Bearing of the Green

A new study reignites the never-ending debate on the value of economic development incentives.

On St. Paddy’s Day, it’s not unusual to run into a leprechaun offering a pot of gold. Every day in economic development, somewhere a location is serving up a pot of golden incentives to seal the deal for a major new project.

economic development incentivesThis week, a new study on the value of state and local incentives for economic development threw another log on the long-simmering debate about the value of these perks, which usually are delivered in the form of long-term tax credits. The data-driven study was produced by Timothy J. Bartik of the W.E. Upjohn Institute for Employment Research. Bartik meticulously compiled data on industries and incentives across the country over a 26-year period.

Bartik estimates, from 1990 to 2015, marginal business taxes and business incentives for 47 cities in 33 states for 45 industries. The 33 states compose 92 percent of U.S. GDP, and the 45 industries compose 91 percent of U.S. labor compensation. The database also describes how business incentives vary over the term of a new business investment (from year 1 to year 20), and it breaks down incentives into different types, including JCTCs, property tax abatements, investment tax credits (ITCs), research and development (R&D) tax credits, and customized job training.

According to Bartik, his methodology enables descriptive analysis that can include an examination of time trends in different types of incentives, and an analysis of how incentives vary with a state’s economic prosperity or with an industry’s wage rates. “With more precise knowledge of how incentives vary with states, industries, and time, the database also will permit better estimates of incentive effects,” he states in the overview of the study.

Here are some of his key conclusions:

  • Business incentives are large. For “export-base” industries (industries that sell their goods and services outside the local economy), incentives for new or expanding businesses in 2015 had a present value that averaged 1.42 percent of business value-added, about 30 percent of average state and local business taxes. This incentive percentage leads to a projection that, for the entire nation, state and local business incentives had an annual cost in 2015 of $45 billion.
  • Business incentives are insufficiently targeted in many states, although targeting is better in some states and has improved somewhat over time. Among export-base industries, incentives today for the average state do not vary as much as they should with industry characteristics that predict greater local benefits, such as industry wages, employment, and R&D. For example, for each 10 percent increase in an industry’s wages, average predicted incentives increase by only 3 percent. In some states a 10 percent increase in wages increases incentives by over 7 percent. In addition, back in 1990, a 10 percent increase in industry wages was only associated with an incentive increase of 1 percent.
  • Business incentives vary greatly by state. Even among adjacent states, business incentives often vary by a factor of 2- or 3-to-1. In many cases, states have higher incentives than nearby states, even though economic conditions are no worse and gross business taxes are similar or lower. A state’s political culture and past practices seem to dictate incentives more than state economic and fiscal conditions.
  • Business incentives have more than tripled since 1990. However, the average national rate of increase has slowed since 2000, and in recent years some states have even subjected incentives to cutbacks.
  • On average in the nation, business incentives are concentrated more in the first years of a business investment, but are still large even after 5 or 10 years of an investment. Given the high discount rates businesses are likely to apply to incentives, longer-term incentives are less effective per dollar than shorter-term incentives in altering business decisions. States vary widely in the degree to which incentives are up front. On average in the nation, up-front incentives have increased over time.
  • Averaged over all states in the database, the biggest type of incentive is JCTCs, followed by property tax abatements. Together, these two types of incentives in 2015 made up over 70 percent of total incentive costs. Since 1990, the incentive type with the biggest increase has been JCTCs. Increased JCTCs make up two-thirds of the 1990–2015 increase in incentive costs.
  • Incentive costs can be significantly reduced by a wide variety of reforms. In addition to eliminating or limiting certain incentive types, simulations using the database show that incentive costs can be significantly reduced by restricting incentive “refundability,” that is, restricting the ability of businesses to receive incentives even if they have no state corporate income tax liability. Incentive costs can also be significantly lowered by reducing the term of incentives, that is, by restricting the incentives to the first few years of an investment. More modest effects on net business taxes are caused by changes in the rules for how business income is apportioned among states. However, changes in business apportionment rules have the potential to increase long-run business tax revenue but at a lower present value cost to businesses.
  • Preliminary work suggests that a state’s incentives are not highly correlated with a state’s fortunes. Incentives do not have a large correlation with a state’s current or past unemployment or income levels, or with future economic growth. However, this preliminary work does not include many other control variables, which might alter results.

To read the full W.E. Upjohn study, visit the the Upjohn Institute website.

Predictably, some high-profile economic development commentators have used Bartik’s study to condemn the use of tax credits as economic development incentives. For example, Richard Florida, the outspoken proponent of “the creative class,” penned a CityLab column in The Atlantic under the headline: Handing Out Tax Credits to Businesses is Worse Than Useless.

Not so fast, Mr. Sunshine State. There’s a lot to chew on in Mr. Bartik’s data, and many of the reforms he has suggested already are being put into place in several states and metros. We think this entry into the incentives debate deserves careful consideration before endorsing or rejecting its conclusions. So we’ll reserve our comments until we can fully digest the findings by washing them down with several pints of Guinness.

Happy St. Paddy’s Day everyone!