Using credits and incentives during an economic slowdown
INSIGHT ARTICLE |
While economic conditions have remained relatively stable over the last several years, there is increasing concern that a downturn could be on the horizon. As discussed in the “RSM US Middle Market Business Index for Q3 of 2019,” weaker revenue, net earnings, hiring, and planned capital outlays as compared with the previous year in the middle market reflect a broader slowdown in growth. The index also notes that worldwide manufacturing is in recession and the risk of a general economic downturn within the next 12 months is elevated. Though the United States is experiencing a manufacturing industry slowdown, the economy as a whole continues to perform well. However, there is concern that continued underperformance in this sector will spill over and negatively affect a wider area. The manufacturing sector is 11 percent of the U.S. economy by gross domestic product, and a downturn in an industry with deep connections to many other sectors of the broader market could have wide-ranging negative effects.
As shifting global trends evolve, the downstream effects will begin to influence state and local tax policy. Historically, the strength of the U.S. economy is not necessarily reflected in overall state tax collections, with those collections growing more slowly, plateauing, or even contracting compared with a positive GDP growth rate. Whether in stagnant economies or economic downturns, states traditionally implement a consistent suite of policies in response, and taxpayers with current or potential credits and incentives must adjust their pursuit of these benefits accordingly.
States’ response to slowdowns
In past economic slowdowns, taxpayers have seen states respond in a series of consistent manners. Because of a reduction in tax revenues flowing from economic activity — primarily from decreased sales and use tax and personal income tax revenues — states look to strengthen existing revenue streams and, in more extreme circumstances, create new revenue flows to keep budgets balanced. A typical state response will include an attempt to reduce spending coupled with steps to eliminate tax exemptions, broaden the tax base to include a wider range of revenue sources and, in situations in which the budgetary constraints are especially dire, raise rates.
However, expanding revenue streams through increased or new taxes is not states’ only method to find additional cash. States will also step up enforcement of existing regulatory schemes, which may involve increased scrutiny through audits of more aggressive tax positions on various issues. More importantly, enforcement will often first look for the low hanging fruit, which includes the compliance of statutory and discretionary credit and incentives arrangements.
Economic downturns provide numerous opportunities for states to recapture credit and incentive benefits from noncompliant taxpayers. These credits and incentives typically have clawback provisions, under which states can not only rescind future benefits when a taxpayer fails to uphold its end of the deal, but may also recoup any amounts previously granted to the taxpayer and impose a penalty in some instances. In the case of job creation programs for which the taxpayer has agreed to expand to specified levels and create a number of new positions, economic downturns can leave the promise of an expanded workforce unfulfilled. These are the kinds of scenarios in which states will seek to regain any taxes foregone in previous periods when taxpayers fail to meet the targets laid out in their agreements.
Shift in taxpayer focus —compliance and renegotiation
As states increasingly focus on compliance with credits and incentives, taxpayers should prepare to face greater scrutiny when participating in credit and incentive agreements. Taxpayers should proactively be performing internal due diligence and review of their current and former agreements: Has all necessary documentation and compliance occurred for the period in which incentives are claimed? Have hiring or investment targets been met? Does the taxpayer have a plan for periods of noncompliance?
Taxpayers should ensure that their documentation and compliance procedures are sufficient and that they are meeting the requirements laid out in their discretionary agreements. Renewing a focus on compliance can help taxpayers avoid clawbacks as states and localities seek to recoup on investments that do not pan out.
However, there may be scenarios in which failure to meet the terms of the agreement is unavoidable. Businesses need not abandon all hope in these cases, as it may be possible to renegotiate credits and incentives when needed, particularly when a business slowdown is causing a company to not meet its agreed-upon targets. Even in cases in which the state does not have specific provisions for renegotiating the provisions of credits and incentives, it frequently has latitude in waiving some requirements.
Taxpayers that find themselves unable to comply with the terms of their agreements because of extenuating economic circumstances should be proactive in reaching out to taxing authorities. The earlier businesses seek assistance, the easier it may be to modify an agreement to include more realistic goals. Businesses should avoid defaulting on these arrangements, as better options may be available from authorities. This approach can help mitigate the damage of failing to comply, especially when considered within a broader reorientation in focus for companies in their credits and incentives strategy.
