Those of a certain age probably remember Steve Martin’s The Jerk, where Martin played the hapless character Navin R. Johnson. Of the countless memorable lines in the movie, one that always stands out is his excitement when the postman drops off the new phone books. “The new phone books are here! The new phone books are here!” he exclaims as he rushes out of the house to collect his prize. It is doubtful, unfortunately, that the annual issuance of state and local governmental financial statements would have elicited the same level of excitement for Navin. However, for the avid users of these financial statements, the release of new financial reporting standards may be equally exciting. This post explores new financial reporting requirements for local governments related to economic development incentives.
Generally accepted accounting principles (GAAP), as promulgated by the Governmental Accounting Standards Board (GASB), establish the ever-evolving accounting and financial reporting requirements for state and local governmental entities. In North Carolina, the General Statutes require local governments to follow GAAP, thus once a year these entities are required to prepare independently audited basic financial statements. The basic financial statements include a comprehensive set of note disclosures that provide details about the reporting government such as their accounting policies and procedures, deposit and investment collateralization arrangements, outstanding debt, pensions and other retirement benefits, and any other types of information related to the organization that would inform the users of the financial statements in their decision-making. New disclosures are identified on an on-going basis as deemed necessary by the GASB.
Occasionally, states and local governments may offer economic development incentives for individuals or entities. While such incentives may come in a variety of forms, local governments in a number of states (but not North Carolina) are empowered to abate the taxes of a company, thereby reducing tax revenues for the jurisdiction. Such arrangements are known as tax abatements. Recently, the GASB published GASB Statement No. 77, Tax Abatement Disclosures that will require those state and local governmental entities that offer tax abatements to provide details about the program or programs in the note disclosures. The primary purpose for this new requirement is to provide more transparency about the impact of such arrangements on a government’s revenues and how its overall financial position is being impacted. The disclosures are not intended to communicate efficiency, effectiveness, or appropriateness of the abatement agreements themselves.
While there are many types of tax reduction programs and exemptions, a tax abatement is specifically defined in this reporting standard as follows:
A reduction in tax revenues that results from an agreement between one or more governments and an individual or entity in which (a) one or more governments promise to forgo tax revenues to which they are otherwise entitled and (b) the individual or entity promises to take a specific action after the agreement has been entered into that contributes to economic development or otherwise benefits the governments or the citizens of those governments.
Thus, the requirement for an agreement, plus part b of the above definition, separates programs that would be subject to this reporting standard from other types of tax reduction programs such as historic designation and senior citizen exemptions. Those types of tax reductions and exemptions do not involve agreements in which an entity promises to take a specific action and therefore are not considered tax abatements.
Current state law prohibits local governments in North Carolina from offering tax abatement as an economic development incentive. The North Carolina Constitution establishes in Section 2 of Article V that only the General Assembly may classify or exempt property for taxation (see this previous post for additional legal analysis). Thus, while not currently applicable to North Carolina local governments, the new GAAP disclosure requirements do apply to local governments in other states with which North Carolina competes for business recruitment, so it is useful to understand these new reporting requirements as they may be evident in many governmental financial statements from other locales that are used for comparative purposes and research.
Reporting governments should adhere to certain guiding principles when preparing the relevant note disclosures. While most tax abatement arrangements are entered into by the reporting government itself, occasionally other governments may have entered into an arrangement that reduces tax revenues for the reporting government (such as a county tax abatement that also reduces revenues for a municipality). Either scenario is still an abatement that would have to be disclosed by the reporting government. Also, it should be noted that for disclosure purposes, the new standard allows abatements to be reported individually or in the aggregate. If the abatements are being reported individually, however, the government should establish a materiality threshold of their choice. This provision simply insures that an insignificant individual abatement would not be subjected to the disclosure requirements.
The note disclosures themselves, fortunately, do not have to be as detailed as Navin’s precious phonebook. In addition, certain aspects of the disclosures may not be relevant to the abatement program and thus would not be included. “Negative disclosure”, where a disclosure notes the absence of disclosure, is never required by GAAP. This is a sin committed by financial statement preparers more often than one may realize. (Financial statement preparers can be quite meticulous sometimes.) In any event, a disclosure that states “The County did not have any tax abatement programs.” is not necessary or appropriate.
So, what are the actual disclosures that are required? Unfortunately, there is not much of a way to spice this up, other than summarizing the list (sorry about that). For governmental entities that enter into their own abatement agreements, the following disclosures should be made:
- Descriptive information
- Name and purpose of the abatement program
- Specific abated taxes
- Authority for the abatement
- Criteria for abatement eligibility
- Abatement mechanism (i.e., how taxes are reduced and how the amount is determined)
- Provisions for abatement recapture, if necessary
- Commitments made by the abatement recipients
- Amount the government’s revenues were reduced during the reporting period by the abatement
- Any commitments the government may have made as part of the abatement agreement
In addition, if there are any revenues that have been received or are to be received by the reporting government from other governments associated with the reduced tax revenues, the names of the other governments, the authority for such payments, and the dollar amounts should be disclosed.
Occasionally, tax revenues will be reduced for an entity because other governmental entities entered into an abatement agreement. In those situations, the following disclosures would need to be made:
- Names of the other governments that entered into a tax abatement agreement and the specific abated taxes
- Amount the reporting government’s tax revenues were reduced during the reporting period
- Any revenues that have been received or are to be received from other governments as a result of the abatement agreements they entered into, those governments should be identified, the authority for the payments should be cited, and the amounts identified.
In both scenarios, it is possible that there may exist legal prohibitions of disclosure of some or all of the above information. Such prohibition may be part of the agreements themselves, or could be statutory in nature. If that is the case, a general description of the abatement information that is omitted and the source of the legal prohibition should be cited.
When new reporting standards are issued, it is not uncommon for the required implementation date to be two to three years out. This standard has a relatively quick implementation period. For governments in North Carolina, these requirements will be required for the fiscal year that begins July 1, 2016. Thus, the first external financial statements for those few governments in North Carolina impacted by this standard will be as of the fiscal year that ends June 30, 2017.
Until then, we always have the phone book.
Greg Allison is a School of Government faculty member.