For those who need it least - at the expense of those who need it most
As the April 15 tax deadline looms, many Hoosiers are frantically searching for the least expensive, and thereby least painful, ways to calculate their income tax. Individuals and businesses have always sought to reduce their tax liability, and there's nothing inherently wrong in doing so. But the enormity of corporate tax credits, incentives, shelters and handouts have proliferated in recent years to such an extent that the state has reached a tipping point, with individual taxpayers shouldering a disproportionate share of the state's tax burden.
Like all of America, Indiana was adversely affected by the economic downturn in 2001, particularly in its loss of more than 100,000 jobs. The state was lucky in the good years, with nearly $2 billion in "savings" that has since been transferred to cover the budget deficits of the past three years.
That surplus has long since vanished, and lawmakers are working to provide a budget for 2006-2007 that simultaneously decreases spending and increases revenue. As a result, Hoosiers have been told to tighten their belts, and prepare for significant cuts in government spending.
Seymour resident Bill Bryden is outraged that the Indiana General Assembly now believes the state's deficit requires proposed changes in funding the state's First Steps Program, resulting in fewer children with Down's Syndrome, autism and other birth defects receiving much-needed assistance.
Indiana serves more than 15,000 people on Medicaid waivers for the disabled, with an additional 23,000 on waiting lists like those at First Steps. No new money has gone into these programs in recent years, and nearly $30 million in funding earmarked for services for the disabled has been diverted to the state's general fund in recent years in order to cover the state deficit.
Bryden's outrage is compounded with the announcement of increased taxes for the purpose of building a new Colts stadium.
"Is the effort to find $800 million to make Jim Irsay wealthier so he stays in Indianapolis more important than an effort to find the $34.5 million to move 4,200 people with tragic disabilities off waiting lists for Medicaid waivers?" he asks.
In the new state budget, the disability division of Medicaid is being asked to trim its budget, leaving tens of thousands of Hoosier parents like Bryden wondering how they will care for their disabled children.
"Why are our government leaders not exploring pull-tab games, hotel room taxes, rental car taxes, etc. to help all our state's children - children like my daughter who is missing part of her brain, has vision problems, can't eat through her mouth and is mentally retarded?" Bryden wonders.
Indiana Gov. Mitch Daniels understands both the emotion and the rationale behind Bryden's question. If Hoosiers are being told to tighten their belts and endure cuts in government funding, how can the state justify using taxpayer dollars to fund a football stadium?
"It's a fair question," Daniels says, "but it's important to remember that it's not just a football stadium - it's also a convention center ... and they have proven again and again to be successful sources of revenue.
"So it has to be looked at as an investment," he continues. "It will create a lot of jobs, and when those employees are part of the economy, it will generate revenue," and that revenue can then be used to fund programs like the one Bryden's daughter depends on.
The logic is simple: Business generates business. A community may lose a certain amount of income to initially grow business, but it profits when the employees become taxpayers themselves and reimburse the state's initial investment with income, sales, vehicle, gas, property and even inheritance taxes.
Hoosiers, however, have a hard-earned right to be skeptical.
This is the same type of economic development philosophy that brought the United Airlines maintenance facility to Indianapolis and left the city and state nearly a half billion dollars poorer.
In 1991, Indiana taxpayers gave the airline more than $300 million in the form of tax subsidies and other assistance in return for the promise to create 7,500 jobs. By the time it closed in 2003, the facility employed approximately 2,500 workers - the majority of whom relocated from United's maintenance operations in California.
It's a classic example of the type of economic development programs designed to lift Indiana out of its fiscal freefall. But these tax dollar giveaways have often done little more than provide tax relief to those who need it least at the expense of those who need it most.
The rich get richer
Over the past 10 years, Indiana has seen an increase in every category of tax revenue except corporate income taxes (see sidebar). Nationally, America's largest and most profitable corporations are finding more and more ways to pay substantially less in taxes at the same time they report increased profits.
Corporate taxes now account for about 7.5 percent of overall federal tax receipts, down from a high of 40 percent during World War II. Despite one of the highest ostensible corporate tax rates in the industrialized world, American companies are in fact among the least taxed.
From 2001 to 2003, more than half of all Fortune 500 companies obtained approximately $200 billion in tax savings, nearly double the amount of the previous three years. In addition, more than 25 percent of the 500 corporations paid no taxes at all during the period, despite having profits of nearly $45 billion.
Overall, the U.S. Commerce Department estimates that while pretax corporate profit rose 26 percent from 2001 to 2003, corporate tax payments fell 21 percent, totaling more than $12 billion in lost state tax revenue and $35 billion lost in federal tax revenue in 2001 alone.