From job creation to job retention
During a slowing economy, taxpayers may be unable to expand their operations and create new jobs. Many states offer tax benefits to companies for retaining current levels of employment. Taxpayers facing a stagnant or decreasing workforce because of a slowdown in their business should consider shifting their incentives strategy to focus on retention versus expansion.
One example of such a program is the Ohio Job Retention Tax Credit. Ohio has the discretion to award nonrefundable tax credits to eligible businesses for capital investment projects that foster job retention. Businesses meeting the program requirements can receive a nonrefundable credit for a period of up to 15 years. The credit is equal to a negotiable percentage of employee payroll.
There are compliance requirements under a Job Retention Tax Credit agreement — for instance, taxpayers must maintain operations at the project site for the greater of the term of the credit plus three years or seven years total. Granting of the credit also depends on whether the taxpayer’s capital investment project will result in the retention of employment in Ohio, whether the taxpayer is economically sound and able to complete the proposed project, and whether receiving the credit is a major factor in the taxpayer’s decision to begin, continue with, or complete the project.
Ohio also provides flexibility in situations in which taxpayers are unable to meet program requirements. When businesses fail to comply with the requirements of their agreements, the state can amend the agreement to reduce the amount or time period of the credit, effective in the current tax or calendar year. And if the state determines that a taxpayer is failing to comply, it may terminate the agreement — but only after giving the taxpayer an opportunity to explain the noncompliance.
Businesses facing a slowdown may be able to take advantage of this program — or similar retention programs found in many states — to continue operations and retention, rather than job expansion. Also, taxpayers that are unable to meet the requirements of their agreements would find it well worth their time to proactively approach the taxing authority, explain their situation, and attempt to negotiate a better position than simple noncompliance and loss of the benefit.
Focus on job training programs
Taxpayers that may not be in a position to expand their workforce will frequently look to invest in their existing workforce. An effective method for retaining talent and increasing capacity in these situations is adding new or supplementing job training programs for employees.
California has a long-established training incentive program in its Employment Training Panel (ETP). The ETP provides funding for training not only new hires, but also existing or retained employees. Launched in 1982, the ETP is funded entirely by a tax on employers rather than through general state coffers. The program grants considerable flexibility to applicants, allowing each company to determine which employees need training, what training plan best fits its needs, and which trainers should be instructing the employees.
Participants are reimbursed at a flat rate per training hour, and funds are only paid after the trainee completes all training and is retained for a minimum period (usually 90 days) at a mandated wage in a position requiring them to use skills they learned in training.
The rationale behind this program is to drive growth and further future workplace training. The ETP notes that employers who participate in funded training are more likely to continue to invest in training future employees. If a company finds itself in a position in which it intends to expand its capacity but is unable to make the investment to expand the number of employees, a training program may be an excellent method to both broaden the business’s capabilities and benefit the state.
Maximize cash flow from retroactive benefits
In addition to evaluating credits and incentives for job retention and employee training, taxpayers should make every attempt to fully monetize any unused or unclaimed tax credits and incentives from prior years, especially in years when a tax liability existed. There may be situations in which taxpayers have left money on the table by not claiming credits in prior tax years for which they may have been eligible. Even with discretionary credits and incentives, taxpayers may be able to claim the benefits of some programs retroactively.
This process involves a significant internal review of company records and history. Taxpayers should review capital investment from the previous two to three years as well as historical job creation. It may also be useful to review historical technology development and deployment efforts, as well as other extraordinary company life events. Businesses should focus on states and programs through which they can retroactively obtain a tax credit, incentive, or other benefit.
One to consider is Georgia and its investment tax credit for manufacturing and telecommunications. Generally, businesses must file a written application requesting approval of the project plan within 30 days of the project’s completion. However, when a taxpayer is unable to submit the request for approval within the 30-day window, it may petition the state for express written approval to file an application outside the time frame.
