What’s Fair in Disclosure Standards for Non-Income Tax Relief

In a heated competition for microchip and electric vehicle plants, along with other sources of jobs and capital, cities and states are scrambling to lure companies with a range of incentives.

Subsidies and grants are common enticements, but local jurisdictions increasingly are drawing businesses with the promise of non-income tax relief—reductions in state and local taxes that are levied on a base other than income.

All these incentive packages present a sticky challenge for policymakers and standard setters.

When they’re eventually realized, the potential performance effects of these incentive packages can be reported in various places throughout a company’s financial statements. A firm’s income tax expense line item may be smaller because of an incentive program, but the company isn’t required to include a footnote disclosing the incentive package.

Non-income based taxes are even more elusive, with effects scattered throughout a financial statement. For example, sales taxes paid on production equipment are capitalized, then depreciated, and included in cost of goods sold.

The employer portion of payroll taxes for non-production employees is included in selling, general, and administrative expenses. Property taxes paid on investment properties are considered non-operating expenses. In short, information about taxes other than those based on income is often buried.

But just because it’s buried doesn’t mean it’s negligible. Prior studies have shown that in some countries and industries, a firm’s non-income tax burden can easily outweigh its income tax obligation—and those studies were done before the US reduced the top statutory corporate tax rate to 21% from 35%. So shouldn’t investors be able to see non-income based tax relief?

This is one question that prompted a recent paper with my colleagues Michael Drake of Brigham Young University, Ryan Hess of Oklahoma State University, and Jaron Wilde of the University of Iowa. We examine whether and how investors impound information about non-income tax relief into stock prices. This information is a powerful predictor of a firm’s future operating performance and does eventually make it into investors’ hands—but slowly.

The new evidence on the inadequacy of firms’ information environment could validate decisions by the Financial Accounting Standards Board and Government Accounting Standards Board to increase disclosure of government assistance.

More specifically, GASB Statement No. 77, released in 2015, requires governments to disclose in their financial statements the aggregate dollars of abated taxes they offered, along with any corresponding commitments—for example, job creation or infrastructure development. While potentially useful at informing those who wanted to monitor local governments’ incentive use, GASB 77 provides no firm-specific information that would be useful to investors in valuing a firm.

In a related attempt, FASB recently issued ASU 2021-10 to prompt companies to start disclosing information about government assistance. However, there seems to be substantial wiggle room in that standard because it is difficult to find many firms making these disclosures.

These decisions raise a new, more complicated question: What effect could full and timely transparency of targeted incentive packages have on local jurisdictions?

Here’s an anecdote from domestic life: Do I give only one of my children a handful of Oreos while the others look on? Some parents would say, “Of course not.” They recognize that my other children will naturally appeal to equity and ask for their fair share, potentially leaving my wife and me with no Oreos to eat after they all go to bed.

While I might be willing to part with a few Oreos as a special reward, I’m not ready to part with the whole package. But the only way to give some cookies and keep some is to give them more discretely.

Meanwhile, some parents would have no problem rewarding just one child in view of the others. Here’s where the analogy breaks down: While our children are stuck with us, scorned businesses are likely to find a home in a more accommodating jurisdiction.

So it is with tax incentives. In a comment letter to the FASB, the Tax Executives Institute Inc. cautioned that too much information about special tax deals for a given company may allow competitors to demand similar incentives. They also warned that “other jurisdictions could use this information to establish a baseline of incentives a business is willing to accept for a given level of investment.”

The difficult job before standard setters and policymakers today is to balance market transparency with economic best practices in this environment of escalating competition among local and state jurisdictions.

In a world with transparent tax incentives, jurisdictions fear that if anyone gets targeted tax relief, then everyone will demand relief. Because this would break local jurisdictions’ limited coffers, they may simply stop offering targeted tax incentives. While some may be happy with the simplicity of this arrangement, it would eliminate the premier tool that jurisdictions use to attract new jobs, business, and investment.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Brady Williams is an associate professor of accounting for the University of Texas at Austin’s McCombs School of Business. His research examining how companies respond to tax incentives and enforcement has been published in several accounting journals.

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