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Washington-In North Carolina this spring, a state court will take up a constitutional challenge to $242 million in state tax breaks given by state officials to Dell Inc. to build a plant in Winston-Salem. In Minnesota, another suit is pending attacking the validity of two multimillion-dollar tax-incentive programs to attract and keep businesses in special zones in that state. The North Carolina and Minnesota suits are among a number percolating around the country that have been inspired largely by a federal appellate decision in 2004 that struck down Ohio’s investment tax credit-a sacred tool of state economic competition. The Ohio case, which involved a $280 million tax incentive plan for DaimlerChrysler Corp.’s expansion in that state, is now before the U.S. Supreme Court, which is scheduled to hear arguments on March 1. DaimlerChrysler Corp. v. Cuno, No. 04-1704; Wilkins v. Cuno, No. 04-1724. The case has raised to a high profile a long-running debate over the constitutionality of state tax incentives under the so-called dormant or negative commerce clause, which prohibits states from acting in a way that interferes with interstate commerce, as well as a debate over the effectiveness of tax incentives as an economic-development tool. Business and government officials predict “dire ramifications” if states lose the ability to offer these incentives and businesses lose the ability to use them. They note that one study reported last year that more than 330 statutory income or franchise tax credits and incentives are offered by 46 states. But of all the many state and local provisions designed to attract and encourage business development, the most common form of tax incentive in America is the investment tax credit, according to Walter Hellerstein of the University of Georgia School of Law, who is considered the leading academic authority on state and local taxation. Since the Ohio credit’s inception in 1995, corporations have used it in investing more than $30 billion in Ohio plants and equipment, according to the state. In 2002, more than 2,100 corporate taxpayers took Ohio ITC credits, totaling more than $73 million. “The Constitution is not an economic suicide pact among the States,” said Ohio State Solicitor Douglas R. Cole in his high court brief. “The Court should not turn it into one here.” Balkanization? But neither is the Constitution a facilitator of the economic balkanization of the states, said retired North Carolina Supreme Court Justice Robert F. Orr, head of the North Carolina Institute for Constitutional Law, which filed the Dell lawsuit. “What we’re seeing nationally is large corporations able to play one state off another,” he said. “States, in desperate search for jobs, are forced to hand out huge tax breaks that shift the burden to small businesses and individuals and deprives local governments of revenue. “This is the modern-day version of the trade wars that the framers put the commerce clause into the Constitution in the first place to prevent.” What the two sides can agree on now is that uncertainty permeates the legal and business landscapes following the Ohio decision by the 6th U.S. Circuit Court of Appeals. “There are a fair number of jurisdictions-upwards of 40- that have similar incentive programs. Is this a precursor for further overturning?” asked Eli J. Dicker, chief tax counsel at Tax Executives Institute, a non-profit association of corporate and other business tax executives. “If a businessperson is trying to plan where to build a factory, whether it be a vehicle or high-tech assembly line, with a lot of jobs in play, I would strongly suspect there is a hesitancy now, especially when the economics may be uncertain.” Ohio precursor? The Ohio story began in the mid-1990s, when DaimlerChrysler decided to expand its capacity to build Jeeps. Faced with a choice of expanding an existing facility in Toledo or crossing the border into Michigan, the company approached Ohio officials about tax incentives to remain in Ohio. One of the decisive incentives for DaimlerChrysler was the investment tax credit, which provides a one-time credit against Ohio’s corporate franchise tax to any company that makes a qualifying investment in the state. The suit challenging the tax incentives was brought by a Toledo resident, a small business owner whose property was taken, and some citizens of Michigan. They claimed that the incentive package discriminated against interstate commerce by “providing preferential treatment to in-state economic activity.” The 6th Circuit agreed, striking down the investment tax credit, but upholding a property tax exemption. On the investment tax credit, the court said that corporations would be treated unequally based on their investment decisions. For example, a business paying Ohio taxes would receive a credit against those taxes in exchange for investing in Ohio, but a business paying Ohio taxes choosing to invest in Michigan would not. The Supreme Court’s jurisprudence in this area is “at best uncertain and at worst indecipherable to those of us who spend our life working in this area,” said Georgia’s Hellerstein. From a practical perspective, Hellerstein said, “There’s an overwhelming need” for clarification. “You have both taxpayers and states that really have no clue as to whether a particular tax incentive is going to be sustained,” he said. “One thing we know is that states are free to enact legislation that encourages economic development. Even in the course of striking down