On a chilly late February evening, the state's deepest-pocketed business lobby held its annual awards event at Milwaukee's Pfister Hotel to celebrate its most successful legislative session in memory.

Members of Wisconsin Manufacturers & Commerce toasted state Sen. Glenn Grothman there for spearheading the "most exemplary public policy initiative in support of manufacturing in more than 35 years," a news release says.

There's good reason WMC was so excited: The new policy effectively eliminates state income taxes for many of Wisconsin's corporations, factory owners and agricultural producers by the time it's fully phased in.

"We had to do something to change the business climate in the state … and this does it big-time," says Grothman, R-West Bend.

Slipped into Gov. Scott Walker's 2011-2013 budget at the last moment, the domestic production tax credit will cost the state $360 million in revenue over the next four years and some $130 million each year thereafter, according to the non-partisan Legislative Fiscal Bureau. Critics warn the impact could be even greater, a key point in a state still struggling with budget shortfalls.

The credit applies to profits derived from manufacturing or agriculture and is available both to corporations and shareholders of limited liability companies, S corporations or others who report business income on their individual tax returns.

As a result, top bracket taxpayers could see their state income tax rate fall from 7.75 percent to less than zero by 2016, when the credit fully kicks in. That's because any unused credits can be counted against other income, like stock dividends, and carried over for up to 15 years.

"It's a total giveaway to the wealthy," says Jack Norman, research director of the Institute for Wisconsin's Future, a Glendale-based watchdog group. "You've got a guy working at the factory making $35,000, paying his share of taxes. Meanwhile, the guy who owns the factory won't pay any state tax and he can also shelter the income of his wife."

Curiously, the new manufacturing credit has received little press coverage — although it's arguably one of the biggest shifts in state income tax policy since Wisconsin first implemented one back in 1911.

Even those who stand to benefit don't know about it. Endres Manufacturing executive Sam Ballweg says he wasn't aware of the credit until Walker mentioned it during a campaign stop at the family-owned Waunakee firm two weeks ago.

"I really don't know much about it, so I better not comment," says Ballweg.

But the credit is now emerging as a wedge issue in the recall election battle between Walker and Milwaukee Mayor Tom Barrett.

Barrett mentioned the production tax credit last month when pressed on what Walker policies he might change if he wins on June 5. Walker jumped on that statement, charging that Barrett is looking to raise taxes on Wisconsin's "job creators."

"Milwaukee Mayor Tom Barrett has repeatedly promised to take Wisconsin backward by repealing tax relief for job creators, but he has failed to say which taxes he would like to raise," says Walker campaign spokeswoman Ciara Matthews. "It is time for Mayor Barrett to come clean and announce his intentions."

Barrett has countered that cutting taxes and boosting credits for selected business owners or investors is not guaranteed to help the broader economy.

"Every tax credit or break must be tied directly to job creation, so everyone in Wisconsin benefits — otherwise the middle-class employees end up paying more, while the wealthy and big business pay less," says Barrett.

The production tax credit was just one of the "gifts" in the budget approved by Walker and the Republican-controlled Legislature last June. Most, if not all, are targeted at corporations, investors, upper-income residents and campaign contributors.

Combined, they will reduce state revenues significantly. Making up the difference, opponents argue, will be average Wisconsin families.

In a report released this week, the Wisconsin Democracy Campaign calculates the decrease in state revenues will cost the average family of four $235 in higher taxes beginning in 2013 and nearly $300 by 2021 if all the credits and incentives are fully implemented. Those figures were gathered by dividing the amount of the tax cuts by the state's population.

Meanwhile, despite strict revenue limits and controversial cuts in school aid, property taxpayers statewide saw just an $11 average reduction in their December 2011 bills.

At the same time that the Walker budget cuts taxes for upper-income residents, it stings lower-income filers by making cuts to the earned income tax credit and the homestead tax credit.

State Sen. Bob Jauch, D-Poplar, calls the GOP approach "shifting the shaft," meaning that it shifts the tax burden off one group — in this case business owners and the wealthy — and leaves everyone else to pick up the difference.

"In the 1 percent vs. 99 percent debate, this is a graphic example," says Jauch. "They have completely sold their souls on any concept of common wealth."

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One of the most outspoken critics of the production tax credit is Mark Harris, the Winnebago County executive. Struggling to balance the budget in his own manufacturing-heavy county in the face of shrinking state support, Harris has been sounding the alarm on the issue for months but has generated little interest, in part because of its complex nature and its highly charged political implications.

An accountant by training, Harris says the tax credit as written is flawed and could lead to a series of unintended consequences — such as companies scrambling to have their business reclassified as manufacturing to avoid paying state taxes. He warns that future reductions in state tax collections will be passed on to cities, counties and villages.

"My point is that this tax cut is very large and it may threaten funding for K-12 education, the university system and municipalities," he says. "My goal is to get this legislation moderated before it ever takes full effect."

So just how large is the production tax credit?

At $129 million annually, that's roughly 18 percent of the $852 million in corporate tax collections in Wisconsin last year, although some of the credit would count against the $6.7 billion in individual income tax collections.

But Grothman maintains that any drop in tax collections will be more than offset by the resulting increases in business activity. He projects that restaurant owners, retailers and all taxpayers will benefit down the line as the entire state economy grows.

"This credit is going to generate so much added economic activity that any cost will be dwarfed by all the new money coming in," he predicts.

The fiscal bureau has estimated the GOP tax cuts will cost the state $2.3 billion in revenue over the next 10 years.

It's not clear how Wisconsin will make up the difference.

"They keep piling these things on with no idea how they will pay for them," says Dale Knapp, research director of the Wisconsin Taxpayers Alliance. "That's why they phase in tax cuts and credits so they don't have to worry about it until down the road."

