$1 trillion a year in tax breaks goes out the door. Are states keeping track?

States routinely give up tax revenue, whether to help build new football stadiums, attract jobs at electric vehicle factories or to help low-income parents make ends meet. But too often, officials don’t keep track of whether those incentives are having the effect they were intended to.

The level of detail that states offer about their tax expenditures and their processes for evaluating those tax breaks vary widely by state, said Matt Fabian and Lisa Washburn of Municipal Market Analytics, Inc., in a report released by the Volcker Alliance last week.

“As the cost of governance rises with needs like addressing climate change, states must ensure their tax dollars are not wasted on policies that do not deliver,” Fabian explained during a webinar. “Our research found states often fail to properly evaluate these multibillion dollar expenditures.”

There’s a lot of money at stake. States forego $1 trillion in revenue because of tax expenditures, although much of that is the result of states mirroring federal tax breaks on income taxes.

“The annual costs of tax expenditures far exceed the $346 billion spent on education and [are] almost 10 times greater than outlays for highways in 2021,” Fabian and Washburn wrote. “Indeed, total state tax collections could be about 50% higher under current tax rates, were it not for tax expenditures.”

“Taxpayers, employers and lenders to governments should demand that states develop and sharpen oversight protocols for all large tax expenditures,” they wrote. “This means defining why every expenditure program was created, tracking its impact, measuring how it may shift a financial burden from some taxpayers onto others, and regularly testing legislators’ interest in continuing it. Without these steps, tax expenditure programs can distort the operation of a state tax system.”

Fabian and Washburn gave the example of Virginia, where lawmakers phased out coal tax credits in 2021 because a review commission determined that the incentives were costly and ineffective. They were originally put in place to encourage coal plants in the state to use Virginia coal. But only one coal plant was planned to be in operation past 2025, and the credit produced negligible benefits. Meanwhile, it cost the state $300 million over nearly a decade, enough to cover the salaries of 450 to 500 state troopers.

“Tax expenditures often go unchecked, potentially continuing long after the intended policy outcome was achieved,” Fabian and Washburn wrote.

The researchers examined efforts by six states—Alabama, Minnesota, New Jersey, Utah and Washington—to provide information to the public about their uses of tax expenditures. It found that Minnesota and Washington are “notably more transparent” than the other states, but “even the best states can improve their tax expenditure oversight and disclosure.”

Five of the six states (all but Utah) for example, produce a comprehensive tax expenditure report. But none of the selected states account for how much revenue is lost by policy area. And only Minnesota and Washington explored other ways to accomplish the goals that they use tax expenditures for, including using direct government spending instead of tax breaks.

Jonathan Ball, Utah’s chief legislative analyst, said that even though Utah did not score well on the Volcker Alliance’s evaluation, state lawmakers there do get a sense of the potential impact of tax breaks. Analysts provide cost estimates for legislative proposals that would have an impact on state revenues. They also write dynamic fiscal notes that help legislators understand what the range of impacts could be, depending on economic conditions, participation in the new program and other factors. Analysts also perform budget “stress tests” to see how programs would perform in economic slowdowns. Finally, the analysts review two tax expenditure programs a year for their effectiveness, and then share those evaluations with lawmakers.

“Sometimes these decisions are not about economic activity and jobs and return on investment,” Ball added. For example, the state offers $12 million a year for rural film tax incentives. “Jokingly, we say that’s so Kevin Costner can make more Westerns. But it’s actually a shift from all of Utah to rural Utah. It’s important for communities that are getting this investment. These are very small towns in the middle of deserts, literally, and this is one of their sources of lifeblood.”

“So there may be an intangible reason to do an incentive, even though overall it might not make money,” Ball said.

But Arlene Martinez, the deputy executive director of Good Jobs First, a nonprofit focused on economic development and government transparency, said the tax breaks for projects to boost civic pride—like sports stadiums—could disproportionately harm low-income residents.