Another program that may offer similar late-filing relief is Tennessee’s job tax credit. Unlike the Georgia investment tax credit, the rules for Tennessee do not provide an explicit path to file late for the credit. However, the statute provides that the plan taxpayers are required to file must be “in the manner prescribed by the commissioner,” leaving the Department of Revenue discretion to permit late filing for the program if benefits are merited. The Georgia and Tennessee programs are just two examples in which taxpayers may be able to claim retroactive benefits. Businesses that have recently expanded, hired, or made large capital investments without claiming benefits should still be considering credits and incentives as a component of the expansion.
States should consider potential policy alternatives
However, it might be argued that the approach generally favored by states of stepping up enforcement while reducing credit and incentive benefits is counterproductive. States do not just have to worry about their budgets, but also need to be concerned with the overall economic conditions within their purview. Allowing more leeway for taxpayers in discretionary credit and incentive agreements, or even granting more of those benefits to taxpayers, may be advantageous for states seeking to buoy their economies. This would offer relief to companies in crisis that may not be able to meet previous commitments, and could shorten the time frame for the slowdown by allowing taxpayers more resources to reinvest in their businesses. The Congressional Research Service has noted that incentives targeting new investment can effectively stimulate growth.  However, it also pointed out that “the empirical literature has not generally found total investment to be considerably responsive to tax incentives.” The CRS explained this by noting that tax incentives for business investment are dependent on large capital outlays — often in single transactions —that may take time to bear fruit, and that in times of economic uncertainty, many taxpayers are less likely to make these types of investments. The CRS suggested that a short window of time be used in which investment credits are available in order to encourage more businesses to take advantage of limited-time opportunities.
Moving away from the traditional strategy to an expansion of credits and incentives to stimulate investment and economic growth would be a significant shift from the policy norm. Many may view this tactic as unconventional, but it may work for states that are well positioned to encourage business expansion.
Whatever the merits of expanding credits and incentives in an economic downturn, it is evidently an uncommon approach by the states in times of economic turmoil. Unless there is a sea change in states’ approach to slowdowns and recessions, taxpayers must be prepared to respond to how states tend to operate historically.
The big picture — changing circumstances
As states begin to tighten their belts on spending and expansion programs in the face of economic downturn, taxpayers must take a twofold approach: They must be rigid when it comes to compliance with rules for existing programs and credits in the face of states looking to recoup discretionary investments from companies not delivering on promises, but remain flexible when it comes to their approach to new credit programs — moving from job creation to job retention and training for employees.
While economic circumstances change, taxpayers must regularly evaluate their approach to credits and incentives to ensure that they are getting the maximum benefit out of their activities everywhere they operate. Changing economic conditions dictate changing strategies, and credits and incentives can be a valuable tool for businesses to lessen any impact from slower growth and allow taxpayers to remain ready for the future.
This article was originally published in Tax Analyst, December 2019.
 RSM US LLP, “RSM US Middle Market Business Index: Q3 2019" (2019).
 See Gina Heeb, “We Just Got the Latest Sign of a Downturn in U.S. Manufacturing — The Opposite of What Trump’s Trade Wars Were
Supposed to Accomplish,” Business Insider, Nov. 4, 2019.
 See Nicholas Johnson, Catherine Collins, and Ashali Singham, “State Tax Changes in Response to the Recession,” Center on Budget and Policy Priorities (March 9, 2010).
 See 72 Pa. Stat. section 9952-C and Del. Code Ann. tit. 30, section 20D-108 for examples of state recapture provisions.
 See 72 Pa. Stat. section 9952-C(b) for an example of a state provision allowing for waiver of requirements.
 Ohio Rev. Code Ann. section 122.171.
 Ohio Rev. Code Ann. section 122.171(B).
 Ohio Rev. Code Ann. section 122.171(D).
 Ohio Rev. Code Ann. section 122.171(F).
 Ohio Rev. Code Ann. section 122.171(J)(1).
 Cal. Code Regs. tit. 22, sections 4400-4499.
 Ga. Code Ann. section 48-7-40.2.
 Ga. Comp. R. & Regs. 560-7-8-.37(3)(C)(4).
 Tenn. Code. Ann. section 67-4-2109(b).
 Tenn. Code. Ann. section 67-4-2109(b)(1)(B).
 Mark P. Keightley, “Fiscal Policy Considerations for the Next Recession,” Congressional Research Service, at 11 (June 20, 2019).