Do Incentives Make Good Policy?
The awarding of incentives to corporations by state and local governments to support business location decisions continues to be a fascinating topic in both economic development and taxpayer group circles.
Economic developers tout the success of the return on the investments through various metrics, such as low unemployment numbers, and the amount of new corporate investment and job creation in their communities. They also point out their standings in business climate rankings, which are issued by different publications and organizations. They typically rank a variety of business criteria, ranging from entrepreneur friendly to best places to do business to best quality of life, among other categories.
Taxpayer groups and policy groups, among others, seek to ensure governments awarding these investments hold recipients’ accountable, certifying effective development takes place. These groups also issue reports related to rankings. In May, Good Jobs First released “Grading Places: What do the Business Climate Rankings Really Tells Us?” which found that the factors evaluated by rankings offer no empirically proven relationship to economic growth, and that scores ignore major differences among state tax systems.
Global Corporate Xpansion has asked leaders in economic development and policy groups to shed light on this compelling topic. We posed the question: Are investment incentives awarded in a global economy good policy at the state and/or local levels?
Interview with Greg LeRoy, executive director, Good Jobs First
Global Corporate Xpansion: Are investment incentives awarded in a global economy good policy at the state and/or local levels?
Greg LeRoy: When you pull back the big picture, sometimes globalization gets invoked by state or local leaders to justify state or local economic development incentives. And we think that is usually quite misleading. Here is why.
If a company can offshore jobs to a low wage market, such as Mexico or China, the amount of money a company would save doing that, especially if the process is at all labor intensive, is in a very different range compared to what you can save a company by shaving off some of their state or local taxes.
The mantra here is all state and local taxes combined come to 1.5 percent of a typical American company’s cost structure. Wages would be anywhere from one-third to two-thirds, depending on the nature of the services and products the company makes.
Tiny changes in big cost factors like labor, like occupancy, like raw materials, like logistics, which are all much bigger cost factors than state or local taxes, matter far more to a company.
We made this point in a study published in January 2010 called “Growing Pennsylvania’s High-Tech Economy.” We looked at data sets having to do with interstate job migration versus certified trade adjustment assistance; layoffs in the state resulting from either job flight offshore or import competition.
The effects of globalization dwarfed interstate job migrations. In fact, for a six-year period, 2001-2006, the ratio was 30:1. That is 30 jobs lost to globalization for every one job that moved to New Jersey, Ohio or New York.
These numbers are light years apart as cost factors and as job issues for economic development.
Trade is a federal issue, and you can’t fix a federal trade issue anyplace except in Washington, D.C.
The other main point to this policy question is in many of our studies over the years, especially involving retail, an incentive can only be justified if it meets the definition of the word “incentive.” And by that I mean something that isn’t happening that people agree should be happening. Something such as locating a grocery store to a food desert.
Or cleaning up a brownfield when there is no responsible party available to fund the cleanup of the brownfield. Or helping an ex-offender become re-employed.
Those really are incentives because we know they aren’t happening enough. This is where public support will really leverage and prime the pump and bring additional resources to any issue that isn’t otherwise being addressed.
When you go beyond that definition, you get into giveaways. We have documented that problem in many dimensions such as governing programs such as tax increment financing or enterprise zones. Or with retail incentives, which can include TIF subsidies in some states.
This is a lack of geographic targeting and therefore pro-sprawl.
We have mapped 5,000 deals in 13 metro areas and analyzed them, and looked at metrics such as proximity to transit access, to poverty and race, to population density, to tax base, and we keep finding they [awards] are very pro-sprawl.
We are not against incentives per se; we use the word subsidies intentionally because too many of these programs fail to meet the definition of the word incentive. They are not sufficiently targeted to make something happen that wouldn’t have happened otherwise.
No matter what your perspective; global, state or local, we would advise any public official to make sure they first understand what is broken. What is it that should be happening in your economy but isn’t happening? And if there is a way to incent private investment to address the issue with some public dollars we are for it.