“In communities like St Louis, Kansas City and Philadelphia, which have large Black and brown populations, they’re losing a lot more per student than neighboring majority white suburban school districts” from stadium deals, she said.

“Poor people are paying more for these things,” Martinez said. “You can talk about team spirit in the rah rah rah feeling of having a sports team in your community, but when you’re a working family, ask them if they would like to pay for a stadium that they’ll probably never be able to afford to go to.”

The cost of creating jobs can also be quite high, warned Tim Bartik, the senior economist at the W.E. Upjohn Institute for Employment Research. It usually costs around $200,000 per job. “That’s a lot of money,” he said. “However, if it’s in Flint, Michigan, or rural Tennessee or rural Kentucky, the benefits of job creation are very big. There are huge effects on the labor market. It can dramatically change people’s prospects for getting jobs. On the other hand, if the job market is booming, it’s not clear that $200,000 per job is worth it, given that there may be other things you can do that might be more effective.”

Martinez said tax expenditures have become more common in recent years.

“The biggest increases in state spending that we have seen are in corporate income tax credits,” she said. Those include credits for research and development, capital investment and hiring. “These have soared because technology and manufacturing projects are increasingly capital intensive. Think about your battery factories, electric vehicle plants, semiconductor [fabs], refineries and chemical plants—all are extremely capital intensive.”

But the size of those tax breaks are often shielded from the public because they’re on income tax returns that are protected by secrecy laws.

Those kinds of capital projects can also deplete sales tax revenues, she added. Many states allow companies to get exemptions from sales taxes on building materials, machinery and other equipment for projects like new data centers.

“There’s a question to be asked about whether companies like Amazon, Microsoft, Google and a lot of other companies that are getting these tax breaks should be given the public’s money to do what they have to do anyway, because this is the future. This is where everyone has to be. They’ve got to be building these server farms” to handle applications like AI and cryptocurrency, Martinez said.

Virginia, one of the top locations for data centers, saw a huge jump in the size of its sales tax credits, she noted. The state lost $135 million in sales tax revenues in 2022, but the next year that had grown to $750 million.

Richard Auxier, a principal policy associate from the Tax Policy Center, who was not involved in the Volcker Alliance event, cautioned that many of the tax expenditures used by state governments are hard-wired into the tax system because they are linked to federal incentives.

A 2020 study from the Tax Policy Center, for example, found that conforming state tax law to federal law accounted for the vast majority of tax expenditures for individual and business income taxes. They amounted to 85% of the income tax expenditures in California and Minnesota, and 72% in Massachusetts and Washington, D.C.

Most states, for example, use the federal definition of adjusted gross income for their own state income taxes, which means they also exclude certain expenses from taxation, such as employer contributions for health insurance, contributions to retirement plans and deductions for student loan interest.

On the business side, Auxier said, states often exempt many transactions from sales taxes if, for example, a manufacturer is buying supplies for finished goods. That avoids “tax pyramiding” where the final sales price includes the cost of sales taxes for every transaction.

Meanwhile, efforts to eliminate tax expenditures are often politically difficult, Auxier noted. Nebraska Gov. Jim Pillen wants to expand the state’s sales tax to services, in an effort to reduce property taxes. But that effort faces strong opposition from lawyers, accountants and business groups.

An effort by Washington, D.C., to tax exercise classes sparked protests of people performing yoga outside the city building and attention from national media outlets before finally passing.

“Once you dig in, those numbers start becoming smaller and smaller really fast as you deal with the technical challenges to repealing them and the political challenges to repealing them,” Auxier said.

While eliminating Virginia’s coal incentives freed up $30 million a year, Auxier noted, it also didn’t fundamentally change the state’s tax structure. “If you put in the hard work, you can find real savings, and those savings can be plowed into teachers, police officers, and all the stuff that state and local governments do,” he said. “But if there was a massive budget crunch, this is not a pot of money that’s sitting there to save the state from fiscal harm.”