Reducing Budget Risks

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In many cases, the cost of specific state tax incentive programs has increased quickly and unexpectedly by tens or hundreds of millions of dollars. As a result, lawmakers have been forced to make difficult choices between raising taxes and cutting spending to keep budgets balanced.

Yet these problems are not inevitable. To understand both the sources of the difficulties and potential solutions, Pew reviewed numerous state documents and news articles and conducted phone interviews with more than 40 government officials and experts from 20 states. Based on this research, this report recommends two strategies for states to employ so that they can use incentives while avoiding budgetary surprises.

Download the full report. (PDF)

Strategy 1: Gather and share high-quality data on the costs of tax incentives. States often don’t realize until after budget problems emerge that the costs of incentives are increasing quickly. If they had more warning, policymakers could either prepare for the cost increases or prevent them by changing the design of the incentives. States can:

• Regularly forecast the cost of incentives.
• Monitor costs and commitments of large and high-risk incentives.
• Share timely information on incentives across relevant agencies.

Strategy 2: Design incentives in ways that reduce fiscal risk. States can structure incentives so that officials can more easily forecast how and when the programs will affect their budgets. When creating new incentives or revisiting existing ones, lawmakers should carefully consider how to design programs that will both achieve economic goals and avoid undue fiscal risk. There are several options policymakers should consider. States can:

• Cap how much programs can cost each year.
• Control the timing of incentive redemptions.
• Require lawmakers to pay for incentives through budget appropriations.
• Restrict the ability of companies to redeem more in credits than they owe in taxes.
• Link incentives to company performance.
• Require businesses to provide advance notice of program participation.