State tax breaks for corporations at risk
It may be common practice for states to lure business with special tax incentives, but a Supreme Court ruling could change all that.
NEW YORK (CNNMoney.com) - It's now common practice for states to lure businesses into their jurisdiction using tax incentives. But a possible Supreme Court ruling could make this a thing of the past, raising some concerns that economic development could slow as corporations reconsider development projects due to higher costs.
The high court is slated to hear opening arguments Wednesday in the case of DaimlerChrysler v. Cuno -- one of a handful of corporate cases on the docket this term -- and one that some say could have even greater implications than the well-publicized eminent domain case of Kelo vs. City of New London.
"Kelo didn't upset the status quo, but Cuno does threaten to do so," said Greg LeRoy, executive director of Good Jobs First., a non-profit research group.
Unlike eminent domain, tax incentives are commonly used by 46 states to attract and keep business within their jurisdiction. Arizona, for instance, provided millions of dollars in tax incentives to get tech giant Intel (Research) to build a manufacturing plant in the city of Chandler. North Carolina, likewise, granted Dell (Research) about $279 million in tax credits and other subsidies to lure the company to build and operate a computer manufacturing facility in the state.
In total, it's estimated that state and local governments spend over $50 billion a year on corporate with tax breaks and other incentives, LeRoy said.
The theory is that new business is positive for economic development, creating new jobs and tax revenue that can be plowed back into the regional economy.
Hindering interstate commerce?
But now, the high court will have to determine if the practice of offering tax incentives to corporations is in fact legal, and whether it violates the dormant commerce clause in the U.S. constitution that prohibits states from impeding interstate commerce. If the practice is found to be in violation of that clause, it could mean millions of dollars of lost savings for Corporate America.
The suit stems from a 1998 decision by the Ohio government to provide $280 million investment tax credit to auto giant DaimlerChrysler (Research), in order to keep the company from relocating its vehicle-assembly plant to Michigan from Toledo.
Toledo small business owner Charlotte Cuno and several Michigan citizens filed a suit claiming that the tax incentives coerce Ohio-based companies into remaining in Ohio in order to benefit from special tax breaks. In addition, the suit claimed that Ohio's tax incentives prevented Michigan citizens from reaping the benefits of the tax revenue that DaimlerChrysler's investment in the state could have brought.
"It's an injury to the state that doesn't get the deal," LeRoy said. "And everybody else has to pay for that lost revenue," using money that LeRoy said could have been better spent in other ways.
He said that if states are competing for a specific corporation's business, they may overspend and diminish state funds needed for other much-needed public projects. And the burden will fall on state tax-payers to make up for that revenue.
A federal court in Toledo originally sided with DiamlerChrysler and the state, but that decision was unanimously overturned by the 6th circuit court of appeals which ruled that tax incentives were unconstitutional.
And now all eyes are on the Supreme Court's decision.
A chilling effect on corporations
"Upholding the lower court's decision could have a chilling effect on tax competition between states" and could be a widespread headache for corporations, said Chris Atkins, staff attorney at The Tax Foundation, a non-partisan public policy group that filed a friend-of-the-court brief in favor of DaimlerChrysler. "If the Supreme Court sides with the lower court, what is the retroactive application of that decision?"
He said corporations could find themselves forced to restate earnings if previous tax incentives were deemed invalid, hurting profitability and putting pressure on investors. And companies may halt current investment projects, seeking instead to move them to lower-cost locations abroad, exacerbating concerns over outsourcing U.S. jobs.
"If they say tax credits violate (the commerce clause), that would make other countries look more attractive," he said, potentially costing billions of dollars from the U.S. economy.
But opponents of the tax incentives scoff at the notion that abolishing incentives will propel companies to go offshore in order to make up for the cost savings.
"It's a red herring," LeRoy said. "All state and local taxes combined as a cost of doing business for the average company in America comes to only 0.8 percent."
He said any savings that a company might achieve through the tax incentives were minimal compared to the savings they could have by moving their operations offshore. Therefore, he added, the argument that abolishing the incentives would result in job losses to foreign countries is without merit.
Still, legal observers worry that if the Supreme Court upholds the appellate court's decision, it could open a Pandora's box of litigation.
A wave of litigation
Already, two similar cases have sprouted up in North Carolina and Minnesota, as private citizens challenged their respective states' tax incentive programs. The high court's case could be the turning point to determine their ultimate outcome.
In Minnesota, two multimillion-dollar tax-incentive programs aimed at attracting and keeping business in special zones within the state are under fire. And last June, the North Carolina Institute for Constitutional Law named Dell in a lawsuit against the state, saying that North Carolina's bid for Dell's business was unconstitutional.
While the case in North Carolina is based on state constitutional issues, if the high court upholds the lower court's decision, it would bolster the group's case that portions of the incentives programs used in North Carolina also violate the U.S. Constitution, said Robert Orr, the executive director of North Carolina Institute for Constitutional Law and a former North Carolina Supreme Court Justice.
"Is it really the government's role to be selectively subsidizing very large companies?" he asked. "In our view, it's not the government's responsibility, especially if they're doing it at the expense of individuals and small business" that have to compete with those companies that received incentives.
But the Tax Foundation's Atkins said there are no competitors among the plaintiffs that can prove they were directly impacted by the tax incentives offered to DaimlerChrysler. That could sway opinion in favor of the state's use of tax incentives to lure business.
"These tax credits have been around for a long time. Society has lived with them and there has never been a claim [against them]," he said, adding that the Supreme Court's decision to hear the case "indicates that the Supreme Court is uncomfortable with the lower court's decision."
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