How corporate tax incentives work and why cities spend so much on them

Kristen Jeffers is a writer, planner and Strong Towns member. The following essay by Kristen is republished from Greater Greater Washington with permission.

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Amazon’s nationwide HQ2 contest, er Request For Proposals, has brought concerns about taxpayer-funded incentives for big businesses to the fore. Some of the region’s residents are furious that companies making millions of dollars a year would be offered millions more to come to town, rather than those funds being spent on needed services. But how do these corporate incentives, like tax abatements and tax credits, actually work?

First, a few definitions: A tax credit, for individual federal filers of income tax, is an amount applied directly to the amount of tax that you owe. It’s like an “X dollars off” coupon or a gift card with money on it.

A tax deduction, on the other hand, reduces your rate by a percentage based on the amount of income you make. Basically it’s an “X percentage off” coupon handed out by the government that lowers the amount of income you need to pay taxes on. However, it may still require you to pay a significant sum to get the savings, or only take a small sliver off of your total tax bill.

While corporations are often treated like people in the legal system, they don’t get taxed like people. A sole proprietorship, which is a single-person company, normally gets taxed at a 15% rate. If you make $100, you owe $15 to Uncle Sam. Corporations get taxed at higher rates (formerly 35% and now 21%), though there are many, many ways to avoid paying this much.

That’s just at the federal level though; businesses are also usually subject to state and local income and property taxes. When state and local jurisdictions waive these taxes for companies, that’s a tax abatement.

Why jurisdictions are ok with some companies paying less taxes

So why would local governments let businesses get away with paying less? Simply put, governments offer incentives when they think a company will add so much money to the local economy that giving the company a pass on some taxes will more than pay for itself.

For example, if Amazon brings 50,000 highly-paid workers to DC, not only are those workers all paying income tax (plus property tax, for some), they're also buying food and clothes and other things, propping up nearby service companies and contributing a lot to sales taxes. Amazon itself is paying a lot of smaller contractor companies, ranging from janitors to internet server manufacturers, who are paying taxes themselves and hiring their own workers who also prop up nearby companies and pay their own taxes.

It's all based on the concept of "primary employers," which are basically jobs that bring money into the local community from the outside, as opposed to "secondary employers" which rely on local money to survive. Big factories are an obvious example of a primary employer, since they manufacture goods that are exported worldwide, and thus they import money from all over the world into a local community.

The headquarters of a massively profitable global corporation also qualifies, since it exports management of the company and imports money from all their worldwide operations. According to this concept, every "primary" job not only supports itself via taxes, but also supports multiple "secondary" jobs, by virtue of providing affluent customers for the local service economy to rely on.

In theory, if primary employers import more money into the community from the outside than the tax incentives cost, the tax incentives are worth it.

Larger companies and cities also add vendor companies to their calculation of benefits, such as the five food trucks they buy out each week to provide lunch as a company perk. Ironically, those food trucks usually pay the larger corporate rates the bigger company would normally pay because they don’t have the same amount of clout to get their taxes waived.

There’s usually a political calculation here: often politicians are praised for “bringing in” companies with these types of incentives, even though there’s little evidence to suggest that tax breaks are a good investment for cities and states. (Quite the opposite, in fact.) Voters seem to like that their elected leaders are making an effort even when they don’t succeed.

Often, the company gives charitable donations to private nonprofits in an effort to appear beneficial to the community without the city having to do anything. Sometimes companies give away objects — for example, Warby Parker gives glasses and Toms gives a pair of shoes for each one purchased by customers.

There’s also the more traditional “CEO shows up with a big paper check” method, which the Publishers Clearing House prefers. A good local example is Washington DC's Capital Pride Parade, where companies pay for the honor to march and show their solidarity with those in the LGBTQIA+ community.

There’s another direct connection that private nonprofit charities and foundations have with cities. They are registered as vendors with the government in order to provide social services that the government used to provide or provide at a higher rate. This process is called privatization, and it’s been going on for decades.

Governments are legally able to farm off pretty much all of what they do to a business as long as it is classified as a vendor, generates income, and takes the responsibility off the agency. Even better if it’s a large corporation, that could in theory generate millions in taxes for just existing. But again, that’s only if they actually work — and often, they don’t.

Of course, this is just a simple overview — often, other more complicated financial things happen. Some cities borrow against their pension funds and other major pockets of money, especially if real money is exchanged up front. However, some companies will pay for all the construction services.

Are these tax incentives a good idea?

Many cities like the good press from seeming like they’re friendly to business. However, sometimes companies don’t produce nearly the revenue or other benefits promised. Some cities realize that long term tax breaks are a money-losing proposition, so they put a time limit on these benefits.

But cities still lose tax revenue during that time, meaning social services such as schools, food programs, parks, and housing can go by the wayside if the city doesn’t have enough money. Even if these services are being provided by vendors, vendors need to get paid. Vendors can sue for payment, but that’s no guarantee. Cities can just charge off the funds and go on.

When cities do this, nonprofit vendors never see the money and in turn, either stop granting money to other needy communities or they stop providing the service, such as emergency healthcare, that they were contracted to do.

Cities can also sue companies for non-payment or for not generating enough money to offset the incentives. However, some companies just pay the settlement amount and move on, sometimes before their 10 years is up, to the next city that will give them a 10-year deal for no taxes. (Walmart is notorious for practices like this.)

It’s easy to promise a company money, especially when the city doesn’t have to spend to prepare the lot, and when the expectation is that the company will always have money to pay for what it wants. However, it can indebt a city in the long run.

These types of incentives can work in special cases where a company would not have otherwise come in (like in an economically depressed city) or expanded, but these are rare.

So, are tax incentives a good investment for local jurisdictions to make? By all indications, they’re not. CityLab calls them “worse than useless,” the Institute on Taxation and Economic Policy says they’re “costly for states, drag on the nation,” and most economists agree such incentives are counterproductive.

So why are so many cities and states offering them anyway? Basically, because everyone else is, and jurisdictions feel like they need to offer perks just to keep up with other local governments. In the end, it’s the residents who suffer.

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About the Author

Kristen E. Jeffers is an author, urban planner, and multimodal transportation advocate. She holds a Master of Public Affairs focused on community and economic development from the University of North Carolina Greensboro, and a Bachelor of Arts in communication with a concentration in public relations from North Carolina State University.

She is the founder of The Black Urbanist, a media platform she created in 2010 to share her thoughts on places and spaces, especially those in the African Diaspora. She has presented at a number of industry and civic conferences on civic pride, cultural diversity, equity, fair housing, and the power of grassroots in communities. She is a Streetsblog Network and Greater Greater Washington Editorial Board Member. She has also contributed articles to CityLab, Next City,[Greensboro] News & Record, Yes! Weekly, Grist, Better! Towns and Cities, Triad City Beat, Urban Escapee and Urbanful.