When State Tax Incentives Clash with ESG 

By | April 18, 2023

Companies and investors have increasingly focused on embedding Environmental, Social, and Governance (ESG) considerations into their strategies. While the term ESG has no official definition and defies easy description, we define companies with an ESG strategy as those making a good faith commitment to managing ESG-related risks to enhance long-term shareholder value. To use the definition of one guide for corporate directors, these companies seek to address “a host of corporate behaviors that have the potential to impose negative externalities in such areas as human rights, the environment, community relations, workplace safety, and the like.”  

Despite the surge in interest in ESG, companies and investors have not applied the ESG framework to an area with potentially large ramifications for the Social or “S” dimension of ESG: the practice of accepting targeted incentives from state and local governments hoping to induce companies to move to, expand in, or remain in a particular jurisdiction. While various government entities offer these incentives at different levels, and while not limited to tax incentives alone, for simplicity, we refer to them collectively as “state tax incentives.” States hold sovereign taxing power within their borders, and tax benefits, such as tax credits or abatements, are the most common form of business incentive. We propose viewing state tax incentives in light of ESG could dramatically alter current practices. 

A Brief Introduction to State Tax Incentives 

At an estimated $50 billion per year, these state tax incentives are a significant part of the business and regulatory landscape, not only in nominal dollar terms but in their impact on government budgets. The deals range from the astronomical (the state of Washington’s $8.7 billion subsidy package for Boeing) to the farcical (multiple companies moving a few miles in the Kansas City area in response to subsidies offered by Kansas and Missouri) to the frenetic (Amazon’s 2017 request for proposals to be the site for its second headquarters) to the bewildering (approximately $79 million in state and local tax breaks for the expansion of Elvis Presley’s Graceland—a facility that presumably would be difficult to move out of Memphis) to the mysterious (the Kansas legislature approving over $1 billion in tax incentives for a company whose name and product were not disclosed to the public or most lawmakers).  

Supporters of incentives argue that the cost in government revenue should be more than compensated in new jobs and economic activity. New jobs will create new spending in the area, which will, in turn, create more jobs and businesses, boost incomes and property values, and increase the amount of taxes collected by the government. 

In theory, state tax incentives can achieve such a virtuous cycle. But to do so without merely taking jobs and growth from other states in a zero-sum game for the country, incentives must have six key characteristics. These characteristics of win-win incentives were outlined by economist Timothy J. Bartik, who has extensively studied the issue of government incentives for business. First, incentives would target only firms in “tradeable industries” that compete in a sizeable interstate market rather than simply displacing existing businesses that serve the local economy. Second, incentives should be offered for geographic areas with high unemployment, aiming to provide jobs for existing unemployed citizens rather than import workers from elsewhere. Third, incentives that provide customized business services, such as worker training programs, are preferred to tax credits and other purely monetary subsidies. Fourth, incentives should be front-loaded and limited in duration. Fifth, incentives should be paid for through increased business taxes rather than decreased government spending, especially on critical services such as infrastructure. Finally, regardless of where the subsidies are provided, the funding should come from the state, rather than local, level. 

Not surprisingly, these “best practice” characteristics do not typically align with companies’ preferences, and in practice, state tax incentives nearly always lack the characteristics that would make them helpful instead of harmful. State tax incentives usually fail to deliver as many new jobs as anticipated, and when they do lead to new activity and new residents, this increases the demand for government services like police and education. The cost of providing those increased services typically equals or exceeds any new tax revenue, leading to a net loss for the local area. And to cap it all off, studies indicate that incentives are rarely the deciding factor in a company’s location decision. All this tends to turn state tax incentives into a net drain on the community offering them. Accordingly, policy experts have overwhelmingly argued that state tax incentives waste public resources and should be discontinued or reformed. But despite the flaws, targeted tax incentives remain popular with elected officials and voters. As a result, attempts to reduce or eliminate the use of state tax incentives have been unsuccessful.  

