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Providence Business News (February 28- March 6, 2005)

Recent news reports suggest Rhode Island may be rethinking its business development incentives spurred in part by a Federal Appeals Court decision striking down an Ohio incentive program similar to one used in Rhode Island.

But that Ohio decision may in fact be an aberration which does not threaten Rhode Island or the majority of other states which grant investment tax credits to businesses expanding within their borders.

Just last month the 6th U.S. Circuit Court of Appeals refused to reconsider its decision holding unconstitutional an investment tax credit program Ohio used to grant business tax credits to DaimlerChrysler when it constructed a factory in Ohio. That decision, which does not directly affect Rhode Island, may be on its way to the U.S. Supreme Court.

Ohio’s program grants a tax credit against the state corporate income tax to a business investing within the state to create new facilities and jobs. Rhode Island has a similar program to encourage businesses to invest in Rhode Island. At least 35 other states use some form of investment tax credit as a business development incentive.

And in fact, the Ohio case presented a fairly typical example of this economic development incentive. DaimlerChrysler agreed to invest approximately $1.2 billion in a new vehicle assembly plant in Toledo, and in exchange was given a 13.5% credit against state corporate tax and certain property tax relief, estimated to be worth approximately $280 million.

The incentive program created “several thousand new jobs” in an “economically depressed area”, but not all Ohioans were overjoyed.

Suit was brought by several Ohio taxpayers and small businesses challenging what one plaintiffs’ lawyer referred to as “corporate welfare”. In essence, the plaintiffs claimed that the incentives discriminated against interstate commerce by granting preferential treatment to in-state investment activity in violation of the Commerce Clause of the U.S. Constitution. The investment tax credit was only available for investments made in Ohio.

The Trial Court rejected the claim, and the Judge’s reasoning was compelling. The Trial Court reasoned that a business’ increased investment activity in Ohio may in fact increase the tax credit under Ohio law for that business, but that a business’ increased investment activity outside of Ohio would not decrease the amount of tax credit or exemption that a company would receive under Ohio law.

In other words, while Ohio certainly was encouraging investment within its borders it was not penalizing a business paying Ohio’s corporate income tax if the corporation invested outside of the state.

The 6th Circuit Court of Appeals saw things differently. It apparently bought the plaintiffs’ argument that although an in-state or out-of-state business could get the tax credit, because the credit applied only if investment was made inside Ohio, the statute was “coercing businesses already subject to the Ohio franchise tax to expand locally rather than out-of-state”.

Coercing? Is it coercion if you are offered an incentive to invest in Ohio but you are not negatively impacted by Ohio if you choose to expand elsewhere?

Additionally, other states in which the corporation may invest may well have their own incentives to lure industry, and these may dwarf Ohio’s incentives.

Do the judges writing this decision actually expect a state such as Ohio to use its taxpayer funds to encourage a business to invest in say Minnesota? Is this what the Founding Fathers intended? Or were the Founding Fathers trying to prevent protectionism, where states use the tax system to burden or penalize activities from sister states? To pose the question seems to demonstrate the flaws of the Court’s reasoning. Nevertheless, the 6th Circuit Court of Appeals found that the U.S. Constitution “implicitly limits the state’s right to tax interstate commerce” and apparently agreed with plaintiffs that by encouraging further investment in Ohio at the expense of development in other states, free trade is hindered.

News report indicate the Rhode Island Economic Development Corporation is watching this case carefully, is preparing for a similar challenge to Rhode Island’s investment tax credit program, and is reevaluating its economic development programs to determine what is most effective in increasing economic growth and development in Rhode Island.

While this preparation and analysis is certainly prudent planning, and to be applauded, the 6th Circuit’s decision should not necessarily loom large in deciding what incentive programs to pursue. That decision should be made by the economic development merits of particular programs.

After all, not every Circuit Court of Appeals’ decision survives U.S. Supreme Court review. For example, for the 2000-2003 terms of the U.S. Supreme Court, the 6th Circuit was reversed or vacated in whole or in part 77% of the time in these four years, representing 24 of 31 6th Circuit cases considered.

Statistics aside, while the law doesn’t always make sense, when a decision seems “a tad odd”, it may well be a candidate for reversal.

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