High-tech tax breaks spark political fight

OLYMPIA — Republicans want to make tax breaks for high-tech and biotech companies permanent despite a debate about their effectiveness and scant evidence the programs have done what the Legislature had hoped: produce jobs for Washington residents.

The Republican-led Senate voted last week to renew the high-tech and bio-tech tax exemptions for another 10 years, rather than wait for a new study that could provide more details on how the programs have worked. The programs are set to expire next year.

"These particular industries are so incredibly valuable," said Sen. Luke Esser, R-Bellevue, chairman of the Senate Technology and Communications Committee. "They are the type of clean industries every state is clamoring to get more of and this is one way, one small way, to get them to invest in our state."

Since the programs took effect in 1995, the tax incentives have saved those industries $508 million.

Democrats say any renewal of the high-tech and biotech tax breaks can wait at least until next year. And reflecting a broader debate about tax cuts for business, House Democrats passed a bill that would require review of each of the state's 431 tax exemptions. The bill died in the Senate.

With the state facing a potential $2.65 billion gap between projected spending and revenue, Democrats say it's time to hold tax breaks to a higher standard.

"We should be scrutinizing tax cuts the same way we do every nickel and dime in the operating budget," said Sen. Erik Poulsen, D-Seattle. "For every dollar we spend on a tax break it's one less dollar for health care for the poor or reducing class sizes."

While Democrats argued against renewing the research and development tax incentives, they have sponsored and supported other tax breaks this session.

Businesses have pushed hard to renew the high-tech and bio-tech tax credits now. The Washington Research Council, a business-backed think tank, issued a report last week touting the benefits of the two tax incentives and saying "a review of tax exemptions is likely to degenerate into a hunt for more tax revenues."

The group conceded that benefits of the research and development tax programs are hard to measure but said no more information is needed.

"Even if we could not prove that they are effective, it would be wrong to let them expire," the report said.

The research and development bills passed last week call for a study every five years. But they do not include provisions the Department of Revenue has said it needs in order to accurately measure the effectiveness of the programs.

Under the tax incentives, companies can apply for:

• A cut of up to $2 million a year in business and occupation taxes — a gross-receipts tax — as a credit against spending on research and development. In effect, a company can subtract up to $2 million in B&O taxes owed to the state for dollars spent on research and development.

• A sales-tax exemption on construction equipment to be used for research and development. The state says 60 firms have taken advantage of the break.

Evidence of jobs produced

The state has studied the effectiveness of the two incentive, twice, focusing on the key reason they were enacted. The results have been, at best, inconclusive.

The most in-depth study, conducted by the Department of Revenue, showed that in 1999, the boom year for the industries, 70 jobs were created as a result of the tax credits. Of those, 41 were filled by Washington residents — costing the state an average of $588,000 in business-and-occupation tax breaks for each state resident hired.

"We can't prove they work," said Mary Welsh, the Department of Revenue's assistant director in charge of research. "That doesn't mean they're not working. We just can't find any evidence they are."

The report, issued in 2000, did show that since the tax credits were enacted, the number of patents issued to high-tech companies had increased, that some firms had expanded and that $10.4 billion in new products had been developed.

But the state's national rankings for research and development spending — used nine years ago to argue that Washington needed to be more nurturing toward the industry — have remained stagnant.

Gov. Gary Locke supports continuing the research and development tax breaks, according to tax policy adviser Jim Hedrick. But since they do not expire until next year, the administration has said the measures do not need to be extended now.

One tool in the box

Former Gov. Mike Lowry, a Democrat, proposed the two tax breaks in late 1993.

Rather than trying to attract a manufacturer, the state was looking for a way to "stimulate economic growth much earlier in the process" and help spur research and development.

"Today's pursuit is not simply for jobs: it is for high-wage jobs in growth areas of the economy," according to a 1993 report by the Department or Revenue.

The 1994 Legislature approved the two tax credits and scheduled them to expire 10 years later. It ordered three studies during that time for a "reassessment of the results and a policy determination of whether the tax incentives should then be extended," according to Lowry's proposal.

But lawmakers provided no specific goals for job creation, or other guidelines.

In the first study, published in 1997, state officials said they didn't have enough information to make a reliable assessment.

For the review of job creation two years later, the Department of Revenue worked with Washington State University's Center for Social and Economic Research to survey 330 companies — 52 percent of all those taking advantage of the business-and-occupation tax credit for research and development. The results were extrapolated for the full number of companies accepting the tax credit.

The Department of Revenue said in its report that many companies did not follow provisions in the law that required certain information from tax-break recipients, making it more difficult for the state to make an assessment.

