Pollution Control Tax Break Not An Incentive

Industrial dust collector, 1450 cf per minute

Not every tax policy decision should be made or measured on whether it stimulates more economic activity and thus more taxable revenue for the government. There are things the government should not tax.

Yet, returning once again to the well-thumbed June report on manufacturing incentives produced by the Joint Legislative Audit and Review Commission, that economic value add test was applied to one of the oldest tax exemptions under the sales tax rules, an exemption for equipment purchased to comply with federal or state environmental laws. 

It failed that test, of course, producing minimal economic activity.  The JLARC report notes that the main purpose of the rule is to reduce the cost of environmental compliance for those businesses, not to stimulate investment.  There is no need to create an incentive for companies to make investments which are mandatory.  The question is, should they be taxed?

The Pollution Control Equipment and Facilities Sales Tax Exemption goes back to 1972, soon after the initial 1966 creation of Virginia’s sales and use tax.  Most states with a sales tax provide some level of tax break or other financial consideration for pollution control and abatement investments, JLARC reports.

The real rub in Virginia is not over the sales tax collected by the state on the original construction or installation, but the continuing annual exemption from local real estate or machinery and tools taxes that comes with it.  The $27 million in sales taxes not collected by the state between 2010 and 2017 is dwarfed by the local tax exemption, not calculated or really recognized by the JLARC report.

The issue is covered in pages 50 through 53 of the JLARC report (here), which was the subject of an earlier Bacon’s Rebellion posts about its discussion of income tax rules (here) and the incentives granted to the data center industry (here).  Those are tax policy issues where it make more sense to try to do an economic score of their effectiveness.

JLARC’s staff listened to complaints from the manufacturers who seek to exempt these investments from sales tax (and thus local taxes).  From this short report section three substantial recommendations flowed, one of which may produce legislation in 2020.  If adopted, companies would expand use of the process to cut their taxes.

  • The Department of Environmental Quality and Department of Mines, Minerals, and Energy should develop guidance documents on (1) the types of pollution control equipment and facilities that are exempt from the retail sales and use tax and (2) the decision-making process for approving certification.
  • The Department of Environmental Quality should develop a list of pre-approved equipment and facilities that typically meet the pollution control certification requirements and create an expedited certification process for equipment and facilities on that list.
  • The General Assembly could amend § 58.1-609.3 or § 58.1-3660 of the Code of Virginia to clarify that the equipment or facility does not need to be constructed before certification can be granted for purposes of claiming the Pollution Control Equipment and Facilities Sales Tax Exemption.

For example, if one factory has installed an Acme Dust Collection System to gather and dispose of hazardous dust from a production process, with DEQ clearance for the tax breaks, another company making an identical installation has to go through the entire review process. It is not like the sales tax holiday where there is a list of what is and isn’t taxable.  Adding to the fun, the exemption decision comes after the work is done and the taxes start being paid, so it’s a matter then of seeking a refund.

That request for a list of standard equipment or facilities that have been approved before and would likely be approved again has long been requested by groups like the Virginia Manufacturing Association. It sparked a six-page letter from DEQ Director David Paylor detailing numerous reasons why it hasn’t done so.  You will find that near the end of the report in Appendix L.

Even when a company is spending money to protect the public from possible pollution, investments made at the mandate of government, some in government still want to collect sales tax up front and an annual pound of property tax flesh forevermore.  More and more in Richmond are among those Winston Churchill described as considering private enterprise “a cow they can milk.”

There was this in the JLARC text, arguing against the exemption:

While the pollution control equipment exemption helps businesses defray part of the costs of complying with federal environmental regulations, it may not be an efficient and effective tool for reducing pollution. Research suggests these subsidies violate the “pollution payer principle,” which requires the pollution emitter to bear the cost of managing or reducing pollution. The exemption instead passes the cost on to society in the form of reduced tax revenues. Exemptions and other subsidies may also encourage the use of pollution control equipment instead of the adoption of newer, less polluting production technologies and practices. Exemptions and other subsidies, which reduce costs of production, may encourage businesses to produce more, which results in more pollution than would occur without the subsidy (Jenkins and Lamech 1994; Goulder and Parry 2008).

And in its response to that part of the draft report, causing one to wonder if this is really why DEQ won’t make this process any easier, one finds this over Paylor’s signature:

While “passes the cost on to society” may be correct on a macro level, the impact of the lost revenue resulting from the exemptions is borne by the people of the Commonwealth and its localities.  The sales tax exemption in §58.1609.3.9 impacts the Virginia revenue directly once per project, and property tax exemption takes money from the coffers of Virginia localities continually, every year the property continues to meet the definition in §58.1-3660.  The funds that are lost by state and local government to the exemptions are either made up from other sources (i.e., other taxpayers), or result in fewer government services being provided to the citizens of the state and localities.

Some of the hostility to this exemption may flow from a recent General Assembly decision to stretch it beyond its original purpose and apply it to to renewable energy equipment, which is neither mandatory nor dictated by environmental regulations and generates great profits.  But that’s another story, one not touched on by JLARC.  Sacred cows are not milked at all.

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7 responses to “Pollution Control Tax Break Not An Incentive

  1. Interesting and “meaty” post!

    but I fear that mixing thinking about tax breaks in general to spur economic activity (and presumably greater tax revenue) with tax breaks for mandatory pollution equipment are two different things which you have actually addressed – partially.

