpayer money. We would still associate Curt Schilling with a bloody sock instead of a bloody mess.
At the local level, some cities and towns in Massachusetts offer “Tax Increment Financing” (TIF). A company with power and the right expertise can get a TIF, which grants them a break on property taxes for improvements to a commercial property.
TIFs are not very effective at achieving a compelling state interest. Municipalities hand out TIFs to promote commercial investment, and jobs, in their community. It does not matter if the company would actually base their location decision on getting a TIF. In fact, studies show that tax breaks are seldom a major factor in location decisions.
TIFs do not pass strict scrutiny. Powerful companies use TIFs as a ploy to get cities and towns within the state to compete against one another. A large company makes a threat and some towns will cave in.
For fiscal year 2013, the Commonwealth of Massachusetts budget identifies $26.5 billion in tax expenditures. Beacon Hill does not subject them to strict scrutiny. Many would not meet the standard.
According to the Treasury Department, federal tax expenditures total over a trillion dollars per year. There are over 200 tax breaks. If Presidential candidates want to be specific on what loopholes they will close to reduce the budget deficit, there are plenty of places to look.
Voters should apply strict scrutiny when choosing whom to elect. If a candidate wants to spend your money on tax breaks, make sure they have a compelling reason.