Does a state have the right to determine its own tax policy by offering nondiscriminatory tax incentives to businesses? Unbelievably according to the U.S. 6th Circuit Court of Appeals the answer last fall in the case Cuno v. Daimler-Chrysler was “no.”
Now the subject of bipartisan legislation in Congress and an appeal to the U.S. Supreme Court, unless overturned the ramifications of this unprecedented legal interpretation will continue growing as they radiate through the U.S. legal and economic system. First by overturning roughly a half-century of legal precedent, the decision threatens similar incentives existing in more than 40 states. Second, it poses an economic threat to businesses already invested anticipating these incentives. Finally and most importantly, it raises a very serious threat to America’s overall global competitiveness by taking away an advantage our international competitors already use.
The facts are straightforward. In 1998, DaimlerChrysler AG received a $280 million tax break to facilitate a $1.2 billion plant expansion to a Toledo, Ohio, plant targeted for potential shutdown. The city’s and two school districts’ package included a 10-year personal property tax exemption and a nonrefundable 13 percent manufacturing and machinery tax credit for investment above DaimlerChrysler’s previous three-year average. While there was nothing unusual in the package — such incentive packages have been around since the 1950s — the twist started when a Ralph Nader-backed group filed suit on behalf of local residents against the package as “corporate welfare.” The somersault was completed when the 6th Circuit overturned a lower court judgment and ruled the arrangement discriminated against interstate commerce.
The court’s perception of discrimination rested on the fact a company already in Ohio would receive the investment tax credit for new manufacturing investment within Ohio but would not receive a similar credit if it located new manufacturing outside Ohio — hence differential tax treatment.
Determining whether state tax law is discriminatory has a history as old as the Constitution, from which its basis arises in the Commerce Clause. Essentially this long constitutional history can be distilled into stopping negative state action — taxing another state’s product at a higher rate.
The 6th Circuit turned this history on its head by switching the focus from denying a negative to preventing a positive — in this case, Toledo’s investment tax credit.
Unsurprisingly, other cases attempting to take advantage of this novel interpretation are already pending (with suits filed in Minnesota and Wisconsin, with additional cases expected in Nebraska, Oklahoma and North Carolina).
Fortunately, the courts don’t have the only role in this area. The Constitution expressly gives Congress authority to regulate interstate commerce and a bipartisan group of members from the states (Ohio, Michigan, Tennessee and Kentucky) encompassing the 6th District introduced legislation May 18, to reaffirm precedent.
The Economic Development Act of 2005, introduced in May by Sens. George Voinovich, Ohio Republican, and Debbie Stabenow, Michigan Democrat, and every senator from the 6th Circuit’s four states and Reps. Pat Tiberi, Ohio Republican, Ben Chandler, Kentucky Democrat, and Ron Lewis, Kentucky Republican, affirms states’ rights to provide nondiscriminatory tax incentives for the purposes of economic development. This bipartisan group of legislators are acting none too soon because the threat is serious and real.
While the Cuno decision has thrown open the question whether states and localities have the right to set their own tax policy by enacting positive tax incentives, the economic aspects of such incentives are beyond debate. For states, such tax incentives are one of the few tools available to them to retain or attract business.
For companies, existing investments and their sunk costs are now jeopardized. In the case of DaimlerChrysler, they committed to $1.2 billion in additional investment. Changing that plan cannot be costless, any more than it is possible to recoup investment already made. Nor can companies costlessly wait on the vagaries of courts when making their decisions.
The business dynamic means companies must now make decisions that will affect their future operations. Therein lies a threat to America as a whole and not just as individual states.
If the U.S. through its courts won’t allow state tax incentives, companies will be pushed to site operations overseas in jurisdictions that can offer and will honor these incentives. While the 6th Circuit may seek to affect movement of business across state borders, it is powerless with international ones.
The United States faces growing global competition. Ironically, one of the elements China has used successfully, and which India recently announced it intended to duplicate, is special economic zones in which businesses receive incentives to operate — including tax concessions. To allow the 6th Circuit’s decision to stand would be tantamount to unilateral economic disarmament.
Much opprobrium has been directed in the last few years of “Benedict Arnold companies” that move their operations overseas. It is strange the thunderous outcry against these companies doesn’t sound equally loudly against actions such as the 6th Circuit’s that would encourage such moves.
Congress should not wait to see if the Supreme Court will overturn this decision, but instead take up its own bipartisan legislation and quickly put a stop to Benedict Arnold courts and keep jobs and investment in the United States.
J.T. Young served in the Treasury Department and the Office for Management and Budget 2001-2004.