GCX: In regard to business climate rankings, you were quoted in the press release announcing “Grading Places” as saying, “We should lay aside these useless reports and debate the real issue: how to build a tax system that is fair, modern and relevant.” Describe a few of the ways to build a fair tax system.
LeRoy: Some of the solutions bear upon issues that are not exactly economic development incentives but certainly are big issues.
For example, right now we have the issue of Internet sales taxation, which has just moved through the Senate. This was a huge fairness issue for small and locally owned businesses; a leveling of the playing field.
There are also large structural issues around taxation. A frequently cited issue is the fact that sales taxes in many states don’t really reflect the composition of the states’ economies.
This goes back to the archaic tax systems written in the 1950s. Back then the service economy as a share of the overall economy was a much smaller share than the two-thirds or 70 percent of the economy it is today.
Many states don’t tax many kinds of services so the share of the economy that is taxed by sales taxes, which are often limited to material goods, means that the base has shrunk.
There is a frequent mantra from both the left and the right [political spectrum] that in order to keep taxes fair, you want to keep the rates as low as possible, but the base as broad as possible.
To the extent that you write a sales tax code that applies to a narrow base or a sliver of the state economy and ignores much of the service sector, you are boxing yourself in; it causes structural deficits.
Some states have flat income taxes or capped income tax rates.
The rest of the income tax rates are much better because they are much more resilient, and more effectively mirror the size of the state GDP, and the cost of public services.
There are a few relevant reforms we track in regard to economic development.
*Disclosure: We have made huge strides on that front. As of 2007 only 23 states had online disclosures. By 2010, 37 states were disclosing online to some degree. Today the number is 46 states, plus the District of Columbia.
To be sure, some states don’t do this very well or don’t do it very broadly, but the needle is moving in the right direction. We will conduct a new study on that issue in the new few months.
*Clawbacks and money back guarantee language: Not many programs are left that don’t feature safeguards or protections or monitoring.
*Job quality standards: Wages, health care and full-time hours are also much more common than used to be.
*Geographic distribution of incentives: This is one reform that we have been pushing for a long time that has made modest progress.
This involves the issue of better aligning the geographic distribution of incentives so they don’t favor sprawl but instead favor cities and inner city revitalization. Very few states have moved on this front.
It is the left hand fighting the right hand story, where we keep finding the left hand called economic development incentives is fighting the right hand, which is called transportation and land use planning.
These silos continue to exist in parallel universes within state law and state practices.
So, where do we go from here? Even though the economy is rebounding and state and local economies are coming back, the fiscal efficiency argument is a bipartisan winner.
Everyone would agree we should be spending economic development dollars in ways that pay off the most effectively. Location efficiency, which ties into transit, sunshine [disclosure], clawbacks, and job quality standards — they all hit that sweet spot.
If we adhere to those principles we can spend less and get more.
And who is against that?
Greg LeRoy, executive director, Good Jobs First, can be contacted by emailing firstname.lastname@example.org or by calling 202-232-1616, ext. 211.
Interview conducted by Rachel Duran.
By Barry Pisano, manager of tax credits, ADP
Recently, opposition to economic development incentives has become more apparent, as evidenced by an editorial in The New York Times and a blog article written by Richard Florida. The opinions expressed in these pieces are that incentives represent a zero-sum game and are useless to state and local governments. In response to criticisms, this article outlines a pro-incentive opinion, demonstrating that these incentives may play a strong role in a company’s decision-making process and can be valuable to economic development.
Before responding to criticisms, it may be helpful to better understand these incentives.
State and local governments use economic development incentives to spur job creation and capital investment. These benefits can come in the form of cash grants, corporate income tax credits, sales tax exemptions, property tax abatements, training grants and utility reductions.
Generally, these incentives fall into the category of discretionary as opposed to statutory. To receive these incentives, companies must generally satisfy the material factor threshold, which necessitates demonstrating that without the incentives, the job creation and capital investment would not occur.
