Creating Fiscally Sound State Tax Incentives: Advice for Legislators

More and more states are establishing and expanding tax incentives to promote economic development. While incentives can help generate jobs and economic activity, they can also generate nasty revenue surprises for state budgets unless they are carefully designed. Louisiana's severance tax exemption for natural gas producers using horizontal drilling is one example. The cost of that exemption, a mere $285,000 in FY 07, jumped to $239 million in FY 10 after the 2008 discovery of a large new natural gas deposit in the state and changes in drilling industry technology.

A new report from the Pew Center for the States highlights these and other tax incentives that turned, unexpectedly, into “blank checks.” Because incentives often function as entitlements, it can be difficult for legislators to rein them in after enactment.  Even if the incentives are later eliminated or scaled back, the credits businesses have already accumulated can continue to create revenue losses over several more years. 

To help avoid such pitfalls, Pew recommends that legislators take the following steps before enacting new tax incentives:

• Insist on reliable cost estimates produced through a professional and transparent process. Estimates should project both annual revenue losses over several fiscal years and the expected timing of those losses.
• Because all estimates are uncertain, (1) set regular budgets for tax incentives with annual limits on the total amount of tax incentives and (2) reconsider existing incentives periodically to ensure they are still working as intended.