Better Questions about Tax Preferences.

• Author: Marlowe, Justin
• Position: PERSPECTIVE

In FY 2020, the State of Arizona collected $19.9 billion in total state tax revenue. That same year it granted hundreds of credits, exemptions, deductions, and other "tax preferences." According to the Arizona Department of Revenue, those tax preferences reduced the total tax liability for Arizona individuals and businesses by $20.3 billion. In other words, Arizona did not collect more revenue than it did collect.

Arizona is not an outlier. Moreover, there's plenty of reason to believe that the size and scope of tax preferences will only expand as states and localities work to compete in the post-COVID-19 economy. At the surface, this seems like a tremendous challenge for state and local finance professionals. But in fact, it's an opportunity to answer some new and compelling questions.

Tax preferences have received unprecedented recent attention among policymakers, journalists, researchers, and regulators. All that attention has so far produced two big outcomes. One is much more visibility into who receives tax preferences. In fact, according to the Institute on Taxation and Economic Policy's catalog of state "tax expenditure" reports, virtually every state now publishes some inventory of tax preferences and their revenue impact. GASB Statement No. 77, Tax Abatement Disclosures, was also a big step toward better visibility into what tax preferences "cost" in foregone revenue. Because of these and other efforts, we now know more than ever about when and where tax preferences happen.

The other big outcome is much more attention to the "benefit" side. If tax preferences are like any other policy or program, then they should produce measurable benefits like jobs created or retained, growth in homeownership, business investment in plant and equipment, and so forth. With that logic in mind, policymakers around the country have turned to legislative auditors, third-party evaluators, and other analysts to look for those measurable benefits. There's considerable debate as to whether this is the right approach, but there's no debate about its growing popularity. According to the Pew Charitable Trusts, in just the last 15 years a total of 28 states have established a process for evaluating the effectiveness of some or all of their tax preferences. Several localities have launched analogous efforts.

This "benefit-cost" approach has shown much promise. But unfortunately, it also suffers from a major drawback: Many tax preferences don't produce these...