Jonathan L. Sangster, Senior Managing Director, CB Richard Ellis (Feb/Mar 10)
Elected officials, economic development professionals, and corporate decision-makers have long debated the merits and value that economic incentives play in the strategic location decision process. Most agree that attracting new business provides a positive economic impact driven by new job creation, quality wages/payroll creation, and capital investment.
As a result, states and communities have designed their statutory and discretionary incentive programs to support these drivers. Historically, the success stories have outnumbered the failures.especially in economic conditions when growth is abundant, and job creation and investment is the norm, resulting in strong state and local tax revenue positions.
But what happens when economic conditions deteriorate, resulting in job losses, high unemployment, and tight capital markets? In recent years, economic challenges - including increased domestic and global competition, offshoring and near-shoring, and global recession - have forced business leaders to re-evaluate their business models to be more flexible and cost-competitive in both the near term and long term. These conditions have driven plant closures, significant corporate downsizing, layoffs, and consolidation of operations. Few communities and states have escaped the impact of these corporate withdrawals.
Focus on Costs
While there are industry sectors that have been recently experiencing growth, the vast majority of project activity in 2009 and 2010 continues to focus on cost-reduction initiatives through consolidations and right sizing of state, regional, and even national operations. The corporate location decision is expected to continue to focus on the total cost of doing business over the long term and is validated by the recent release of Area Development's 24th Annual Corporate Survey results. These results indicate that seven of the top-10 site selection factors are related to business costs (labor, energy, real estate/construction, shipping) and the availability of incentives to support the financial business case (tax exemptions, state and local incentives). So what can be inferred from this?
1. The cost of doing business (labor, energy, real estate, transportation, taxes and incentives to offset start-up and operating costs) will continue to drive corporate leadership's decision process.
2. Business consolidations will continue and will result in winners and losers. Corporate decision-makers will be closely evaluating existing operations across their platform to determine if those operations can be cost-competitive and remain open. Communities and states will be competing to retain existing operations.
3. The role of flexible incentives may become more important as companies are seeking ways to offset start-up costs, new investment, and long-term operating costs. Incentive programs that have traditionally targeted new job creation and investment become ineffective or a non-factor in the retention evaluation process.
4. States and communities that recognize the value of retention incentives during these challenging times may have an advantage in the competition to retain their operations.
A Job Retained is Just as Good as a Job Gained
Existing jobs and investment currently are contributing to state and local coffers through ongoing tax-revenue generation, primarily including payroll withholding, corporate income taxes, property taxes, and sales taxes. The economic and fiscal impact cannot be ignored.
Consider a financial services company located in the Rust Belt with 1,000 existing jobs and an average salary of $62,000. Due to the recirculation of wages throughout an economy, this company has a net effect of 3,577 jobs and $159 million annual payroll. From a tax revenue perspective, the state collects $9.1 million annually from this company. The city and county collect about $10.5 million annually. If this financial services company leaves, these ongoing tax revenues are gone and upward of 3,577 jobs are likely lost. (See Exhibit 1.)
From an economic development perspective, the question becomes, "What level of incentives should be considered to hold on to the $10.5 million in annual state tax revenues?" Any community or state in this situation will need to decide if crafting a retention incentive package of $1 million, for example, is worth saving $10.5 million in recurring revenue flow to the general fund.
Retention strategies require creativity and an economic way of thinking, with particular focus on "no opportunity cost" solutions. No opportunity cost simply means that a state is not giving away more money than it is reasonably generating from the economic activity. Redirecting existing, recurring revenues to "keep" quality jobs is the path to being economically smart and fulfilling the responsibility of "doing the people's business" by keeping residents employed.
Who is "Showing the Money" to Retain Quality Jobs?
The reality is, today, there are few states and communities that are proactively offering incentives to retain existing businesses or operations. Economic prosperity has driven economic incentive policies and strategies toward attraction versus retention, especially in geographic regions including the southeastern and south-central United States and the Eastern Seaboard.
However, there are regions of the United States that are demonstrating trends of higher job loss due to a variety of factors, including a high cost of living, a high cost of doing business, less-than-favorable tax environments, and work-force challenges such as declining population trends. Thus, there are states that have recognized the value in trying to retain jobs and reward job creation at the same time.
So while there are a number of states that may subtly consider the retention of jobs in their incentive programs, most focus on job creation, new payroll, and new capital investment. However, there are at least five effective state incentive programs designed to target business retention. A brief description of these follows:
The retention incentive program in Illinois is called EDGE (Economic Development for a Growing Economy). It is a discretionary incentive program that awards corporate income tax credits equal to up to 100 percent of withholding taxes for up to 10 years. The percentage of withholding taxes and term of the incentive are dependent on the number of jobs and average wage compared to the county average wage.
