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Refundable Tax Credits Are Spending By Another Name

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Louisiana Gov. Bobby Jindal (R) recently released his new budget proposal, and the press is having a hard time wrapping its head around the intricacies of tax policy, such as how cutting a check to people or entities in excess of their tax liability is a spending increase and not a tax cut.

One thing Gov. Jindal did to balance his budget was cut spending by changing refundable tax credits to non-refundable. The Washington Examiner’s Tim Carney explains how the refundable portion of a refundable tax credit is really spending:

Refundable tax credits allow you to get back your taxes, and then more.

For instance, say your state gives you a tax credit worth the entire cost of sending your kids to ballet class. Say ballet class cost $1,000. Say your state tax liability was only $800. If the ballet-credit were "refundable," you'd end up owing zero dollars in state taxes, and then you'd get a $200 check.

So, a refundable tax credit is basically a direct government subsidy.”

Louisiana Gov. Bobby Jindal (photo credit: Gage Skidmore)

That refundable tax credits are a mixture of spending and tax relief is not an opinion of Gov. Jindal, American for Tax Reform, or anyone else; it is a fact that is also recognized by the federal government. The federal Joint Committee on Taxation scores the refundable portion of refundable tax credits as spending. For a concrete example of this, read the federal Joint Committee on Taxation’s score on the post-fiscal cliff tax cut, known as ATRA. As can be seen in footnote 1, JCT breaks down the subset of the score (by line item) which represents outlay effects. Again, it’s not an opinion, it’s a fact recognized by the government that changing a tax credit from refundable to non-refundable is a spending cut, not a tax increase.

A big point of contention with Gov. Jindal’s budget is that it gets the state out of the business of covering for bad tax policy at the local level. Local governments assess an inventory tax on businesses' tangible personal property. The inventory tax is a bad tax, worse than most, as it disincentivizes investment in locales in which it is levied and results in tax pyramiding that ultimately drives up costs for consumers. That’s why inventory taxes are imposed in so few states and those that have them are moving to eliminate them.

To make up for this economically damaging local tax, in 1991 the Louisiana legislature decided to issue a refundable tax credit against a company’s state corporate and franchise tax liability for the amount of local inventory taxes paid. However, because this credit is refundable, in many instances the state must cut a check to companies in excess of what businesses pay in state corporate and franchise taxes. In this case the state is not reducing a tax liability, it is simply spending more state tax dollars to make up for bad tax policy at the local level.

Louisiana Capitol (photo credit: thepipe26)

The business community understandably does not like Jindal's inventory tax credit proposal. However, their ire should be directed at local officials who impose such an economically damaging tax. Constituents should urge their local government officials to get rid of the inventory tax, a levy that economists of all political stripes agree is unsound policy. Local governments could repeal their inventory tax and make up for it with spending restraint, by replacing it with a less harmful tax, or a combination of the two.

The best solution has been put forth by Louisiana Association of Business & Industry president Stephen Waguespack:

“We could actually repeal the inventory tax itself, which would make the credit no longer necessary and the state would save $462 million (using FY 14 numbers),” writes Waguespack on The Hayride, Louisiana’s premier political website. “This type of approach would make us much more economically competitive as a state and save Louisiana hundreds of millions of dollars to invest in higher education and health care each year. This would be a ‘win-win’ for taxpayers of epic proportions.”

Tax and spending issues look to be the top items debated during the 2015 session of the Louisiana legislature, which gavels in on April 13. One thing is clear: after being hit with over 20 federal tax increases from Washington in just the last five years, the last thing that Louisiana taxpayers need are higher taxes at the state level.

Patrick Gleason is director of state affairs at Americans for Tax Reform and a senior fellow at the Nashville-based Beacon Center of Tennessee. Follow Patrick on Twitter @PatrickMGleason