Tax Incentive Evaluation in 2016—in Law and Practice

This article was originally published by the Economic Development Tax Incentives project, an initiative of The Pew Charitable Trusts, and was written by Josh Goodman and John Hamman.

Many states have made progress in recent years toward regular, rigorous evaluations of their economic development tax incentives. In the 2016 legislative session, Alabama, Colorado, Hawaii, Virginia, and Utah enacted laws requiring regular evaluation, while several other states made progress to implement evaluation laws passed in previous years. As a result, lawmakers in numerous states will soon have evidence on the results of their incentives—information that they can use to improve the effectiveness of the programs.

New Evaluation Laws and Proposals

In the five states that approved laws this year, like others before them, support for evaluation was bipartisan and included both proponents and skeptics of incentives. In Colorado, where Democrats control the House and Republicans the Senate, lawmakers unanimously adopted their evaluation bill. In the Republican-controlled Virginia General Assembly, lawmakers passed tax incentive evaluation legislation with support from the state’s economic development agency and Democratic governor.

Although each state has customized its approach to its own needs and circumstances, the five new laws have much in common. In each case, professional staff is responsible for evaluating incentives. For example, the laws in Virginia, Colorado, and Hawaii direct legislative auditors to review and report on the effectiveness of each state’s incentives. That approach has worked well elsewhere: Washington’s legislative auditor has produced detailed evaluations of the state’s incentives for a decade. Under each law, evaluations will be conducted on a rotating, multiyear cycle, so that evaluators and policymakers can study a select group of incentives in more depth each year. Utah is using a three-year cycle, for instance, while Alabama’s will be four years.

The laws also build a direct connection between evaluations and the policymaking process. In Utah, the committee overseeing evaluations is directed to hold at least one hearing each year to examine credits scheduled for review; make recommendations on whether the credits should be continued, modified, or repealed; and invite interested parties to provide testimony. Similarly, Alabama’s law requires hearings with recommendations every other year, to be held just before the start of the legislative session.

About half of states now have in place processes for regular evaluation of tax incentives, while others are looking at joining them. The Ohio Senate unanimously approved evaluation legislation in May that had previously passed the House. However, an unrelated amendment to the Senate bill means that the two houses still need to finalize the legislation. In California, the state auditor recommended that the Legislature pass a law directing a state entity to conduct a comprehensive evaluation of tax credits, exemptions, and deductions. The auditor noted that, without such analysis, it’s difficult to determine whether these programs are achieving their goals.

Progress Evaluating Incentives

States that have enacted evaluation laws in previous legislative sessions continued to make progress on their assessments this year. For example, Minnesota and Oklahoma have reached key organizational milestones. The commission overseeing the evaluation process in Oklahoma recently adopted its evaluation schedule, moving forward the state’s first examination of the effectiveness of its tax incentives under a 2015 evaluation law. The firm contracted to produce the evaluations is set to examine $110 million in incentives this year.

Minnesota’s legislative auditor has positioned the state to produce high-quality evaluations. In January, the auditor adopted a plan that outlines what each evaluation should include: an assessment of whether the incentive has met its goals, the incentive’s economic and fiscal impact, and recommendations for improvement. The evaluations will estimate the degree to which incentives actually influence business decisions, a key step for rigorously measuring economic impact. Using this framework, the legislative auditor plans to release an evaluation of the state’s research and development tax credit in early 2017.

In Nebraska and North Dakota, new evaluation processes are already set to inform policy decisions. Lawmakers in Nebraska have expressed interest in making changes to one of the state’s signature economic development incentives, the Nebraska Advantage Act. To inform discussions around the incentive, Nebraska’s Legislative Performance Audit Committee selected the act to be the first incentive examined under the state’s new evaluation law. The report is scheduled to be released in November, giving legislators time to review its recommendations before the next legislative session begins.

In North Dakota, the legislative committee responsible for overseeing evaluation of the state’s incentives has met regularly since legislators passed an evaluation law in 2015. This work has helped lawmakers identify a potential flaw in the state’s angel fund investment tax credit: an investor receives a credit whether or not North Dakota benefits from the investments. That discovery has led lawmakers to discuss how to reform the program in the 2017 session.

Using evaluations to improve incentive policy is the ultimate objective of each of these laws. Some states with longer-standing evaluation processes are already doing just that. For example, Maryland lawmakers this year extended the state’s historic preservation tax credit for another five years, while also modifying the scoring system used to determine which projects qualify. That action directly followed the findings of an evaluation that described the credit as a model incentive program overall but also identified weaknesses in the scoring system.

As Maryland’s example shows, tax incentive evaluation can help policymakers ensure that incentives are working well for businesses, workers, and taxpayers. The states that are adopting and implementing regular evaluation processes are well on their way to achieving similar successes.