Walker campaign spokeswoman Matthews declined to comment on how the governor would pay for the tax cuts for business. She referred those questions to Walker's staff spokesman Cullen Werwie, who did not return phone calls or emails.

In theory, reducing taxes for factory owners is a way to lure companies from other states to Wisconsin.

James Buchen, vice president of government affairs for WMC, says eliminating taxes for factory owners will begin to level the playing field for Wisconsin against states like Texas or Florida, which are among seven that have no state income tax at all.

"The policy was intended to enhance the competitiveness of all Wisconsin manufacturing companies as they compete in national and global markets," he says. "It will cement the state's position as a center of manufacturing for years to come and ensure there will be a ready supply of good-paying manufacturing jobs for our families and communities."

But Harris is skeptical that simply eliminating taxes will spark any burst of hiring. Drawing upon his years in the private sector, Harris says business owners hire based on whether adding staff will increase profits — not on tax policy.

"My gut feeling is that any tax cut will just go back into the owner's pocket," says Harris, who also holds a law degree from the University of Michigan.

As an example, Harris points to U.S. Sen. Ron Johnson, whose family owns the PACUR manufacturing company in Oshkosh. Johnson paid $645,000 in state income taxes on income of $9.5 million from 1997 to 2008, according to campaign finance reports. Under the production credit, Johnson would have seen his state income taxes eliminated — with enough left over to shelter some of his investment income.

"I'm not trying to single out Senator Johnson ... but that is just one example of how wrong this thing is," says Harris.

Whether Wisconsin factory owners are in dire need of an income tax cut is open to debate.

Manufacturing is one of the only sectors of the state economy to show much recovery from the recession, adding 12,000 jobs over the past 14 months. Longer-term, the state has been losing manufacturing jobs along with the rest of the country — but at a slower pace. From 1990-2011, manufacturing employment in Wisconsin fell 15 percent vs. a 34 percent drop nationwide. From 2007-2011, it fell 12 percent in Wisconsin compared with 16 percent nationwide.

It's even harder to make a case that eliminating income taxes for agricultural producers will spark the broader economy. Farmers can't simply pull up their operation and move it across state lines because taxes are lower.

Actually, it's unclear how agricultural activity was added to the tax credit program in the first place. Some speculate it was to generate support for the tax cut among rural lawmakers.

"We weren't involved," says Wisconsin Farm Bureau Federation lobbyist Paul Zimmerman. "At this point, we're not sure if Joe Farmer milking cows would even qualify."

Still, owners of corporate dairy farms, cranberry growers or any agricultural producer with a sharp-eyed accountant could see their income taxes cut or eliminated altogether under the credit. Wisconsin counted more than $2 billion in agricultural income last year, but it's unclear how much the credit would affect tax collections.

Grothman, whose district includes both manufacturing and agriculture, says farming was included because agriculture is such a key piece of the state economy. But he admits the credit favors two sectors over many other business categories in the state.

"Hey, I'd like to cut everybody's taxes, but with the budget crisis we can't afford to do that," says Grothman. "The point is that manufacturing and agriculture are the leading industries in Wisconsin and we should be doing all we can to support them."

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The production tax credit kicks in beginning in 2013, giving businesses classified as manufacturing or agricultural a dollar-for-dollar tax credit of 1.875 percent on reported income. The credit increases to 3.75 percent in 2014, 5.526 percent in 2015 and 7.5 percent in 2016 and beyond.

As written, however, the policy would end up providing more in tax credit than taxes owed. That's because Wisconsin's income tax rate doesn't hit the 7.75 percent maximum level until a tax filer reaches $300,000 in income.

At $300,000, for example, there would be enough credit left over to shelter another $39,400 in outside income. In fact, the amount of credit exceeds state taxes due until a filer hits $1.5 million in income.

Department of Revenue Secretary Rick Chandler has been touring the state touting the credit as yet another example of Wisconsin working with business rather than against it.

"Manufacturing and agriculture have historically been the twin drivers of Wisconsin's economy," says Chandler. "They are poised to thrive in the future, if we have the right policies in place to encourage their vitality. Supporting manufacturing and agriculture has been a long-standing bipartisan approach. If these sectors do well, so do all other sectors of the economy."

In addition to the manufacturing and agricultural tax credits, higher income tax filers in Wisconsin next year will also begin reaping the rewards of broad exemptions on capital gains — money made from stocks, bonds, real estate or other investments.

Right now, Wisconsin exempts 30 percent of capital gains on assets held at least one year and allows 100 percent exclusion for gains on the sale of business assets to a family member. Walker's budget makes all capital gains free from state income tax as long as the money is reinvested in a qualified Wisconsin business for at least five years.

Of course, capital gains tax cuts overwhelmingly benefit those at the top. According to the Legislative Fiscal Bureau, almost 80 percent of taxpayers with incomes over $200,000 reported some capital gains income, while only about 20 percent of all taxpayers with incomes below $200,000 reported any. For the vast majority of taxpayers, the only significant capital gain in their lifetime comes from the sale of a house — and that gain is already exempt from state and federal taxes up to $250,000.

Once fully phased in over the next several years, capital gains tax collections would fall by more than $100 million annually, the fiscal bureau estimates.

The Wisconsin Democracy Campaign, in its report titled "Special Interest Smorgasbord," says the production credit and capital gains cuts are the largest of 55 policy changes that collectively will cost the state $335 million in 2013 and at least $439 million by 2021.

"Don't be fooled when the Republicans tell you they're for smaller government," says Rep. Tamara Grigsby, D-Milwaukee. "These policies are just an excuse to kill education and health care for the middle class while putting corporate executives on permanent and extremely costly life support. It's ironic, it's dishonest, and it's cruel."