    On the pollution side, yes, if we give tax breaks for ANY pollution equipment said to be bought to achieve something – if we have not defined and quantified performance…. I dunno..

    but this also goes back to the idea of cutting taxes in general on the premise that by doing so a less expensive service or product is delivered – which in turn presumes that more of it will be sold thus taking in more tax revenues.

    we talk about “scoring” – but the scoring I have seen is more general hand waving than specifics that also show – for instance, for every penny “cut” it delivers (an unquantified) “more” in general tax revenue.

    Going further – do we , can we, also “score” what it was the collected tax was being used to provide such that we know, for instance, an additional state trooper is not “worth” the extra tax collected to pay for him?

    I recognize that little of this is easily calculated but on the other hand it’s no better to make unproven claims about taxes and performance – good or bad… it’s just a lot of hand waving that we call “scoring”.

  2. Good post, Steve. It is a reminder that tax policies can have differing objectives and, thus, should not be evaluated in the same way. In the case of the exemption of pollution control equipment from the sales tax, it is one of fairness. “You are being required by government to buy this equipment, so government should not profit from your expense.” It is somewhat akin to the exemption of prescription drugs from the sales tax.

    As you point out, that $27 million saved by industry was over a 10-year period. JLARC calculates that the annual average savings was $3.3 million. That amount is not really of much effect on the state level. The annual exemption from local property taxes could make a significant difference in some localities.

  3. Oh, some localities hate it. This will not be one of the widely read posts, not on this topic, but it will circulate in certain key circles 🙂 Of course now that we’re #1 on the CNBC list again, inertia will continue to rule in Richmond.

  4. This strikes me as a classic illustration of how difficult it is to parse out the benefits and detriments that flow from a tax subsidy. Why do we grant this subsidy at all? It seems to me the JLARC and Paylor comments are right on. Businesses make decisions all the time about upgrading or modernizing or replacing or consolidating equipment and one of the biggest factors is the cost of keeping something going that’s obsolete, that ought to be replaced, versus the capital cost to replace it. I can understand back in the early days of the EPA and the Clean Air and Clean Water acts and their implementation by the States, there was GA sentiment (sometimes tinged with anti-federal, anti-Green sentiment) to defray the initial, simultaneous hit to the bottom line of compliance with these environmental initiatives — but now, nearly fifty years later, that initial impac is fully phased in; these are just another set of costs of doing business, another reason to decide to upgrade or not, and the source of the business imperative — whether it’s customer-driven preferences or agency regulation imposing the cost — should make no difference whatsoever.

    The baseline should be no subsidy; that is, no exemption from these State and local taxes. So, relative to that baseline who is benefitting here? The polluter, that’s who. Thus I come down on the side of the JLARC’s comment: “Research suggests these subsidies violate the “pollution payer principle,” which requires the pollution emitter to bear the cost of managing or reducing pollution.” Only I’d add “research and common sense suggest.”

  5. You didn’t pay a sales tax on your last haircut, Acbar – was that a subsidy? Is a policy decision not to tax something always a subsidy? Why should the government “subsidize” your haircut and then “penalize” a business ordered to comply with a regulation?

    The business buys the control equipment and thus is the “pollution payer”, the customer buying the product is the ultimate “pollution payer” and the only question is should the government shove its hand even further into their pockets by adding 6 percent on the original purchase cost and taxing about 1 percent per annum thereafter. The only argument for that is the classic one – tax him more so you can tax me less. Tax business because it hides the true cost of taxes, which ultimately can only be paid by people.

    This was a tough topic to try to take on in 1,000 words (longer than most posts.) A point I left out is that if this equipment is also integral to the production process itself, there is no exemption. So we are talking about equipment or real estate that does not add value to the production process, rather sucks out value, and that negative impact only grows when tax is added.

    But behind your argument is my big complaint about the DEQ comment (outside its swim lane) that government is the driver here, believing the money belongs to it until it deigns to let the poor taxpayer keep some of it.

    • I don’t think haircuts should be exempt, either; as a matter of economics the whole goods versus services distinction is suspect. As for “equipment or real estate that does not add value to the production process, rather sucks out value,” why, it adds value all right — in the eyes of those who care about aligning production and environmental values. Some such folks are investors in the production process, too; but the rest of us are allowed to have opinions about the environment too. Of course “that negative impact only grows when tax is added” but the competition in Virginia would pay the same tax, and since we’re talking about modifications to existing production equipment here (not new installations from scratch), it seems darned unlikely that folks would relocate to another State simply to avoid this tax.

      Your comment about “government is the driver here” is fair enough. My problems with the sales tax are a whole ‘nother subject. My only point: when the people approve a tax, and then the government uses tax exemptions to pick winners and losers, that strikes me as among the most arrogant things the government could do. “Deigns” is the right word for it. And we, the rest of the taxpayers (particularly in those local jurisdictions that lose this tax revenue every year), are the losers. Yes I’ll grant you the involvement of the GA in those exemptions also, but most of that stuff happens below the public’s radar, whereas the basic sales tax looms large with voters.

  6. There’s no free lunch, so whose buying?

    The cost to society is not the lost or counter tax revenue, but the cost of regulation vs the cost to society of the issue regulation is trying to resolve.

    In all these debates, the real issue is the tax collection policy itself (fighting each individual regulation is a Sisyphean task.) The cost of taxes and regulatory compliance borne by a business is ultimately passed on to an individual (quite likely a voting citizen). The benefit of this scheme to politicians and bureaucrats, is that it hides the true cost of the regulations from the voter. Hence, there is a disconnect between the voter who demands these regulations, and the cost of the regulation itself.

    The idea of the pollution payer principle is to hide the “costs of doing something” from those who demand we “do something.” Its a lot easier to demand things, than pay for them to be done. There’s no free lunch, so whose buying?

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