Tax Break Tug-of-War

9/25/2019

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Results Are Mixed, but States Continue to Lure Big Employers With Tax Incentives.

By Jackson Brainerd

When it comes to politics and policy, the economy is always a top priority. How to generate job growth and develop prosperous communities are perennial questions. And the policy options are vast. Changes to education, infrastructure, the environment, wages and work hours, the criminal justice system, pensions, health care, and tax policy all can affect economic development.

Despite the breadth of the economic development umbrella, however, the term itself is often associated exclusively with business tax incentives. Most state economic development offices are charged with recruiting or retaining businesses, and they rely on tax incentives to accomplish the goal. In their efforts to spur growth using these incentives, states and local governments forgo between $40 billion and $70 billion in revenue annually.

The incentives come in different forms: breaks or credits on property, sales or income taxes; issuance of tax-exempt industrial revenue bonds or low-cost loans; sale of underpriced land; customized workforce training; or assistance with regulations. Some are available to all businesses; many are not.

Often, states gear tax credits or other incentives specifically toward large multinational corporations. Indiana, for example, provided a $7 million incentive package to the Carrier Corp. in 2017 to keep jobs in the state, Virginia recently offered Amazon a $750 million package to establish a new headquarters there, and Wisconsin offered Foxconn Technology Group a $4.8 billion package in 2018 to build a new manufacturing plant.

The long-standing debate on targeted incentives is whether they actually work. Are they effective economic development tools, or do they primarily benefit large, individual companies? Despite mixed evidence on their success, tax incentives aren’t going away anytime soon.

Effective Tool, or Waste of Revenue?

Proponents believe that coaxing large, successful businesses to a region can create jobs and generate new investments, creating new wealth for entire communities and generating new tax revenue for state and local governments. For businesses choosing between cities that offer similar markets, supplies and labor, lowering the cost of doing business by reducing tax burdens could be a deciding factor.

The results of landing a large employer can be immediately tangible. Mercedes-Benz had a significant impact on Tuscaloosa, Ala., when it relocated in the early 1990s after being granted $250 million in tax incentives. Since 1999, German companies have invested nearly $9 billion in Alabama operations, creating 15,500 direct jobs,” Alabama Secretary of Commerce Greg Canfield told the Tuscaloosa News in 2018. He believes the company’s presence attracted other auto manufacturers and raised the state’s global investment profile.

“Taxes matter, but not nearly as much as politicians think,” says nationally known state and local tax policy expert David Brunori, research professor of public policy at The George Washington University. Taxes are a small component of site selection decisions as they are only about 2% of the cost of doing business, Brunori says. Surveys of business leaders suggest that location of suppliers and markets, availability of labor, status of infrastructure and quality of life, among other factors, are more important. And, every dollar lost to incentives is a dollar not spent on improving those criteria, opponents argue.

Even in cases when business locations are influenced by tax incentives and a specific region benefits, this necessarily comes at the expense of another region. For the country as a whole, the result can be a net loss, unless a state is luring a foreign business, of course.

Opponents also argue that tax incentives create an uneven playing field. Alleviating taxes for a few businesses leaves other companies and taxpayers with the burden of making up the difference. This picking and choosing of who pays and who doesn’t invites scrutiny. A recent audit of the New Jersey Economic Development Authority’s tax incentive programs found inadequate monitoring and oversight and inaccurate job creation claims.

And the Research Says

The existing research is not particularly kind to tax incentives. A 2019 North Carolina University study determined that “financial incentives negatively impact the overall fiscal health of the states offering the incentives.” The effects of job-creation incentives, specifically, were found to be a wash, having no effect on state fiscal health.

In a review of 26 peer reviewed academic studies that assessed whether targeted business tax incentives improved the broader economy. Researchers with the Mercatus Center at George Mason University, a free-market-oriented think tank, found only one study showing positive effects. Four found negative effects, 13 found no statistically measurable effects, and eight found both positive and negative effects, or distinct winners and losers.

Another recent study, by the W.E. Upjohn Institute for Employment Research, an independent research organization, found that incentives “do not have a large correlation with a state’s current or past unemployment or income levels, or with future economic growth.” A follow-up report concluded that in about 2% of cases the tax incentive appears to have made the difference—but the same decision would have been made without the incentive up to 98% percent of the time.

Every State Competes

For a long time, no one really knew whether the billions of dollars being offered in tax incentives were working as intended. In 2012, The Pew Charitable Trusts wrote that, “No state regularly and rigorously tests whether those [subsidy] investments are working” and that none “consider this information when deciding whether to use them, how much to spend and who should get them.” Since then, states have increased oversight of tax incentives, and at least 35 states do so today.

