Government incentives come in various forms, from tax rebates and abatements to targeted industry support or demographic targeted incentives.
Incentivization schemes encourage businesses to produce economic activity they would not have undertaken otherwise, prompting evaluations that factor this displacement into calculations and provide policymakers with useful data regarding whether an incentive is effective.
Tax Subsidies
Tax subsidies are government breaks designed to lower the overall costs associated with economic activities, with the intention of encouraging certain kinds of economic development and supporting specific social objectives. Subsidies may be used as tax offsets, or to promote economic activity or protect businesses against competition; well-designed subsidies can have positive results for an economy while at the same time it is essential to understand their potential misuse or abuse and their possible adverse effects on other parts of it.
Tax subsidy provisions can be found at all levels of government – local, state and federal. Each level offers incentives that align with its economic impact aims; local municipalities may use property tax abatements and rebates as economic incentives in order to encourage investments that will generate increased local tax revenues; state governments tend to focus more on job creation/retention as their priority economic impact area by offering job creation tax credits against state income taxes.
Federal governments offer more comprehensive economic subsidies. These may include investment tax credits and cash grants tied to specific economic variables like land, labor or capital.
Subsidies have the power to alter supply and demand curves for any product or service they subsidize, from tax breaks for consumers that reduce disposable income to producer subsidies that increase production capacity by shifting supply curves rightward, increasing supply volumes while simultaneously lowering production costs thereby expanding profit margins.
As with any economic policy, there are multiple ways that subsidies may be misused or abused. To protect taxpayer dollars and ensure they are being spent appropriately, many programs exist that audit and monitor how resources such as subsidies are spent; the Federal Tax Incentives Review Committee (FTRIC) for instance reviews and authenticates all tax incentive expenditures.
Direct Cash Payments
Governments face numerous incentives when designing and implementing direct cash transfer programs that give vulnerable households cash payments instead or alongside services. Such programs are particularly significant in low-income developing countries and emerging market economies with large informal sectors and poorer regions that may be harder to reach through traditional aid delivery means. Experiences from COVID-19 pandemic have underscored the necessity of efficiently and cost-effectively implementing such programs.
Direct cash payments can be costly to administer for large numbers of beneficiaries, posing an administrative challenge in terms of reaching vulnerable populations such as informal sector residents who lack official documents and banking services. An effective program can ease this burden on treasuries through incentives designed to encourage eligible individuals to enroll, use the service and pay taxes on what they receive as payments.
One approach could involve hiring local nongovernmental organizations (NGOs) or community workers as identifyrs of vulnerable people, similar to what has been accomplished through pilot projects of GiveDirectly – an international nonprofit based out of the United States which sends unconditional cash transfers directly into poor households via mobile phone (“M-Pesa”). Alternatively, postal systems can serve as government cashiers by validating addresses before making payment through its network – while private money transfer firms could act as “banking correspondents” who could remit payments directly.
Some research from institutions like the University of Maryland and MIT’s Abdul Latif Jameel Poverty Action Lab suggests that direct payments may be an effective tool in combatting poverty, improving living standards, and helping families build resilience against economic shocks. Furthermore, other research shows they may improve health outcomes like mental distress reduction and energy levels.
Implementing strong ex ante and ex post controls provided by a country’s supreme audit institution and legislature when relaxing administrative procedures to speed up grant and incentive payment is vitally important. Furthermore, data protection standards must also be applied when operating schemes with databases, particularly where payment recipients need their identity verified or their financial history assessed.
Economic Impact Reports
Governments are increasingly turning to economic impact analysis to assess the economic benefits of projects, policies, and programs. Economic impact analyses serve as an invaluable way of measuring whether projects achieve strategic goals such as regional expansion, revitalizing distressed areas or creating higher paying jobs. Economic impact studies typically measure changes in business revenue, profits and personal wages at specific locations.
Governments offering tax incentives to private firms must ensure that such subsidies do not negatively affect local economies, forcing them to cut other public services to cover for any shortfall. Furthermore, high incentive packages could create competition among localities that undermines national economic interests.
Researchers report in the Journal of Economic Perspectives that state and local government business tax incentives cost at least $30 billion each year. Furthermore, per capita spending on incentives was higher in poorer states and counties. They used an exclusive data set to provide concrete statistics about government business tax incentives as well as show how broad economic development benefits could replace them altogether.
Imagine this: a county in Virginia decides to offer a warehouse company a $25 million subsidy towards construction costs, creating direct and indirect jobs during its construction as well as increasing worker earnings, sales revenues and tax base for their county – these tax revenues could then go toward school, hospital or infrastructure improvements.
Project developers must generate an economic impact statement in order to gauge the economic effects of their activities, which provides a detailed, quantitative description of economic changes associated with a specific project. It includes estimates for direct, indirect, and induced impacts – this data can then be visualized using an input-output model which displays this data across regions, years, elements of industry sectors as well as user drill-down capabilities on graphs to view the underlying tables of information.
Accounting Issues
Companies receiving government incentives through grants or loans need to take special consideration when accounting for them, including potential accounting challenges related to grants that contain specific terms such as meeting environmental standards or producing certain volumes of goods. When managing this type of grant, certain accounting considerations need to be addressed. One such issue involves adopting a special-purpose accounting model if required by its nature – something common when terms contain obligations like meeting environmental standards or producing specific amounts.
Accounting models also influence when grants should be recognized. For instance, grants that require the sale of manufactured product to qualified buyers should be recognized when that transaction takes place rather than when funds become available to an entity. Furthermore, grants conditioned upon fulfilling certain environmental or other requirements should be recognized when it appears likely that these terms will be fulfilled.
Another key question regarding grants is how they should be classified – either as income or as a deduction from carrying amount of an asset. Companies choosing to recognise grants as income should disclose why this decision has been made so investors can accurately assess their entity.
The FASB is currently reviewing a proposed new standard that would require business entities to disclose all government incentives they receive, consistent with IFRS disclosure standards. Public business entities would have to begin disclosing such information starting on or after December 15, 2020 while nonpublic ones will have one year later implementation dates.
State governments devote billions annually in tax breaks that they hope will spur job creation or other economic benefits, yet it isn’t always clear that these incentives work as intended. While many states boast high incentive spending levels, their success doesn’t always match expectations when it comes to job creation or other measures of success. Deloitte can assist businesses in understanding all available options available to them and making informed decisions regarding which ones might work best to reach their goals by taking advantage of tax incentives – from identifying eligible programs through to helping clients prepare application documentation that increases chances of being awarded grants or tax credits.