On Oct. 22 of last year, just 11 days before the election, President Bush signed the American Jobs Creation Act of 2004, providing more than $135 billion in new tax breaks for corporate America. Originally intended as an effort to end a $5 billion-a-year corporate tax subsidy that had been declared illegal by the World Trade Organization, it grew to become the largest tax giveaway in more than two decades.
Included in the legislation was a "tax holiday" spear-headed by lobbyists from Indiana-based Eli Lilly and Co. that allows multinational companies to bring profits from overseas tax shelter accounts back to the U.S. at a tax rate of 5 percent, instead of the federally mandated 35 percent. For Lilly, the "holiday" means they can transfer a reported $8 billion into U.S. accounts and pay $400 million instead of $2.4 billion in taxes.
This multibillion dollar tax windfall came less than a month after the non-profit, non-partisan groups Citizens for Tax Justice and the Institute on Taxation and Economic Policy released a study detailing the disparity between corporate profits and corporate taxes.
The report named Eli Lilly as one of the most successful at using corporate tax breaks to reduce its tax burden, paying an average of 12.2 percent from 2001 to 2003 instead of the 35 percent maximum. Lilly disputes the figures, claiming they averaged a 21 percent tax rate during these years.
But it isn't just the federal government giving Lilly the opportunity to pay less in taxes. Our state and local governments are doing it as well.
In 1999, for example, the state and city gave Lilly $214 million in tax abatements and incentives in exchange for creating 7,500 new jobs over a 10-year period. Last November, more than five years later, the company had added only half of those positions when it announced a hiring freeze and layoffs.
More recently, Indianapolis-based Simon Properties is receiving nearly $4 million in property tax abatements for its new downtown headquarters in exchange for 40 new jobs. A few blocks away, the Hilton Corporation is receiving more than $800 million in tax credits to build its Conrad Hotel and create 250 new jobs.
Leveling the playing field
Between 1999 to 2001, Indiana gave nearly $150 million in state tax breaks to 63 companies in exchange for the creation of 10,704 new jobs, an average of $14,000 in tax revenue per new employee. As of August of last year, those same companies remained 3,000 short of their job creation goals, for a total of $42 million spent with no return on the investment.
Indiana lawmakers got into the game of providing tax credits to attract new business to the state during the recession of the 1980s.
Mark Akers, adjunct professor at the Indiana University Kelley School of Business at IUPUI, explains, "We were losing jobs right and left to other states. We had to get into that game in order to compete."
As part of Gov. Robert Orr's Administration in the early 1980s, Akers helped implement some of the state's earliest economic development programs.
Akers believes tax reductions are intrinsic to maintaining a healthy state economy. "If you don't play the game, not only do you not attract new business, you lose existing business."
The goal, according to experts like Akers, is to level the playing field.
"When the national economy is good, Indiana does well, but when it isn't, Indiana is one of the hardest hit states in the country," according to Akers. "And if the nation catches a cold, Indiana catches pneumonia."
Gov. Daniels won last year's election in large part because of his promise to put Indiana back on the right economic track.
While his plans continue the practice of giving tax incentives to new businesses, Daniels vows to give the benefits of state economic development policies to the small businesses, rather than large multinational companies. Many of his new economic development plans for the state exclude retail companies and large businesses that are already receiving incentives from existing tax programs.
Small businesses create two-thirds of new private sector jobs in America and employ more than half of all workers. According to Daniels, that's where the emphasis on economic development needs to be.
To help in these efforts, the governor named former Lilly executive Ryan Kitchell as head of the Indiana Finance Development Authority. Kitchell believes the governor's cost-cutting reputation will serve the state well.
"One of the things I like about the governor, why I was eager to work with him, is he's really tight [with money]. Every time someone proposes a tax incentive or a tax credit, the governor wants to know the return on that investment. And he's particularly interested in seeing small businesses benefit," Kitchell says.
Kitchell understands the criticisms of Indiana's past economic development efforts, and believes Daniels' plans will reform many of the abuses.
"I agree, the United Airlines bankruptcy was a disaster for Indiana," he admits, "but it was one of the last actual cash handouts to businesses. The governor wants to move away from handouts and towards a pay for performance system."
The governor has also shaken things up in the state's EDGE program, Economic Development for a Growing Economy, where he is streamlining the application requirements, reducing administrative costs and simplifying and automating the process for awarding these credits to encourage greater small business participation.
Economic experts like Akers are optimistic that these moves will create positive change for the state.
"They're still staffing up, but so far they've brought in some awfully bright people, and they're putting together some aggressive and innovative policies to replace existing ones."
Cash giveaways in the form of tax credits and abatements aren't the only ways states like Indiana decrease state revenue in hard economic times. The corporate income tax laws of the majority of states are riddled with loopholes that permit many large corporations to avoid paying tax on a significant share of their profits.