legislation that it has found violative of the commerce clause, the court has made clear states are not hamstrung in those efforts,” Hellerstein said. Drawing the line But where is the line between what is discriminatory and what isn’t, asked Chris Atkins, senior attorney with the Tax Foundation. “We want the court to say this type of investment credit is OK or draw a reasonable line saying, it’s not OK but lowering tax rates or building new roads is OK,” said Atkins. “The 6th Circuit didn’t draw that line. Saying the credit discriminated because it encouraged investment in Ohio is very broad. There’s a whole range of spending policies that encourage investment in the state, from infrastructure improvements to building schools.” The Ohio case differs from prior high court challenges in this area. The commerce clause historically has been enforced by one business suing to take away a benefit given to another. But the Ohio case is brought by nonbusiness taxpayers, raising a potential standing problem on which the justices have ordered briefing, and which could prevent a ruling on the merits. “The usual plaintiffs who typically would bring challenges are choosing not to because if they’re being discriminated against by Ohio, they may be, by the same token, getting the benefit of the same provision in Alabama or Minnesota,” said Peter Enrich of Northeastern University School of Law, who is counsel to the Ohio plaintiffs. “The way these tax incentives have grown like topsy has created a situation where it’s not in the interests of business taxpayers to bring these suits.” Although Enrich argues that his clients do have standing, his high court opponent, Theodore B. Olson of Los Angeles-based Gibson, Dunn & Crutcher, who is counsel to DaimlerChrysler, contends that their standing is “even weaker than usual” because they do not complain that the state has imposed a discriminatory tax on them, but that a credit against that tax-which most of them do not pay-”somehow reduces the state’s overall tax receipts” to which they contribute. That is not the “concrete and particularized injury” that standing demands, according to Olson. Dire impact? If the high court gets beyond the standing issue and reaches the merits of the case, the impact of any decision, of course, will depend on how it is written. The U.S. Chamber of Commerce and other business groups contend that the 6th Circuit’s approach would result in a loss of economic investment and activity to various foreign countries, as well as a decrease in investment by foreign manufacturers in the United States. They also predict that there would be “significant financial statement impacts” on those companies that included the incentives in their calculations of profitability. Philadelphia firm Blank Rome, in a tax bulletin on the Ohio decision, warned that “the magnitude of the credits that may be ‘clawed back’ or voided in the future could cause many publicly traded companies to restate their earnings.” Tax counsel Walter Nagel of the Washington office of Boston’s Sullivan & Worcester, predicted that the most likely impact of a decision against Ohio would be some action by Congress to overturn the Supreme Court ruling. Ohio senators already have introduced bills to overturn the 6th Circuit ruling, he noted. However, he and others agreed, Congress appears to be waiting to see what the high court does. But, Nagel asked, “What happens to everybody up until Congress overrides it? Then there’s real potential for chaos in terms of who gets taxes back, which benefits go away. One ramification is that only the immediate taxpayer loses the benefit, but another ramification is everybody else-taxpayers indirectly injured by paying higher taxes-could well enjoy a modest reduction because it’s a large base.” Nagel said that there is no consistent rule regarding what happens when a tax or economic incentive is found to be unconstitutional. A decade of litigation over the appropriate remedy, he said, has followed key Supreme Court decisions finding taxes unconstitutional. States are infinitely creative in finding ways to attract business, said a number of tax scholars and practitioners, and will continue to be creative if Ohio loses in the high court. Georgia’s Hellerstein thinks Ohio will win, given the court’s current composition. But, he added, “One easy way for states to encourage business is simply to subsidize them. They can provide in-kind benefits in the form of subsidies.” The high court has indicated that subsidies from the general treasury do not create the same constitutional problems as using the state taxing power. But the Tax Foundation’s Atkins countered, “I think businesses might feel more comfortable keeping more of their own money taking that credit off their liability than essentially becoming beholden to the appropriations process. Some may see it as a bit more entanglement than they are willing to endure.” And direct cash subsidies could invite litigation, said Enrich. “The pressures on states to find ways to advantage in-state economic activity are immense. I think states would continue to look for new ways to do that. Some won’t pose constitutional problems.” Regardless of what the high court decides, North Carolina’s Orr said, his foundation is organizing a national, bipartisan coalition to generate debate about these tax policies. “We now see more and more local companies threatening to move unless they get incentives to stay,” said Orr. “We’re not taking this lying down.”

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