State Tax Incentives through an ESG Lens 

Notably, prior efforts to curb state tax incentives have always focused on the supply side, attempting to prohibit or discourage state and local governments from offering them to get courts to declare them unconstitutional. In contrast, the rise of ESG presents a new opportunity to address state tax incentives from the demand side by prompting ESG-minded companies to consciously decide whether these incentives are consistent with their ESG strategies. If they are not, companies can either decline the incentives or work with governments to craft incentives that possess the “best practice” characteristics that would allow them to benefit both companies and the communities where they operate. Given the considerable distance between the theoretically beneficial incentives and the kind of incentives offered in practice, we expect that the use of state tax incentives would significantly decline if companies were to assess them under an ESG framework. But why would a company ever rationally decline to seek or accept tax incentives, and how can we realistically expect them to do so? Wouldn’t any chance to reduce tax expense tend to benefit shareholders in the long run? 

To answer, we must return to our definition of a company adopting an ESG strategy. Such a company believes an ESG strategy benefits shareholders by effectively addressing long-term risks. For example, an ESG-minded company may engage in efforts to reduce pollution or increase worker safety, which could cost money and reduce profitability in the short term. However, the company can avoid significantly costlier outcomes such as lawsuits, fines, and reputational damage in the long term. The actions will also create many intangible benefits, such as better worker morale, improved community relations, and other forms of goodwill. A company pursuing an ESG strategy, if they were to assess the impact of many state tax incentives deliberately, would likely determine that it is not in the company’s best interest to accept incentives that could threaten the provision of essential government services and infrastructure in communities where the company hopes to operate for many years.   

State Tax Incentives as Tax Avoidance 

The literature further bolsters this conclusion on tax avoidance, by which we mean aggressive tax planning, which is technically legal but results in tax savings unintended by the government. We argue that state tax incentives constitute tax avoidance whenever they operate contrary to the intent of the government offering them. For example, if incentives were intended to induce a company to locate in a jurisdiction or create new jobs for unemployed residents, but the tax incentives did not determine the company’s location decision or the company imports existing workers from another jurisdiction, the company has extracted benefits that the government did not intend. 

While there is little work on tax avoidance and ESG, there is ample work on tax avoidance and Corporate Social Responsibility (CSR), an earlier concept largely consistent with the “Social” dimension of ESG, especially regarding taxes. For example, under the analysis of professor Reuven Avi-Yonah, even corporations taking the narrowest view of their social responsibilities should shun tax avoidance because it undermines the ability of governments to carry out essential functions which corporations rely on and cannot perform themselves. Professors Alex Hilling and Daniel Ostas reach a slightly more lenient conclusion in their book, synthesizing much of the literature on social responsibility and taxation, for they leave open the possibility that mere compliance with the strict legal requirements of the corporate income tax may be sufficient. However, they posit that laws impacting the safety and health of human beings trigger a higher degree of duty, which they label “cooperation.” This requires corporations to go beyond minimum legal requirements if necessary to protect these morally salient interests. 

Arguably, given the ability of state tax incentives to negatively impact local budgets, including the provision of services like policing and public health, mere compliance with the letter of the law is not sufficient. This is especially true if the company lobbied to enact the law creating the incentives. In fact, Hilling and Ostas argue that lobbying is inconsistent with social responsibility when all interested stakeholders do not have a voice. And state tax incentives are often negotiated out of the public view, with little input from stakeholders. When the incentive package is publicized, the benefits are touted, but the costs are often downplayed or ignored.  

An ESG Reporting Framework for State Tax Incentives 

Even if corporate managers conclude that particular state tax incentives are inconsistent with their ESG strategy because of long-term negative effects on the community and, therefore, the company, these harms will take a long time to manifest, and any impact on the company’s financial results is likely to be indirect and difficult to demonstrate. In contrast, the benefits of, say, a large tax credit are immediately apparent on an income statement. Therefore, it could be difficult for ESG-minded managers to resist short-term pressures to seek and accept state tax incentives. 

