Taxes and Incentives - Factor Into the Site Selection Equation
Corporate tax rate, state and local incentives, and tax exemptions were among the top-10 ranked site selection factors by the respondents to Area Development's 2007 Corporate Survey. Let's find out why.
Rita Williams, Incentis Group (Feb/Mar 08)

Corporations use various tools in selecting locations for capital investment and consider numerous factors in determining the optimal sites for such investment. These factors will vary from industry to industry, but several factors are key for most companies; these include labor availability, energy availability and costs, and corporate tax burden.

Increasingly, state and local incentive programs are added to this list of top factors because of the impact incentives have upon the other factors. For example, employee-training grants have an impact upon labor costs; electric and natural gas riders upon energy costs; tax exemptions and credits upon the tax burden, etc. As advisors to companies conducting location studies (and trying to secure state and local incentives), we can provide some insight into the importance of corporate tax burden and state and local incentives upon the site selection process.

Disparity Among Locations
Enhanced transportation modes and the Internet have tremendously changed the landscape for commerce in the United States and, indeed, globally. Certain U.S.-based companies that once depended upon close proximity to markets - such as manufacturers and providers of information services - can now serve customers from locations remote from their customers, where they can gain advantages from lower labor, energy, and tax costs. Yet other U.S. businesses - such as distributors, service companies, and retailers - still rely heavily upon proximity to markets. Although location factors such as highway access and distance to customers play a greater role in site selection for many of these firms, the importance of the other key factors of labor availability, energy availability, and tax burden become even more critical since these companies cannot necessarily serve customers from lower cost, remote locations.

Corporate Survey 2007
Combined Ratings* of 2007 Factors
Site Selection Factors                   2007
Ranking
1. Highway accessibility 96.9
2. Labor costs 92.3
3. Energy availability and costs 89.0
4. Availability of skilled labor 88.7
5. Occupancy or construction costs 88.2
6. Available land 85.4
7. Corporate tax rate 83.8
8. State and local incentives 83.4
9. Environmental regulations 83.2
10. Tax Exemptions 82.8
*All figures are percentages and are the total of "very important" and "important" ratings of the Area Development Corporate Survey and are rounded to the nearest tenth of a percent.
On the cost side of location analysis, operating costs such as labor and energy have begun to align more closely among regions across the United States; one of the remaining areas where there is greater disparity of costs is tax. The primary state and local corporate taxes - including income/franchise tax, sales and use tax, and property tax - vary widely among states and municipalities. Such variations exist both in tax rates and in how the taxes are applied; i.e., differences are found among states in the types of taxes that are levied on corporations. For instance, while most states have a corporate income/franchise tax, many states have eliminated personal property taxes, making these states much more competitive in attracting production capital.

Increased Importance of Tax Burden
For companies whose location options are restricted to the continental United States, state and local tax burden plays an important role in site selection. There are several primary reasons for the importance of tax burden in corporate location decision-making, as follows:

1. The level of business taxes generated in a state is one factor to consider when determining the state's level of competitiveness as compared to the level of economic activity that is being taxed. In general, businesses usually base their location decision primarily on the origin-based taxes, such as property tax and sales tax, as opposed to destination-based taxes. For example, there are a few states - including Texas, Indiana, and Arizona - that generate the majority of business-related taxes from sales and property taxes. These states generate a significant portion of their taxes based on business capital located in the state.

2. State and local taxes, as a portion of operating costs, have increased over the past 10 years. In general, income taxes have increased three times faster than all state taxes. This is primarily due to the fact that states have become more aggressive in raising revenue from the business sector. When the economy is in a recession, the amount of tax revenue generation is greatly reduced. Many states experience revenue loss in relation to growing costs and incur deficits, which results in the need for additional sources of revenue. These sources often include changes in business tax structures and alternative taxing methods.

For example, the states of Ohio and Texas have recently undergone tax restructuring that shifts corporate tax burden away from production-based companies to consumer-based companies. Ohio tax restructuring replaced the state corporate income tax with a corporate activity tax or a modified gross receipts tax that moved the basis for corporate taxes from productive assets to out-of-state sales. Texas has also expanded its definition of a taxable corporation doing business within the state, and now the tax is calculated on the basis of gross revenues generated from the privilege of doing business within the state. Additionally, Ohio has phased out its personal property tax, as a means of shifting tax away from productive assets. This has relieved the tax burden on manufacturers and is equally valuable to companies that export goods from Ohio - either to other states or globally.