“Tax incentives given to one group of taxpayers are paid for by other taxpayers,” says Indiana Senator Eric Koch (R) who has done what in this area?. “It’s therefore important that we ensure that tax incentives are evaluated to ensure that they are achieving the desired results in a cost-effective manner.”

Improving evaluation processes allows state officials to better define the goals of incentives and determine which ones result in economic benefits for a community or broader region, rather than just specific companies.

The Upjohn Institute research suggests that incentives can be improved by targeting firms with high job multipliers and higher wages; replacing incentives with customized training and regulatory assistance; and creating jobs for the local unemployed population.

In addition to improved oversight, the fiscal risks posed by tax incentives can be mitigated in other ways. Setting caps, whether by program or by company, can ensure costs do not unexpectedly balloon during a bidding war. States can also require companies to meet job or investment thresholds before receiving tax incentives, or they can withhold benefits if targets aren’t met.

Given the problems incentives pose in terms of fairness and effectiveness, should states bother with them at all? Is playing the incentive game an unfortunate but unavoidable part of policymaking? As former Michigan Governor Jennifer Granholm (D) said, “Every state is competing, and we cannot lay down our arms.”

But it’s not necessarily an inevitability. The evidence suggests that unilateral disarmament would not, in fact, have a negative economic impact. But declining to pursue successful companies while other states actively coax them with tax incentives could make for challenging political optics.

Are Incentives Even Legal?

Although business tax incentives have become ubiquitous, there are some scholars who still question whether they are constitutional. The U.S. Constitution’s commerce clause implicitly prohibits states from hindering interstate commerce (it gives regulatory power to Congress), and the U.S. Supreme Court has found certain tax incentives to be discriminatory, though it hasn’t clearly defined which ones aren’t.

Others have speculated that allowing a select set of big corporations to operate without paying taxes could be viewed as a violation of the equal protection clause of the 14th Amendment. Neither argument appears likely to gain ground in the near term.

One obvious way to end the bidding wars would be an outright federal ban on interstate tax incentives. Of course, preempting state sovereignty would undoubtedly result in a substantial backlash. The corporate subsidies watchdog group Good Jobs First has recommended a “carrot” approach used in the past: Withhold a certain amount of federal appropriations until a state signs a pledge not to pirate jobs from other states. That’s what the federal government did in 1984 with a small portion of highway funding until states increased their legal drinking age to 21.

Congress, however, has not shown a similar desire to get involved in this issue.

Why Can’t the States Agree?

While incentive relief through the courts or the federal government appears unlikely in the near future, another option would be for all states to simply agree not to offer any company a tax incentive to relocate from another state. The European Union reduced the use of tax incentives by regulating the business subsidies that member states can dole out.

“Member states can only give individual businesses a subsidy under certain conditions—for example, if the subsidy benefits a region that is economically depressed or if it serves an environmental purpose,” according the Council on Foreign Relations. The rules require advance notice be given to the European Commission of the enactment of any new subsidy program. The commission, which serves as the EU’s executive branch, can disallow deals it deems overly distortive to trade.

Compacts among U.S. states to curb the use of business subsidies, however, have not been very successful. In 1991, Connecticut, New Jersey and New York signed a cooperation treaty calling for an end to advertising aimed at luring businesses from one state to another. New Jersey violated the terms just a few months in and the deal fell apart.

In 2001, some Illinois lawmakers attempted to call a tax incentives truce after their winning battle over Boeing cost them up to $41 million in tax and other incentives over 20 years.

This year, Missouri and Kansas broke new ground by signing a truce to end a long-running incentive battle over Kansas City business activity. According to the Hall Family Foundation, a private philanthropic organization in Kansas City, the combined $335 million spent by the states since 2010 has resulted in a net gain of just 1,200 jobs for Kansas.

Missouri passed legislation to curb offers of incentives to businesses in neighboring Kansas counties, and Kansas Governor Laura Kelly (D) signed a matching executive order. Of course, if localities in the states fail to abide by the rules, the deal could easily fall apart.

Elsewhere, Arizona, Illinois, New York and West Virginia lawmakers have introduced legislation to form a multistate compact, which may be joined by any other state. Illinois Senator and former NCSL President Toi Hutchinson says the bill she introduced was intended to generate discussion after years of frustration with interstate poaching and concern that incentives weren’t providing adequate return on investment.

“What we’ve been doing is not bolstering state economies,” she says. “What would happen if we could think differently?”

States are locked in a battle with one another for the latest corporate relocation or expansion, Hutchinson argues. They would benefit from a more cooperative, regionalized approach to economic development because so much business activity takes place across state lines.

“You can make a case,” she says, “that the stronger surrounding states are, the stronger we are.”  

Jackson Brainerd is a policy specialist in NCSL’s Fiscal Affairs Program.

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