Incentives are designed to encourage businesses to produce economic activity they would not have otherwise, "but for" the incentive provided by the state. Almost always, however, they at least partially reward businesses for what they would have done anyway. With that in mind, high-quality evaluations estimate the amount of incentivized activity attributable to the incentive.
Economic activity created by incentivized businesses can come at the expense of other businesses in the state. For example, if an incentive helps a business expand, its competitors could be worse off as a result. To take into account this displacement, evaluations have measured the net effect of incentives on the state economy (rather than merely focusing on the results for the companies that received incentives).
Many evaluations use models such as a REMI (Regional Economic Models, Inc.) or IMPLAN to measure the economic impact of incentives. These models are based on a series of equations that represent economic relationships. They can be used to measure how one change in the economy, such as the introduction of a tax incentive, affects other areas of the economy.
In many states, the costs of incentives have increased quickly and unexpectedly, causing budget challenges. Evaluations have described the causes of these cost increases or have analyzed whether adequate protections are in place to avoid them.
For most incentives, a state agency or agencies are responsible for operating the program. Depending on the specifics of the program, these administering agencies may be charged with advertising the availability of the incentives, determining which companies are eligible, and monitoring the performance of companies that benefit. Evaluations often study whether administering agencies are performing these tasks efficiently and effectively and identify potential improvements.
To evaluate incentives, state officials often gather data from a variety of sources including revenue departments, workforce agencies, and businesses themselves. Frequently, evaluations describe challenges related to data quality and data access or solutions to these challenges.
Incentive programs differ in many ways, including which companies are eligible, how the size of the benefits are determined, and whether they take the form of tax breaks, grants, or loans. Even subtle differences in a program’s design can have a large impact on its return on investment. For that reason, many evaluations analyze whether incentives have been well-designed to achieve their intended goals and offer recommendations for improving their effectiveness.
When incentivized companies produce economic activity in a state, some of the benefits will likely flow to others states. For example, if an incentive prompts a manufacturer to locate in a state, but it buys supplies from a business in another state, the supplier’s state receives those indirect benefits. High-quality evaluations estimate how much leakage is taking place to help measure the in-state economic impact.
Many evaluations discuss academic literature or other economic research. These literature reviews are often helpful for describing the history, rationale, and effectiveness of particular types of incentives (e.g. film tax credits). Some evaluations have also used academic literature on the responsiveness of businesses to reductions in their taxes as a way to gauge what happened because of the incentive and what would have happened anyway.
The direct economic activity created by incentivized businesses may also produce additional benefits. For example, if a new manufacturer purchases supplies from other in-state businesses, those businesses may also grow—multiplying the impact. Economic researchers have developed estimates for these multipliers, which vary based on a variety of factors such as the industry of the company directly receiving incentives. High-quality evaluations are transparent about the multipliers they use and explain the rationale behind them.
When states dedicate revenue to business incentives, they lose the ability to spend that revenue on other priorities, such as education, transportation, or broad-based tax cuts. Opportunity costs represent the benefits of those alternatives and provide an important benchmark to compare with the outcomes of incentives to determine their effectiveness.
Regression models estimate the relationship between a single independent variable and one or more dependent variables. Evaluations sometimes use regression analysis to estimate the effects of incentives.