It could be said that economic development incentives represent corporate welfare. It could also be said that the material factor requirements lack substance because a company’s motivation to expand or relocate is driven by a myriad of factors other than the possible savings from an incentive offering. Such factors as cost of doing business, real estate availability, access to skilled labor or the personal preference of senior management could all play a role.
For opponents to economic development incentives, one school of thought is that if these factors shape a company’s final decision, economic development incentives are unnecessary, and the benefits and savings that may be realized as a result of the incentives essentially become ‘free money’ because a company is incentivized for doing something it was already planning to do.
Responding to these criticisms, the ‘pro-incentive’ opinion below highlights four key points.
1. Presumptive Thinking
In Richard Florida’s article, The Uselessness of Economic Development Incentives2, he labels state or local government’s incentive offers as useless rather than a genuine inducement of business and industry. This label, however, may be presumptuous because it assumes a company has made its decision before discussions with economic development officials have occurred; and that the company is not considering alternative real estate scenarios in another state or jurisdiction.
Similarly, the anti-incentive sentiment is rooted in the belief that even if a company is still assessing potential locations, the opportunity to procure incentives may be far down the list of priorities and unnecessary.
A more accurate assessment could be that companies have not always identified the final location for a project. The fact that they typically involve multiple parties in site selection, including in-house real estate departments or vendors, human resource departments, finance and tax departments and incentive consultants, supports this assertion. These groups are tasked with evaluating multiple states, if not regions of the country, to identify locations best aligned with a company’s business plan and objectives.
If a company had a pre-determined location, it would seem to be counterintuitive to engage so many different business units and incur expenses associated with retaining third-party vendors (i.e., real estate and consultants).
Moreover, often when a company compares multiple states or localities, there may be an equal amount of pros and cons. The availability or quality of economic development incentives may be a key differentiator.
2. Minimum Qualification Thresholds
Playing devil’s advocate and agreeing with the presumption that incentives do not play a material factor in a company’s decision-making process, there is still reason to refute the theory that these incentives are useless to state and local governments.
Specifically, advocacy for economic development incentives is strengthened by the minimum qualification thresholds, which are required for qualifying for many incentives.
While the argument may be that a company’s mind is already made up as to where to locate or expand operations, the question should then become whether or not qualifying for an incentive plays a material factor in determining how many jobs to create, or how much investment to make.
For example, the more lucrative incentive programs in Georgia (Quality Jobs Tax Credit), Texas (Enterprise Fund), and Utah (Economic Development Tax Increment Financing) require a minimum of 50 net new jobs. And, in New Jersey (BEIP Grant), Arizona (Quality Jobs Tax Credit) and Illinois (EDGE Tax Credit), the employment threshold is 25 jobs.
For companies expanding in metropolitan areas in Arizona, the Quality Jobs Tax Credit carries the added requirement of incurring a capital expense of at least $5 million.
And, Utah’s Economic Development Zone Tax Increment Financing does not explicitly reference an investment threshold, but eligibility is dependent upon a company’s making a ‘significant’ investment.
Similarly, eligibility for the incentives may be predicated on satisfying a wage threshold or creating a minimum net new payroll. In Oklahoma, a requisite to qualifying for the Quality Jobs Program is creating a net new payroll of at least $2.5 million.Texas’ Enterprise Fund requires that employers pay above the prevailing county wage with respect to new jobs.
When approaching economic development and government officials, a company may have decided to locate to that particular state. However, if a company is motivated to create additional jobs, increase entry-level wages or incur more significant investments to qualify for economic development incentives, there is often a tangible benefit for state and local governments — such as the opportunity to collect additional revenues from withholding, property and sales taxes. This opportunity may not come to fruition without an incentive offering.
3. Return on Investment
Many economic development officials across the country adhere to return-on-investment calculations and analyses when negotiating an incentive offer. The financial assistance made available for a particular project is often indicative of its potential for job creation and tax revenue generation.