3. States are becoming more sophisticated about interpreting and drafting new tax law, which may result in incremental tax liabilities for some industries as opposed to others. For example, Michigan has revamped the Single Business Tax, which was once a gross receipts tax, to a modified gross receipts tax and income tax - the Michigan Business Tax. Although this change will affect business in different ways, the state's overall revenue collection will impact the state favorably.

4. With businesses downsizing in various sectors, states have also looked for other ways to increase revenue. Some states have increased the definition of "taxpayer" to include entities that were not previously subject to tax. States have also modified their tax bases by disallowing exemptions and deductions that were once allowed as part of the overall tax structure.


The Impact of Tax Incentives
The rising impact of taxes upon companies has increased the importance of tax incentives in the site selection process. Tax incentives are used both by public authorities and companies, albeit to accomplish different objectives. The former use them to attract operations, while the latter use them in choosing sites for relocation and expansion.

Tax incentives serve as a way to equalize the tax burden among states and municipalities. However, property tax abatement in one community may be no more valuable than no abatement in a second community due to higher property tax rates in the first locality. Nevertheless, the tax abatement may be necessary to make the first location competitive in attracting investment. For example, communities in states such as Michigan that levy personal property tax on manufacturing assets need to offer personal property tax abatement to remain competitive with communities in states with no personal property tax.

Corporate Survey 2007
Combined Ratings* of 2007 Factors
Site Selection Factors                   2007
Ranking
1. Highway accessibility 96.9
2. Labor costs 92.3
3. Energy availability and costs 89.0
4. Availability of skilled labor 88.7
5. Occupancy or construction costs 88.2
6. Available land 85.4
7. Corporate tax rate 83.8
8. State and local incentives 83.4
9. Environmental regulations 83.2
10. Tax Exemptions 82.8
*All figures are percentages and are the total of "very important" and "important" ratings of the Area Development Corporate Survey and are rounded to the nearest tenth of a percent.
Tax incentives are also looked at as a means to reduce the long-term impact of taxes upon operating costs. Effective location analysis models estimate and evaluate key operating costs such as labor, transportation, energy, and taxes over the long term (typically between 10 and 20 years). Many tax incentives provide benefits for 10 years or longer, including income tax credits based upon job creation, property tax exemptions and refunds, and employee withholdings refunds. Even in cases of nonrefundable tax credits, where a company may not have immediate tax liability to apply the credits against, such benefits may be carried forward for future use over 10 or more years.

In addition, taxes generated by new or expanded operations may be used as a method to finance the start-up costs of the operations. As an example, many states use a tool known as tax increment financing to support certain costs incurred by companies in establishing or expanding operations within their jurisdictions. The incremental taxes generated by the operations over an extended period (typically 20 or more years) are used to service bonds - the proceeds of which are used for the benefit of the project. These taxes vary from state to state, but often include property taxes, sales taxes, and special assessments. In some cases, future incremental taxes generated by unrelated operations are used to support the costs of a single operation.

A Determining Factor
Each of these objectives is key to companies when determining the optimal location for new investment. Whether the impact of incentives is short term in offsetting the up-front costs of an investment or longer term in reducing operating costs, the effects of inducements can have a significant impact upon the competitiveness of operations at alternative sites. We have seen numerous occasions where a company's initial preferable location for investment was upended by the impact of incentives upon start-up and operational costs. In some cases, the impact has been significant enough to reverse decisions that were far along in the corporate approval process.

Incentives not only influence decisions regarding alternative locations for investment, but may also be the determining factor as to whether an investment with a single location option goes forward. We have seen instances in which the return on investment required by an approving corporate board has been substantially influenced by incentives. In other words, the shorter-term return on the investment does not allow management to justify the investment without the financial benefit of incentives.

State and local taxes and incentives will continue to be a key factor in location decision-making. Taxes will likely grow as a component of operating costs, while businesses will view incentives as a viable means to reduce these costs and increase return on investment. For states and communities, tax structures and tax incentives will both be scrutinized to determine the fiscal and economic impacts upon their economies and upon the competitiveness of these jurisdictions in attracting new investment.

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