How Microsoft, Google and Other Tech Giants Exploit Strapped U.S. States

Last Updated Mar 4, 2011 7:30 PM EST

Microsoft founder Bill Gates says U.S. states facing large budget shortfalls are doing a poor job of balancing their books:
Instead they're building budgets on tricks â€"- selling off assets, creative accounting â€"- and fictions, like assuming that pension fund investments will produce much higher gains than anyone should reasonably expect.
Here's an idea for how the nation's governors can help plug the hole: End the enormous tax giveaways states offer companies, which research shows costs state and local government upwards of $70 billion a year.

Take the software maker's home state of Washington, which is projected to have a $4.6 billion deficit. It provides a temporary sales tax exemption to Microsoft (MSFT) and other large technology companies for building and running so-called server farms, which are used to handle Internet traffic and store data, in rural areas of the state. One analysis put the total value of the subsidy at more than $1 billion.

In 2007, Washington's attorney general repealed this giveaway on grounds that server farms don't make products to be sold. Microsoft promptly relocated its Quincy, Wash., data center to San Antonio, Texas, where city officials agreed to waive all taxes for 10 years. When Washington Gov. Chris Gregoire restored the tax break last year, the company moved back.

Down on the farm
The rationale for such corporate subsidies is that they create jobs. There's just one problem, writes David Cay Johnston, one of the nation's foremost tax experts:
Server farms need very few workers. Oh, there's some programming work, but it can be done as far off-site as India. However, there will be jobs for air conditioning mechanics and security guards who must be on site to keep intruders and summer air at bay.
Quincy officials estimate that Microsoft's center employs no more than 70 people. For Microsoft, the subsidy is directly worth $34 million, or $486,000 per job. Given that server farm jobs offer fairly modest pay, Washington is unlikely to recoup in payroll taxes what it shells out in tax preferences for many, many years.

Microsoft isn't the only company capitalizing on the shaky financial position of states, which compete in offering rich tax benefits in hopes of luring major employers. Yahoo (YHOO) and Intuit (INTU) also get tax breaks from operating data centers in Quincy. Elsewhere in the U.S., Johnston points to the $200 million in state and local tax benefits Yahoo got last year to build a server farm in Lockport, N.Y. Including a discount for electricity usage and other credits granted to the company, the Internet company got $268 million to create 125 jobs.

Wireless giant Verizon (VZ) got an even better deal to put a data center in Somerset, N.Y., drawing $614 million in tax and other subsidies to create some 200 jobs. Google (GOOG), which it's worth noting pays a miniscule effective tax rate of 2.4 percent on overseas profits, received $260 million in tax breaks to open a server farm in North Carolina.

Corporate tax revenues dive
Eliminating these giveaways wouldn't put states in the black, since companies contribute a relatively small share of state revenue. But corporate income taxes aren't exactly peanuts, either, representing the third-largest source of tax revenue for states.

In 2007, before the financial crisis, such taxes yielded $53 billion, according to the Center on Budget and Policy Priorities, or more than the revenue raised by taxing alcohol, tobacco and amusement combined. Since the financial crisis, the amount of revenue states generate from corporate taxes is down dramatically, falling nearly 21 percent between 2008-10.

With governors around the nation frantically slashing budgets, the question is whether the revenue drained from states through lucrative tax breaks might be better spent on services that foster long-term economic growth, such as health care, infrastructure development and education. In Washington, for instance, Gregoire has proposed reducing funding for state programs offering health care for the working poor, financial assistance to disabled people and educational programs for public school students.

Why tax cuts don't work
If laying lavish tax subsidies on big businesses won't help states recover, cutting corporate taxes is an even worse idea. CBPP senior fellow Michael Mazerov explains why:
[A] state would have to offset the estimated loss of revenue from reducing or eliminating the state corporate income tax by a tax increase of the same size on other taxpayers or an equivalent cut in state spending on programs and services. Therefore, even if the corporation spent the entire tax cut in-state... there would be no net stimulus.
Yet that's not stopping states from chopping corporate taxes. In Wisconsin, where two-thirds of corporations already pay no taxes, Gov. Scott Walker recently moved to cut them even more, while slashing school funding and raiding employee pension funds for savings. In Iowa, Gov. Terry Branstad is cutting the state's highest corporate income-tax rate in half, while reducing state funding for preschool. Florida Gov. Rick Scott is paring the corporate tax rate from 5.5 percent to 3 percent, costing the state nearly $500 million a year in revenue.

None of this will help states make ends meet. If they are "building budgets on tricks," as Gates would have it, then companies like Microsoft are in on the ruse.

Image from Wikimedia CC 2.0
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  • Alain Sherter On Twitter»

    Alain Sherter is an award-winning business journalist who has written for The Deal, MarketWatch and Thomson Financial Media.

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