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Tax credits for a few vs. business deductions for everyone

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-Joe Kristan is a founding member of Roth & Company P.C

Every targeted tax break is a choice to favor one business or economic activity over another. Most years, that choice is hidden in the budget process. Not this time.

This year the General Assembly can choose between two tax policy approaches. The choices:

  1. A provision to allow all profitable businesses in the state to deduct currently their costs of purchasing machinery and equipment, up to a generous limit -- one identical to a provision in the federal tax law. It is used widely by farmers and small businesses, benefiting thousands of filers.
  1. A series of provisions -- some new, but most at least a few years old -- that provide tax credits to selected businesses and industries who convince the General Assembly that they deserve special treatment - and regardless of whether they actually have taxes to pay.

As things stand now, the Iowa General Assembly seems likely to choose the second option. And that says a lot about how poorly the Iowa business income tax system treats smaller businesses.

Option 1 is the "Section 179 deduction." The federal tax bill, passed in December, makes permanent the $500,000 annual limit on the deduction, which allows taxpayers to take a current deduction in the year machinery and equipment is first used; otherwise, the deduction is spread over a period of years through depreciation deductions. This limit has been at $500,000 for several years on a temporary basis, and Iowa has allowed the same deduction since 2010.

The $500,000 limit has been popular. It is available regardless of whether your business is bio-chemical, renewable fuels, films, or another economic development flavor-of-the-month. It’s simple to administer – you just use the number you claim on your federal return.

Governor Branstad recently told Iowa business leaders that the state can't afford to renew the $500,000 amount. Instead, the deduction will be limited to $25,000 per year in 2015 and future years. This tax increase could net the state somewhere around $90 million in additional revenue in any given year. Because it is a matter of timing, it is close to revenue neutral over a five-year period.

Option 2 is to expend the millions of dollars of tax credits in the budget targeted to promote specific industries, lure businesses, or favor certain investments. For example, the budget includes a new credit for "Renewable Bio-Chemical production." While the number of taxpayers who would receive this credit is unknown, it's safe to say that it is a tiny fraction of those who benefit from the $500,000 Section 179 limit. It's possible that fewer than 100 Iowa businesses will qualify for the new credit.

The budget also continues to fund a refundable research credit, which operates as a $40 million cash grant program to some of Iowa's largest businesses. It funds another $37.4 million renewable fuel and bio-fuel credits, and $20.1 million in sales tax refunds to big businesses lured to Iowa by the economic development bureau. Altogether, the budget provides around $277 million in tax credits to lure new businesses or to subsidize business behavior the state has deemed worthy of special favors. These credits are permanent; they generate no offsetting revenue in future years.

Might these special favors be better for the economy than some farmer or small business who buys a new tractor or machine? You could make that case, but it would be plausible only if these favors were enacted by a process where the state looked at the vast menu of possible industries to support and carefully evaluated which ones were more persuasive. That never happens. Instead, the credits follow the path of the notorious Iowa film industry credits, where an industry gets some legislators and business boosters excited and builds support -- sometimes with "studies" funded by booster groups. There is no evaluation of the opportunity costs, of whether the funds would be better used elsewhere.

Boosters of these favors will remind us of what wonderful employers the recipients of these special favors are. While that may be true, the employers in every county who stand to lose their Section 179 deduction are wonderful too -- and in this budget, they (and their employees, suppliers and customers) pay for the special favors. They may not feel that they're less important than the industries favored with tax credits. There are a lot more of them. Whether their numbers will enable them to prevent having their taxes increased remains to be seen.

Joe Kristan wrote this piece. He speaks only for himself, not for his firm, colleagues or clients.

Comments

What the writer fails to identify is that a tax credit is a non-cash contribution to the entity. The State or Federal Government is not writing a check to the business, it is incentivizing the business to provide jobs or in some cases develop real estate in needed areas. All businesses have the ability to purchase tax credits from real estate developers which decreases the business's tax liability and redirects capital from an inefficient government budget to a needed project for a community and provides construction jobs. The jobs created by the tax credits generates income tax and other revenue to the government providing a return on the governments non-cash investment that goes beyond the short sided view of only revenue reduction. Tax credits can be carried forward several years where deductions have a limiting time constraint. Incentivizing businesses to invest in our state through tax credits allows governments to leverage the tax credit without much if any risk. It's easy to point to one tax credit that was abused but not point out the other extremely successful tax credit programs that have added value. It's disappointing to see that a tax professional does not realize this, but then again he doesn’t claim to be an investment expert.

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