Given these conflicting pressures, simple additions to ESG reporting standards could greatly assist managers and investors. ESG reporting is currently voluntary and inconsistent in the U.S., but a growing number of ESG reports discuss taxes in the “S” section as part of a company’s support for the community. Several nongovernmental or nonprofit organizations have created ESG reporting frameworks, although they are voluntary and independent of each other. These include the Global Reporting Initiative (GRI), which issues standards used by eighty-two percent of the world’s 250 largest companies, and the International Sustainability Standards Board (ISSB), formed in 2022 by consolidating several ESG-related standard setters. Despite the lack of standardization, ESG reporting has become popular with amazing speed. As of 2019, ninety percent of S&P 500 companies issue ESG reports (also called sustainability reports), up from twenty percent just nine years prior. Various rating agencies use ESG reports and other data to rate, score, or rank companies on ESG performance. Investors use ESG reports to apply “screens” to identify companies that do or do not meet specific ESG standards, like those for limiting carbon footprint or increasing board diversity. 

In the context of state tax incentives, even this voluntary ESG reporting system could be quite effective. Reporting would allow an ESG-minded manager to communicate that they have applied an ESG approach and foregone harmful state tax incentives. If a company is willing to refuse easy-to-attain tax incentives, it will signal that its overall ESG strategy has substance—and is not mere window dressing. Investors and rating services focusing on ESG investing can then easily create screens for such companies, allowing them to receive the capital market benefits from increased investment flows and the ability to communicate that they have better managed ESG-related risks. State tax incentives are particularly well-suited for a reporting framework because standards can easily be crafted around the six characteristics of beneficial incentives. For example, companies issuing an ESG report can list whether the target area has high unemployment and the number of new workers hired from the area; whether the incentives are in the form of services, tax credits, or other tax or financial subsidies; the duration of the incentives; and so forth. The criteria are readily translatable into simple disclosures that are relatively easy to calculate and audit. 

State Tax Incentives and Political Entanglements 

There are other reasons to think that an ESG approach to state tax incentives can help companies avoid long-term risks. First, to the extent that this approach leads companies to forgo incentives, they will be more likely to avoid costly political entanglements. For example, In 2019, Nike was granted incentives to locate a manufacturing plant in Goodyear, Arizona. At about the same time, Nike canceled a planned line of shoes at the suggestion of former NFL player and Nike endorser Colin Kaepernick, who believed that the design of the shoes was offensive. Governor Doug Ducey lambasted the cancelation on Twitter, stating that “Arizona’s economy is doing just fine without Nike” and ordering state officials to “withdraw all [state] financial incentive dollars” that the company was eligible for. Similarly, when Disney voiced its opposition to pending legislation in Florida in 2022, it lost control of the special taxing district surrounding Disney World that it had been granted in 1967. These cases demonstrate how the acceptance of state tax incentives can make it costly for the company to speak or act on other issues that it deems important. 


When ESG-minded companies eschew state tax incentives that do not truly benefit the company and the community, they embrace good business and legal strategy. Since ESG standards exist to help companies and investors adopt such beneficial long-term practices, a useful state tax incentive reporting standard should be part of their mission. As a side benefit, adopting an ESG approach could help states end flawed programs that over a quarter century of cogent legal and policy arguments have failed to curtail. As ESG evolves, investors realize the negative impact of state tax incentives and start demanding more disclosures, and business-community relationships continue to be renegotiated, more companies, after engaging in intentional-decision processes, will view most state tax incentives as incompatible with their ESG strategies. And that will have the happy side effect of reducing demand for something that seems to be in endless supply.  


Mark Cowan is a Professor of Accountancy and Director of the Master of Science in Accountancy- Taxation program at Boise State University’s College of Business and Economics. 

Joshua Cutler is an Assistant Professor of Accountancy at Boise State University’s College of Business and Economics. 

This post was adapted from their “ESG and the Demand for State Tax Incentives” paper, which was forthcoming in the Florida Tax Review and available on SSRN. 

Leave a Reply

Your email address will not be published. Required fields are marked *