And despite efforts to reverse that trend, Indiana lawmakers are doing little to increase state revenue by making businesses pay their fair share of taxes owed.
As the Washington-based Center on Budget and Policy Priorities reports, "The growing sophistication of corporations in exploiting these flaws has undoubtedly contributed to declining corporate state income tax."
Passive Investment Corporations (PICs) (see sidebar) are just one of the ways American businesses gain enormous corporate income tax savings at a very small cost, and a majority of large U.S. corporations have created PICs exactly for that purpose.
Rep. John Day (D) of Indianapolis is one of several lawmakers working to join nearly every other state in the country and close the PIC loophole. "In addition to raising millions of dollars in tax revenue, closing the loophole would make the tax laws more fair," according to Day. "Even if it only raised 10 cents, it's a matter of fairness for taxpayers."
Passive Investment Companies
What is a Passive Investment Company?
PICs refer to corporate subsidiaries set up for the primary purpose of avoiding state taxes.
Often, PICs employ no one, produce nothing and have one shareholder: the parent corporation that established it.
The parent corporation transfers ownership of trademarks, logos, etc. to the subsidiary and then pays a royalty fee to the subsidiary for the rights to use the trademarks.
The fees paid to the phantom company transfers profits earned in Indiana and other states to the out-of-state subsidiary, where the income won't be taxed.
The subsidiary often loans "profits" back to the parent company, and the parent company can then deduct the loan interest from their taxable income.
Who uses Passive Investment Companies?
The state of Maryland recently sued the following companies for back taxes and penalties owed to the state as a result of the PIC loophole, nearly 100 companies in all are named in the litigation:
Abercrombie and Fitch
American Greeting Corporation
Bath and Body Works
Lane Bryant, Inc.
Long John Silver's
May Department Stores
Pepperidge Farm, Inc.
How much tax revenue does Indiana lose as a result of the PIC loophole?
According to a recent Indiana Department of Revenue audit of 12 companies, the PIC loophole saved those companies $4.2 million in Indiana state tax in one year alone. Estimates of the total Indiana tax revenue lost as a result of the loophole range from $100 million to $300 million every year.
Former State Budget Director Marilyn Schultz agrees. "Closing the loophole is a matter of fairness and savings. Otherwise, it becomes a game of hide and seek - the corporations hide the profits, and the state is forced to seek them out."
Last year, a bill that would have closed the PIC loophole was passed by the House, but did not pass the Senate. Instead, the Senate convened an Interim Study Committee on Corporate Taxation, made up of members of both the House and Senate, in order to determine if it was necessary and/or beneficial for Indiana to close the loophole.
According to Day, who co-chaired the committee, lobbyists on behalf of business interests showed strong opposition during committee hearings.
"We were bombarded with chamber of commerce types who attacked the idea of closing the loophole, claiming it would drive businesses away from the state and result in lost jobs," Day says.
The Indiana Manufacturers Association (IMA) was but one lobbying group working to keep the loophole in place, though the overwhelming majority of Indiana manufacturers do not participate in PICs and would not be affected by closing the loophole.
IMA's Director of Taxation Mark Cahoon believes the move to stop PICs is simply "part of a larger umbrella of tax reforms that will penalize business."
"My concern is the unintended consequences of the legislation. The bill and issues are so complicated that any changes meant to fix problems might actually penalize legitimate business practices."
Cahoon believes politicians are just reacting to public pressure.
"They are looking for an enemy in the post-Enron environment. The practices haven't changed, only the scrutiny - and it's just temporary. Once public interest dies down, so will the scrutiny."
In his testimony to the legislative tax study committee, Cahoon asked lawmakers to "be sure that there is a problem with PICs in Indiana before passing legislation that would penalize them."
Publicly, Cahoon went as far as telling The Indianapolis Star he considered closing the loophole a tax increase on businesses, a claim Schultz finds ridiculous.
"If you don't pay all the taxes you are required to pay, and then you are caught cheating, yes - you have to pay more taxes. However, it is tax you should have paid in the first place. Yes, it is an increase in the tax paid - but it is not an increase in tax due."
Independence at any cost
During committee hearings, Chairman of the House Ways and Means Committee Rep. Jeff Espich (R) remained unconvinced that it was necessary to close the PIC loophole.
"How do we know as fact that the majority of states have already passed similar legislation?" he asked the other members of the committee when it came time for a vote. "How do we know for a fact that it would bring in more money?"
"Because it's true," responded Sen. Vi Simpson (D), "and because we heard testimony in earlier meetings that discussed the effectiveness of this type of legislation in other states."
"Yes," Espich replied, "but does that make it a fact?"
