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The Challenge of Tax Incentives

The views expressed are those of the author and do not necessarily reflect the views of ASPA as an organization.

By Ben Tafoya
February 23, 2016

Economic development is one of the terms in public administration that has different meanings to different actors under different conditions. For some, it is a policy area that leads to increased jobs or higher incomes for area residents. For others, it refers to the challenge of expanding a tax base to help generate revenues that fund expanded community services. Other uses of the concept include redeveloping underutilized property to remove blight. Finally, some communities are challenged with a lack of retail establishments and consumer services that leaders try to enhance to engender a greater sense of community.

Construction CraneEach of these concepts requires a specific set of actions by state and local government leaders to further their specific goals. In the U.S. system, with the absence of federal planning, the process of economic development, however it is defined, is largely left to state and local government. As a result, we have a dizzying array of incentives to promote one or another of the goals. Broadly speaking there are two kinds of opportunities for tax reduction, “as of right” incentives and selective incentives. Examples of “as of right” include investment tax credits, which reward firms that make capital investment in plant and equipment. For example, Massachusetts gives a corporate tax reduction for firms in manufacturing and other encouraged industries. Selective credits include those like The Indiana EDGE program, which “reward” firms for hiring new workers as a result of meeting specific criteria reviewed by the state.

Certainly, part of the conversation relates to the effectiveness of the various programs. Given that the nation is covered by these programs, how do they differentiate among the states in such a way that they actually make a difference? The challenge of the selective programs is how you prove the counter-factual. Would these projects go forward in the targeted state and locality in the absence of the incentive? According to research compiled by the Tax Foundation, virtually every state with a corporate income tax has some combination of job, investment or research incentives. The incentives give subsidies for capital investment, hiring, payroll and sales tax rebates and infrastructure improvements.

A new study from the business subsidy-tracking group, Good Jobs First, looked at 4,200 awards in 14 states. They found that 80 percent to 96 percent of the dollar value of incentives went to large businesses. The study, “Shortchanging Small Business,” recommends limiting the awards to only smaller firms (less than 101 employees). In an unpublished paper by this author, an examination of 1,200 instances of selective incentives over a 15-year period in Massachusetts found the communities that most frequently use the incentives are below the median in income and wealth. Several hundred of the incentives went to firms that invested a million dollars or less in plant and equipment which raises the question of effectiveness given what little a million dollars can buy in much of the state. From the perspective of policy implementation and analysis, giving incentives to big and smaller firms could be wrong as the direction of the programs should depend on the four goals outlined in the opening paragraphs.

To some extent, Massachusetts recognized this in 2010 when it rolled out new rules for incentive programs giving firms more options as to how to qualify. While the state has cut down on use of the incentives for retail establishments, it does allow firms to apply for incentives based on adding employees rather than capital investment. The state government is also increasing efforts to make firms prove the employment activity results in additional jobs into the Commonwealth from outside rather than movement from one city to another. On the other hand, it does allow firms to qualify based on maintaining manufacturing operations in a poorer community. The state has also become more aggressive in rolling back incentives from firms that do not meet employment goals. This illustrates the point of critics of the tax incentive programs that (for example) property taxes are not a big enough concern to change the behavior of a firm.

The place based incentives and corporate tax abatements provide easy to recognize evidence that public officials are trying to generate economic activity in their communities. However, many of these programs deprive states and communities of necessary resources to improve the quality of life of its residents. Alternative policies exist in terms of expedited permitting and cooperative programs for workforce development which might give communities a more substantial advantage in the search for good jobs and incomes. Expedited permitting might save firms money in design and construction. While a more educated and skilled workforce will save firms money in hiring and training. The literature on tax incentives is full of the debate among economists and policy analysts as to the effectiveness of the programs. Many of the communities utilizing these programs have multiple needs for “economic development.” particularly jobs, incomes and higher order property redevelopment. Aligning the goals of the community more closely with public action can improve the outcomes.


Author: Dr. Ben Tafoya is the undergraduate program director in the School of Public Policy and Administration at Walden University. He served as a local elected official in Massachusetts for nine years and is still active in governmental affairs. Ben has his Ph.D. in Law and Policy from Northeastern University and a B.A. in Economics from Georgetown University. He can be reached at [email protected].

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One Response to The Challenge of Tax Incentives

  1. Norm Sims Reply

    February 24, 2016 at 10:04 am

    It is unfortunate that the author didn’t look beyond the one study from Good Jobs First and the singular case of Mass., particularly in making the blanket comment that business retention, expansion and attraction programs “deprive states and communities of necessary resources to improve quality of life”. The question of the effectiveness of both state and local financial incentive programs has been studied for many years. I am aware of that since the Council of State Governments did a review of such programs in the 1980s when I was directing its research and analysis efforts.

    And since many of the programs provide assistance to the companies to train new employees, rather than to provide per employee tax abatement and credits, the benefits may actually accrue as much — if not more — to the employees as to their employers. The same is true, for example, of financial assistance to a company for necessary infrastructure, such as roads, sewer and water, as these all represent improvements in fixed assets that most often spill over as larger community benefits.

    As to Good Jobs First’s findings that the vast majority of assistance goes to large enterprises, I am not surprised and other studies have similar findings. This is often driven by state and local requirements that directly tie incentives not just to the degree of job creation and retention promised by the enterprise, but are also skewed toward manufacturing. This is somewhat logical in that manufacturing-based projects tend to be those adding the greatest proportion of value-added jobs.

    Simply saying that the rules should be changed so that only smaller businesses would have access to the programs, overlooks the fact that smaller businesses seldom have the resources or patience to deal with the red-tape government assistance programs often require (particularly small technology and start-up firms), are often lower-pay retail or service industry businesses, and represent high business “churn” and turnover which makes elected officials wary of the initial investment. Also, state and local business assistance programs — particularly those using federal funds from programs such as CDBG — may require match that smaller businesses can’t afford, or establish minimum employment requirements (such as 51% or more of the new jobs going to low to moderate income people) that sometimes scare smaller businesses away or lead them to believe they cannot find the initial skill-sets they need.

    As someone who has studied this issue and been responsible for economic development for a state as well as for a mid-size city and a larger metro area, it has always been my position that: better information is needed as to how incentives really perform (rather than just who gets them); the best performance measure is the degree to which the program leverages new private sector investment and capital formation (rather than just the number of jobs); performance measures supported by “clawback” provisions should be a required component of every assistance program; and the programs should be tiered in assistance level so that they take into account different project and community sizes. What constitutes a “big” business in a community of 1 million is far different from that in a community of 10,000.

    Granted that both state and local governments want to improve quality of life and need the resources to do so, but we need to keep in mind that these resources do not grow on the state’s or municipality’s money tree; even in Mass. Wealth is generated by growing, prosperous businesses, and as long as it is, governments are going to be looking for ways to entice more of them to stay, expand and move into their bounds.

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