Competition, Not Corporate Welfare: 3 Ways to Help All Businesses Flourish

Key Takeaways

• In 2020-21, Pennsylvania will spend $958 million on corporate welfare, according to initial estimates from the Governor’s Executive Budget.
• More than half of this spending is allocated to just four programs.
• The state wastes roughly $120 million on underperforming tax credits each year.
• If the state eliminated all corporate welfare, we could save $958 million per year, which is enough to reduce the CNIT by more than two percentage points bringing the 9.99% rate down to 7.22% while remaining revenue neutral.

Background

For every economic problem, there is no shortage of ill-advised “solutions.” The latest comes from presidential hopefulJoe Biden, who is touting his plan of government protectionism and favoritism as a solution to the COVID-19 health and economic crisis. But stricter government regulation will only make our economic problems worse.

One timely example is Paycheck Protection Program (PPP) loans. Despite being touted as a lifeline to help businesses stay afloat during the crisis, the Washington Post reported that many of these loans went to politically connected businesses. Additionally, billion-dollar companies—such as Kanye West’s Yeezy—received millions of dollars of loans through PPP.

As of April, over 60%  of Pennsylvania’s small businesses were at risk of closing if COVID-19–- related disruptions continued. Given that small businesses make up over 98% of all businesses and are responsible for 47% of job creation in Pennsylvania, the state can’t ignore their survival and just hope for economic recovery. While government-directed investment might reach some of its intended recipients, there are better solutions that will benefit all businesses.

Corporate Welfare’s Good Intentions and Poor Results

Corporate welfare is an amalgamation of two distinct economic ideas. On one front, these programs embrace the economic reality that business growth creates jobs and opportunity. However, the targeted distribution of these incentives results in government favoritism for selected businesses or industries. This favoritism comes at the expense of other businesses, who are left to compete on a now-uneven playing field. 

Corporate welfare encompasses multiple programs, including subsidies, grants, loans, tax credits, or tax breaks. It’s not “stimulus”—it’s favoritism for one industry, company, or region over others. And it doesn’t lead to lasting job growth.

In fact, these government handouts often reward firms for decisions they would have made even without the handouts. Additionally, any job growth that does occur comes at a high cost. A 2020 paper in the Journal of Economic Perspectives, for example, found that the average subsidized job cost Pennsylvania taxpayers over $93,000, well above the state average household income of less than $60,000.

 

Chart: Corporate Handouts in the State Budget

In 2020-21, Pennsylvania will spend $958 million on corporate welfare, according to initial estimates from the Governor’s Executive Budget. This spending encompasses 37 different programs, making it impossible to evaluate the expenditures as a whole. However, more than half of this spending is allocated to just four areas. 

 

Chart: A Minority of Programs Dominate the Majority of Corporate Welfare

Entertainment Production and R&D Tax Credits

Tax credits are incentives that allow individuals and businesses to subtract qualifying amounts of income from their tax liability. Not all credits qualify as corporate welfare. The largest tax credits that do qualify¹ are for Entertainment Production and Research and Development (R&D). The largest portion of the entertainment production program is the Film Production Tax Credit, which totals $70 million and isn’t worth the price tag. A report by the Independent Fiscal Office (IFO) found that every dollar in credit produces only 13 cents in economic activity. Put another way, this tax credit is projected to cost the commonwealth over $60 million for every year it’s in place. 

The next largest credit program is for R&D, first instituted in Pennsylvania in 1997. The program was intended to encourage investment in R&D that would spur long-term innovation and economic growth. Many of these benefits go to society or a particular industry as a whole, and therefore may not serve as adequate motivation for investing firms, hence the program. Like the Film Production Tax Credit, the IFO report found the R&D Tax Credit to have a low return on investment of only 16 cents on the dollar. This means that with over $55 million dedicated to the program, about $46 million of that is useless spending. 

Accounting for other states’ programs, R&D incentives were found to be zero-sum, with increases in one state offset by decreases in another. Overall, they have a minimal impact on total R&D spending. After the federal enactment of the tax credit in 1981, 55 percent of companies said the credit didn’t impact their overall spending on R&D.