In the end, the Interim Tax Study Committee on Corporate Taxation did recommend closing the PIC loophole and, during the current session of the Indiana General Assembly, Simpson co-sponsored Senate Bill 608 meant to do just that.
The bill was referred to the Senate Committee on Tax and Fiscal Policy in January, but it was never introduced, and therefore died before coming to either the Senate or House floors for a vote.
As a result, corporations doing business in Indiana will continue to legally divert hundreds of millions of tax revenue away from the state and back into their shareholders' pockets for at least another year.
In addition to its refusal to pass legislation closing the PIC loophole, the Indiana General Assembly has steadfastly refused to join the Multi-State Tax Commission (MSTC), a coalition of 45 other states working to standardize corporate tax laws and prevent out-of-state corporate tax sheltering. The state was once a member of the commission, but dropped out in the mid-1970s.
During the hearings of the Interim Tax Study Commission on Corporate Taxation, legislators heard from a variety of local and national advocates urging lawmakers to rejoin the multistate coalition and increase state revenue by forcing businesses to pay the taxes they owe.
LaPorte attorney Shaw Friedman testified that participation in the Multi-State Tax Commission could help Indiana recoup nearly $350 million each year in tax revenue lost as a result of tax shelters, abatements and loopholes.
"In a time of very tight state budgets, when services are stretched thin and lawmakers are looking for new revenue streams, the losses due to abuses like Passive Investment Corporations are costing Hoosier taxpayers dearly," according to Friedman.
Akers remembers when the state used to be a part of the MSTC, but isn't sure what caused the end of its participation.
"I don't know for sure, but my guess is that we just don't like to give up our independence. Indiana has always been very independent - it's still mostly rural, and the Legislature accurately represents that constituency. I think that explains a lot of the independence," he believes.
But the actions of Espich during the legislative hearings last summer point to a more antagonistic relationship with the MSTC.
While the committee debated the contents of its final report to the state Legislature, Espich made a motion to strike all testimony in support of and all references to the Multi-State Tax Commission. With no other lawmaker to second it, his motion did not carry.
Former State Budget Director Schultz believes the state would benefit from membership, but even in not joining the state has continued to use the commission's resources.
"It is inaccurate to say we don't participate. We 'sit at the table,' and we have sought their input and advice on the PIC issue and other issues like Internet taxation. But the Legislature would have to approve actual membership, and so far they have been unwilling to do that."
More of the same?
Indiana continues to be one of the states lining up to give the country's largest and most successful corporations millions of taxpayer dollars just for doing business in the state.
In early January, the new Indiana Secretary of Commerce Pat Miller announced that Wal-Mart, the state's largest private employer, would be building a new distribution center near Marion that would create 500 new jobs.
In order to lure the new facility to Indiana, state and local governments promised to provide nearly $5 million in grants, infrastructure development and tax credits. But the investment could potentially cost Hoosier taxpayers millions of dollars more every year.
In California, taxpayers pay approximately $86 million in Medicaid, food stamps, school lunch programs and subsidized housing each year for Wal-Mart employees. In Arkansas, the company's birthplace and headquarters, employees receive nearly $40 million in public assistance annually.
Twenty-five percent of all Wal-Mart workers in Tennessee receive Medicaid benefits, while taxpayers in Alabama spend more than $8 million each year in Medicaid expenses for those on the Wal-Mart payroll. The numbers are just as distressing in Georgia, where the parents of one in five children on the state's Medicaid program are employed by the company.
Additionally, Wal-Mart employees were eligible for an estimated $2.5 billion in federal assistance during 2004 alone.
But these aren't the only types of taxpayer compensation that helps raise Wal-Mart's profit margins. While its founders and majority stockholders top the list of Forbes richest Americans, and annual sales exceed $218 billion from its more than 3,000 discount stores, the Wal-Mart corporation itself is the recipient of $1 billion each year in government subsidy deals.
In other words, Indiana taxpayers will pay more than $10,000 per employee before Wal-Mart opens the door on its new facility in Grant County and potentially millions more each year in public assistance to help those new Wal-Mart employees and their families make ends meet.
Perhaps it's too easy to blame the decrease in state revenue and resulting budget deficits on economic development tax giveaways and the Legislature's refusal to close tax loopholes, though these two items alone cost the state nearly the same amount as the current budget deficit.
And it's certainly too soon for Indiana taxpayers to cynically predict that economic development under the new Daniels Administration will continue the practice of giving more than a half-billion dollars a year in tax reduction opportunities to corporations like United Airlines, Eli Lilly and Co., Simon Properties and Wal-Mart.
For now, Hoosiers must wait and see how Daniels and state legislators will work to attract new businesses and create new jobs in ways that benefit all taxpayers - giving much needed economic benefits to those who need it most, not just those who need it least.