Consultant’s Corner: Incentives For Economic Development – A Good Or Bad Idea?
By Mark Williams
From the January/February 2015 issue
The wisdom of providing aggressive public sector financial incentives to attract economic development projects remains a hotly contested topic. Recent big projects, including those by Tesla and Boeing—and the aggressive financial incentive packages attached to these projects—continue to fuel vigorous debate on whether to use site location incentives to attract large projects.
Some in the public sector, certain media outlets, and political factions characterize incentives for industrial and headquarters locations as “giveaways” and “corporate welfare,” calling for a “cease fire” among states and local governments and asking these entities to stop the escalating value of incentives. They paint a picture where providing incentives is squandering precious financial public resources for the purpose of feeding corporate greed.
Others, in both the public and private sector, believe incentives are an essential tool in attracting investments and jobs in an increasingly competitive global economy. They contend that the payback on public investments in incentives is profoundly positive and note that industrial operations typically cost the public sector very little while paying taxes at rates much higher than typical households.
So where does the truth lie about incentives: are they good or bad?
Whether one agrees with the use of site location incentives or not, they are increasingly being used to lure significant capital investments and related jobs in both industrial and headquarters projects. Over time, the value of various inducements used to attract economic development projects is trending upward. For example, the State of Nevada reportedly offered Tesla a $1.3-billion incentive package to locate its planned $5-billion lithium-ion battery factory near Reno, creating about 6,500 direct jobs. Also, following the 2008-2009 recession, the ratio of the value of incentives to jobs created has increased significantly as the public sector aggressively pursues new job creation to reduce unemployment and jump start local economies.
It is difficult to fully understand from press reports the exact components of incentive packages offered to any project and the true value of these incentives to the company receiving the offer. Further, the true positive economic impact of projects cannot be verified until well after they are placed in service. For larger projects, particularly in the automotive and aeronautics industries, economists have attempted to model the value of economic impacts relative to investment made, jobs created, and incentives offered.
THE PUBLIC SECTOR PERSPECTIVE
Perhaps the best way for the public sector to look at incentives is the way any of us would look at personal investment opportunities we face in our private lives. On one end of the spectrum, some investments pay profoundly positive risk adjusted returns while others are simply “dumb deals” typically resulting from decisions based on incomplete or inaccurate information.
Governors, secretaries of Commerce, county officials, and mayors are blessed in good economic times with the opportunities to make either profoundly positive incentive investment decisions or decisions that generate large net losses for the public sector. Thus, making incentive investment decisions is a weighty business for public officials and, in the best cases, is a result of economic impact modeling that verifies appropriate incentive levels related to anticipated economic impacts. These decisions often require years to confirm success or failure. Recommendations for the public sector to increase the probability of success when considering site location incentive offers include:
- Focus use of incentives on competitive projects only when incentives positively influence site location decision, i.e.—if a decision has already been made to locate in a community it makes no sense for that community to negotiate against itself by offering greater incentives.
- Understand the assets/liabilities of competing locations related to incentives, other site characteristics and adjust incentive offers to mitigate weaknesses.
- Study and understand the financial strength of the entities requesting incentives to verify the likelihood projects will be fully implemented.
- Understand the costs of incentives to the public sector and the likely positive economic impact from successful site locations. A variety of economic impact models are useful in projecting direct and indirect impacts of site location projects utilizing variables including the type of industry and profiles of job creation and investment.
- Offer performance-based incentives when possible to ensure that companies are rewarded when they actually create jobs and investment as projected.
- In cases where incentives must be provided before verification of that job and investment thresholds have been met (i.e. for site preparation and utility extensions), construct agreements with “claw back” provisions to increase the likelihood the community will receive repayment if the project is not implemented as planned.
THE PRIVATE SECTOR PERSPECTIVE
The private sector typically has two primary motivations in site selection and incentive negotiation, 1) obtaining the lowest short and long-term cost structure at sites with optimum functionality, and 2) maintaining and enhancing goodwill in the cities where they locate.
Key mistakes often made by corporations undertaking site selection projects include not setting up a competitive situation for incentive negotiations and not understanding the true, usable value of incentives that are being offered. The following are recommendations for corporations undertaking the site selection process:
- Understand the likely positive public economic impact of a project and negotiate incentives accordingly.
- Verify the usable value of tax incentives and other incentives; some tax credits have little or no value based on individual tax situations.
- Conduct Net Present Value or other financial analysis to compare the short and long-term expenses/operating costs of sites being analyzed and the risk-adjusted value of incentives being offered.
- Don’t let incentives steer a project to a site that has operational challenges. Operational losses from the wrong location last forever.
- Develop binding agreements to ensure incentives are delivered at the value and timing they are promised.
Incentives play an increasingly important role in site selection decisions and their increasing value has caused many to question whether incentives are good public policy while others believe that incentives are a critical tool for competing for jobs and investment in the global site location marketplace.
The fact of the matter is that incentives can be both good or bad for both the public and private sector. For the public sector, incentives are “good” when the public makes informed decisions to offer incentives based on anticipated net positive economic impacts. Conversely, incentives are bad when uniformed decisions lead to expenditures that result in net negative economic impact for the public.
Similarly, incentives are “good” for the private sector when they drive investment to sites that have the highest operational and cost efficiencies and “bad” when they encourage site selections at locations that jeopardize cost competitiveness. Thus, both the public and private sector must utilize great care when offering or accepting incentives.
Williams is president of Strategy Development Group, Inc.