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.
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.