Economic Zones Don’t Create Jobs

Targeted Economic Zones (EZ) refer to specific geographical areas that offer specialized tax climates and/or business incentives. In Pennsylvania, these zones impact almost every county.²

However, EZs generally show no measurable influence on a business’s location decision and barely any influence on the creation of new jobs. Since EZs are in virtually every county, it is difficult to compare county-level impacts. When measured at the state and regional level, there has been no discernible difference in employment growth before the two largest EZ programs and after.

 

Chart: Pennsylvania Job Growth, Keyston Opportunity Zones

 

 

Chart: Pennsylvania Job Growth, Neighborhood Improvement Zone

 

Like all government favoritism, these programs have winners and losers. A 2018 paper from the Upjohn Institute found that incentive programs influenced location decisions in firms between only 2 to 25% of the time. In other words, the other 75 to 98% of the time, these tax incentives acted as rewards for decisions the business would have made regardless of the program. 

A 2019 report in The Philadelphia Inquirer makes this very point with the story about David Waxman, who runs a development company. David is primed to take advantage of federal opportunity zones, but his project of transforming a former brewery into luxury apartments in Philadelphia was planned well in advance of the program and would have occurred without it. 

Missing from The Inquirer’s report are the stories of all the businesses that existed in the area prior to the opportunity zone designation that aren’t allotted the same benefits. They now have to compete with David’s new business and its unfair tax advantage.

 

Chart: Counties with Economic Zones

Race Horse Development Fund and Similar Handouts

The most blatant examples of government favoritism are industry-specific handouts. In Pennsylvania, these industry handouts total almost $250 million.³ While they clearly violate fairness principles by favoring one industry over another, there are also economic reasons to end the practice. These handouts put Pennsylvanians on the hook for benefits that flow to other states and even other countries. One example is Pennsylvania’s Race Horse Development Fund (RHDF). Although most disbursements from the RHDF go to Pennsylvanians, the state is not gaining revenue from the program. According to a 2017 IFO report, the state operates at a net loss of about $44 million, with about $80 million leaving the state and only about $36 million coming in.

 

Chart: Total Money Flow from the RHDF

Solutions That Help All Businesses

1. Pass legislation to automatically sunset underperforming tax credit programs. Pennsylvania has 12 programs that fall into this category of corporate welfare and cost over $245 million a year.⁴ Fortunately, the passage of Act 48 in 2017 mandates that the IFO conduct evaluations of existing tax credit programs. In its first year, the IFO reviewed the New Jobs Tax Credit and the Film Production Tax Credit. Following the review of the New Jobs Tax Credit, the program was eliminated. 

   Legislators should continue to use the evaluations from the IFO in order to make smart decisions about budgeting. Last year’s evaluations included the Research and Development Tax Credit, the Keystone Innovation Zone Tax Credit, and the Mobile Telecommunications Broadband Investment Tax Credit. By IFO estimates, these programs wasted $60 million last year. Passing legislation to automatically sunset underperforming programs with less than a dollar-for-dollar return will reduce wasteful spending. 

2. Eliminate corporate welfare entirely and use the savings to dramatically reduce the corporate net income tax (CNIT) for all businesses. Pennsylvania’s CNIT⁵ is third highest in the nation at 9.99%. Instead of picking favorites through targeted handouts, reducing this tax would benefit all Pennsylvanians by increasing investment and spurring economic growth. If the state eliminated all corporate welfare, we could save $958 million per year, which is enough to reduce the CNIT by more than two percentage points,⁶ bringing the 9.99% rate down to 7.22% while remaining revenue neutral.
3. Reduce corporate welfare and use the money to reduce the CNIT for all businesses. Alternatively, by redirecting the resources used in industry-specific handouts and economic zones, Pennsylvania can cut the CNIT by over a full percentage point. Combined with sunsetting tax credits, Pennsylvania could reduce its CNIT considerably and save up to $245 million. Remaining programs would include but are not limited to marketing, regional partnerships, and improvement incentives. 

 

Chart: Potential Reducation of CNIT

Conclusion

To effectively promote economic growth and job creation, policymakers need to stop investing tax dollars in failed programs and start enacting policies that benefit a wide range of job creators, like reducing the CNIT. In just two years, IFO reports have identified $120 million⁷ that the state wasted on underperforming tax credits each year.⁸ Spending on failed programs is not only wasteful, it is wrong for the government to pick economic winners and losers. By implementing these changes, Pennsylvania can give all businesses a needed hand up.