Because of tax-confidentiality laws, it is not known whether Microsoft or other specific companies were included in the survey, or responded. The only public information available on individual companies is the amount of sales-tax exemption a company applies for.

It's been equally difficult to judge other tax programs.

A 2000 study by the House Finance Committee was unable to determine whether a tax break to boost manufacturing had any effect on job creation.

And in 1996, the Department of Revenue found that a series of tax incentives designed to boost the state's rural economy created only one-quarter of the jobs projected.

Around the country similar programs have brought similar results, according to a national expert on state taxes.

"There is a belief that they work, that they actually stimulate economic development and they stimulate job growth and they keep companies from moving away or they lure companies in," said David Brunori. He is a contributing editor to State Tax Notes, a newsletter on state tax issues, and teaches tax law at George Washington University Law School in Washington, D.C.

"There is virtually no evidence that that is the case."

Because tax cuts do not get the scrutiny that spending in the budget does, Brunori said, business-tax cuts tend to survive even in tough times.

"It's the gift that keeps on giving."

The Washington State Tax Structure Committee, appointed by the Legislature and led by William H. Gates Sr., the father of the Microsoft founder, has pushed for more review. In its November report, the committee said tax exemptions should be reviewed every 10 years "to make sure economic and social goals are achieved."

Debate in Olympia

The fight surrounding the high-tech and biotech tax breaks has surfaced as a major one this session as lawmakers struggle to balance the budget. Ending them would increase state tax revenues by $75 million during the next two years.

Eight Senate Democrats joined Republicans to extend the tax cuts. House Democrats have proposed a budget that assumes the exemptions will expire next year.

That doesn't mean House Democrats oppose renewal, said House Finance Chairman Jeff Gombosky, D-Spokane. He said Democrats could vote to renew them next year.

What's missing from the state studies, business groups say, is the "downstream" economic benefits of jobs created by the tax incentives.

Rachel Le Mieux, senior tax manager for the Seattle-based accounting firm Moss Adams, said the studies do not look at other jobs created as a result of a growth in the research-and-development industry, or the benefits of money spent by research-and-development employees.

"You can't just say we have to get rid of all these incentives to make up our deficit," Le Mieux said. "That might make it 10 times worse if we get rid of something that might be pouring money into the downstream."

Senate Ways and Means Chairman Dino Rossi, R-Sammamish, said whether there are disputes about how many jobs have been created by the tax credits, "You'll see the jobs that go away" if the programs are allowed to expire.

"What message are you sending to the high-tech community? It's backward thinking that already put an aircraft company in Chicago," he said, referring to the 2001 move of Boeing's corporate headquarters. "I don't want Microsoft moving."

Brunori said politicians often act out of fear in approving tax breaks.

"What happens in every state, and what will happen in Washington, is the business community will come in and say, 'If we lose these incentives we lose jobs, you will lose companies,' " he said.

"No one wants to take the chance politically that they may not work."

This legislative session, businesses have said the exemptions have had a dramatic effect on the development of new products.

Shannon Child of Paladin Data Systems, which has 72 employees and is based in Poulsbo, told Esser's committee the tax incentives go far in "offsetting the risks of a volatile industry."

Without them, she said, the "company may not be able to justify doing business in our state."

Child said she knew the budget situation this year could lead some lawmakers to consider ending the tax programs. But, she said, "There is no better time than now to invest in the companies and bolster the companies that are going to create these jobs."

Zeroing in on Microsoft

While it was mostly smaller companies that testified, Microsoft has applied for the most sales-tax breaks by far. State records show the company has applied for $117 million in sales-tax exemptions of the $338 million total applied for under the sales-tax program. The state does not release information on how much companies actually receive.

"I would say we are in a very competitive business and the incentives allow us to remain competitive," said Microsoft spokeswoman Stacy Drake.

She said the tax breaks "are definitely one of the reasons that we were able to grow."

Microsoft, the state's largest high-tech company, employs 54,000 people worldwide. About half are in Washington state.

The company has become a prime target of critics of the tax-break programs. They argue Microsoft doesn't need the help.

"They need to be good corporate citizens and can well afford to pay their taxes like everyone else does," said Ellie Menzies, a lobbyist for the Service Employees International Union. "At a time like this we can't afford to be giving away money."

The Washington State Labor Council has told lawmakers not to approve or renew any tax breaks until a review is done and those that don't meet the grade are eliminated. Labor unions worry the tax incentives are not creating enough jobs for state residents and that firms that don't need the help are taking away precious state dollars.

"There's got to be some hammer," said Jeff Johnson, the council's research director.

Locke backs the bill to review all tax exemptions. In a speech to the labor council, he said many exemptions are needed to help the state's economy, but not all.

David Postman: 360-943-9882 or dpostman@seattletimes.com