The value of incentives, when measured against the anticipated incremental increase in taxes, which may be collected by the applicable state or local taxing authority, often demonstrates a positive return-on-investment. For example, in Texas, the governor’s office uses a detailed input-output calculation, demonstrating how the state can generate a positive return on its incentive offer. The corresponding return-on-investment determines the value of the Texas Enterprise Fund.
Similarly, the state of Utah quantifies the Economic Development Zone Tax Increment Financing based on a percentage of the state tax revenues to be generated from a company’s expansion or relocation.
Such calculations help state and local governments avoid situations where the value of the incentives exceeds the long-term benefits resulting from a company’s job creation or investment.
4. Public Disclosure
The claim that economic development incentives are useless or represent a zero-sum game may be further refuted by the fact that both state and local governments disclose the parameters surrounding an incentive offer.
Following the approval of an incentive award and subsequent execution of mandating documents, government officials generally coordinate press releases or similar public statements. These statements highlight a company’s anticipated job creation, corresponding wage rates, capital investment and terms of the incentive benefits (i.e., value and duration).
Public disclosure is an advertisement of sorts to business and industry. While incentives may not always be the primary differentiator in a site selection process, in some instances, they may be the material factor.
If companies are familiar with the incentive-friendly nature of certain states, those states are more likely to be on a company’s radar. If one incentive offer triggers additional job creation and investment opportunities in the future, it is likely factually incorrect to label such investing as being without value or useless to the state and locality.
In short, the backlash against economic development incentives may not be entirely justified. There are reasons to believe that when companies move forward with the site selection process, they often evaluate multiple real estate scenarios. If incentives are not the primary determinant, they may play a role in the selection among locations that are inherently equal.
Even when a company’s final decision is not motivated by incentives, the potential for these benefits may serve as an inducement to accelerate or augment job creation or capital investment schedules. The increased headcount and additional tax revenues will often provide more than a zero-sum game to states and localities.
Public disclosure and attention provided to incentive awards can help generate positive publicity for states and help serve as a reminder to business and industry that incentive awards offered to companies helps to fortify future recruitment and retention efforts.
Barry Pisano, manager of tax credits, ADP, can be reached by emailing email@example.com or by calling 609-819-8076.
1“As Companies Seek Tax Deals, Governments Pay High Price” http://www.nytimes.com/2012/12/02/us/how-local-taxpayers-bankroll-corporations.html?_r=0
2“The Uselessness of Economic Development Incentives,” Richard Florida http://www.theatlanticcities.com/jobs-and-economy/2012/12/uselessness-economic-development-incentives/4081/
3 Ga. Code Ann §48-7-40.17 (2010).
4 Texas Government Code §481.078 (2005).
5Utah Code Ann §63M-1-2401 to 2408; 59-7-614.2; 59-10-1107 (2008).
6 NJ Revised Statute §34:1B-124 et seq. (1996).
7 AZ Revised Statutes §43-1161, 43-1074 & 41-1525 (2011).
8 35 ILCS §10/5-5 to 5-45 & §5/211 (1999).
11 OK Code | §68-3604
- When selecting sites for new facilities, we do not let the incentives tail wag the decision dog — they become important once we have narrowed our search to our finalist sites.
- When states and local communities do a good job of identifying their strengths and weaknesses, they can create incentives that will attract industries and companies that will empower their communities.
- We haven’t seen any specific fallout as it relates to lining up incentive packages, though in California we no longer have redevelopment to use as a tool for tax increment financing.
*Gov. Jerry Brown dismantled that program as part of his budget process when he came into office.
- For the most part, modern day incentives are designed to be performance-based.
*For example, a property tax rebate is only provided to a company if it builds a new building and additional property tax is incurred to the community; if the company decides to back out of the deal before the building is constructed, no incremental property tax is collected and hence rebated to the company.