Retention incentive offers are tied to basic industries. An eligible company must retain at least 25 jobs, pay an average wage equal to at least the county average, and invest $5 million in new capital investment into the existing facility. Companies receiving EDGE tax credits will be required to maintain operations and retain a pre-determined number of jobs for a period of time. Penalties are negotiable on a case-by-case basis.
retention incentive program in Indiana is also called EDGE. It rewards
job creation and recognizes retention. The EDGE Program is a
discretionary incentive program that awards corporate income tax
credits equal to up to 100 percent of withholding taxes for up to 10
years. The percentage of withholding taxes and term of the incentive
are dependent on the number of jobs and average wage compared to the
county average wage.
Retention incentive offers are tied to
manufacturing, business services, and R&D only. An eligible company
must retain at least 35 jobs and pay an average wage equal to at least
105 percent of the county average. Companies receiving EDGE tax credits
will be required to maintain operations and retain a pre-determined
number of jobs for two years beyond the term of the EDGE award.
Kentucky Reinvestment Act
retention incentive program in Kentucky is called the Kentucky
Reinvestment Act (KRA). The KRA program is a discretionary incentive
program that awards corporate income tax credits up to 10 years and
equal to (a) not more than 50 percent of approved capital costs and (b)
not more than 100 percent of training costs to upgrade the skills of
existing employees. The approved tax credit benefits are dependent on
the number of jobs and average wage compared to the county average wage.
incentive offers are tied to manufacturing and related operations. An
eligible company must retain at least 85 percent of the employment
level in the previous year and incur at least $2.5 million in new
capital investment. Companies receiving KRA tax credits will be
required to maintain operations and retain a pre-determined number of
jobs for a negotiated retention period. Clawbacks are negotiable.
Michigan MEGA Retention Tax Credit Program
Michigan Economic Growth Authority (MEGA) program is a discretionary
incentive program of corporate income tax credits equal to up to 100
percent of withholding taxes for up to 20 years. This program is
dependent on the number of jobs and average wages as well as the
economic impact of the company on the state and community. Offers are
tied to key industry sectors including manufacturing, mining, film and
digital media, and office operations. Projects must maintain 50 jobs
and pay 150 percent of federal minimum wage with an investment of at
least $50,000 per retained jobs. Clawbacks are negotiable.
New Jersey BRRAG
Retention and Relocation Assistance Grant (BRRAG) is a discretionary
incentive program with corporate income tax credits equal up to $1,500
per retained job. Eligible companies must maintain 50 jobs and pay at
least county average wages. Companies receiving tax credits must
maintain operations and retain a predetermined number of jobs for five
years. Clawbacks include 100 percent recapture of tax credits if job
retention is not met.
Ohio Job Retention Tax Credit Program
Ohio JRTC (Job Retention Tax Credit) program is a discretionary tax
credit program equal to up to 75 percent of withholding taxes for up to
10 years. The percentage is dependent on the number of jobs and average
Retention is tied to jobs in key clusters and projects
must retain at least 500 jobs with an investment of $50 million for
manufacturing facilities and $20 million for headquarters/
Clawbacks are negotiable.
Show Me the Money.Maybe
2007-2009 recession has revealed structural problems with state and
regional economies and, thus, tax revenue stability. Strategically
maintaining existing industries and attracting high-quality prospects
should be given equal attention. Economic conditions of a state or
community are not static and require re-evaluation of economic
development strategy including incentive programs.
and economic development policy should provide long-term benefits to a
community and state's residents through new job creation and retention,
enhancement of the overall tax base, expansion and diversification of
the state's economic base, and increase in tax revenue to the state.
Incentives and economic development policy should increase the economic
competitiveness of a state in attracting and retaining industries and
jobs relative to other states that have historically defined and
carried out business assistance more aggressively.
and community approaches the retention incentive discussion and
decision based upon their circumstances and economic environment. In
doing so, the following best practices should be considered and
recognized by companies considering those locations:
incentives should be connected with specific industries and projects
that align with the state and community's economic development policies.
• Incentives should be performance-based with penalties/clawbacks negotiated to protect the stakeholders and taxpayers.
Retention incentives should be discretionary - funded by programs like
withholding taxes, with governing agencies having flexibility to reward
amounts based upon the strength of the project and its economic impact
on the state and community
• If tax credits are utilized, programs that can be monetized or converted to cash should be created.
decision to withdraw an operation from a community and state is not an
easy one for companies. Creating a business case and solution to retain
the jobs and investment should be a collaborative effort between the
company and the economic development community.