Your employer may be pocketing your state income tax

State tax incentives for businesses are on the rise. Proponents say they help keep companies in a state and create jobs, making them important to statewide economic development. What they often don’t show is who pays for these costly incentives. Increasingly, employees foot the bill – often without their knowledge.

Most employees assume that states use their state income taxes to improve school systems, pave roads, or hire more police. That is, after all, part of the social contract we have with our government. We pay taxes and get public services.

But more and more of those tax dollars aren’t funding services; they aren’t even getting to the state capital. Sixteen states now allow corporations to withhold state income taxes from employees and keep the money as an incentive to locate to or remain in a state. That means that, in effect, employees pay personal income tax to their company rather than their state government. (The 16 states are: Colorado, Connecticut, Georgia, Illinois, Indiana, Kansas, Kentucky, Maine, Mississippi, Missouri, New Jersey, New Mexico, North Carolina, Ohio, South Carolina, and Utah.)

A recent report from Good Jobs First entitled, “Paying Taxes to the Boss,” sheds light on how widespread this practice has grown. An estimated 2,700 companies now take advantage of this welfare system, fueling an economic war between states that costs employees an estimated $700 million a year in diverted tax income, the report concludes. Those who profit include corporate giants like Sears, Goldman Sachs, and General Electric.

In Illinois, the EDGE program offers a special tax incentive that can divert up to 100 percent of withheld taxes into subsidies to encourage companies to locate or expand operations in Illinois when the companies are actively considering a competing location in another state.

New Jersey’s Business Employment Incentive Program (BEIP) is among the most costly of these programs, with new grants totaling more than $73 million. Ohio and Kentucky top the list of states for the number of companies they subsidize through employee personal income tax withholding.

The practice has been around for more than a decade, and it’s continuing steadily – with six of the 22 programs identified nationwide enacted since 2009 – according to Good Jobs First, a policy resource center that focuses on economic development and "smart growth."

Most corporate tax incentives are simply bad policy, representing an attempt at social engineering our already patchwork tax code. For one thing, businesses don’t make investment decisions based solely on state tax burdens. For another, tax loopholes enable the savviest companies to live tax-free.

Since money is fungible, some claim it doesn’t matter whether this corporate welfare comes from corporate taxes or personal income taxes. The states are out $700 million in either case. But it does and should matter.

The personal income tax is a covenant between the citizen and the state. For the executives and shareholders to retain those tax dollars violates that covenant. Employee-funded corporate tax incentives reduce the amount of tax dollars available for vital social services like schools and law enforcement.

They are also at the heart of an ongoing economic war between states and interstate job "piracy" that seduces people and companies to cross state borders.

Worst of all, most American workers have no idea that their withheld income is going into their boss’s pockets because states don’t require employers to include this information on employee pay stubs. It’s time that state lawmakers stop hiding behind the label of economic development and call it what it is: a corporate welfare program funded by hard-working American taxpayers. 

David Brunori is the executive vice president of editorial operations for the nonprofit Tax Analysts. The author of several books and articles on state taxation, he is a research professor of public policy at George Washington University, where he also teaches state and local tax law.