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A Smarter Way to Incentivize

Governments and corporate site selectors alike should consider whether sometimes overly generous tax incentives are the best way to align their goals.

Q3 2018
Editor’s note: Area Development’s St. Petersburg Consultants Forum (Dec. 4–6, 2017) featured a presentation on tax incentives and economic development by Dan Levine, Practice Leader, Location Strategies, Oxford Economics. The following are some key ideas from Levine’s presentation. When Amazon announced its search for a second operations location, states and cities across the United States appeared ready to offer a plethora of incentives to land the online retailer. It’s a familiar scenario, in which the stakes have risen considerably since the global financial recession. Yet, growing public skepticism — and increased government transparency — may be changing the game.

The merits — or lack thereof — of corporate tax incentives have been debatable for some time, and for good reason. Overwhelming evidence shows that state and local tax incentives often have little to no positive effect on promoting real economic growth. Instead, incentives simply transfer the tax burden from a small group of businesses that benefit to a wide base of corporations and individual taxpayers who now must pay more. And, the burden can be high when a deal fails to deliver the jobs and capital investment promised. It is not too soon for companies and communities to begin partnering on the development of new ecosystems that will support a workforce in urgent need of upgrading skills and increasing flexibility in response to the accelerating pace of smart technology adaption. Dan Levin, Practice Leader, Location Strategies, Oxford Economics

To be clear, some financially sound economic development programs make effective use of tax credits and incentives. Incentives have been part of business recruitment for decades, of course, to revitalize slow growth in U.S. living standards. However, the global financial crisis inspired new heights of generosity as states sought to revive their battered economies.

States awarded $45 billion in incentives in 2015, for instance, to new or expanding export-based industries — think manufacturing, technology, media, or any company that exports goods or services beyond the local economy. These incentives outweighed state and local business taxes by 30 percent and cost the U.S. $45 billion, according to data from the W.E. Upjohn Institute for Employment Research. The Upjohn report analyzed 26 years of data about incentives in 33 states and found, based on preliminary analyses, very little correlation between tax incentives and a state’s current or past unemployment or income levels, or with future economic growth.

Changes in Federal Tax Policy
The lack of transparency into how much state and local governments actually provide in incentives prompted the announcement of the 2015 Government Accounting Standards Board Statement No. 77 (GASB 77) concerning tax abatement reporting. Effective in 2015, the guidance requires governments to report the purpose and value of the corporate tax incentives provided to businesses. Whether the effort succeeds will depend on whether government entities actually commit to transparency. If successfully implemented, taxpayers and policymakers will be able to quantify and compare the revenue losses causes by tax incentives.

Changes in federal tax policy and accounting standards also could help rein in the incentives arms race. Specifically, federal tax reporting could distinguish between incentives such as tax credits that are offered “by-right” and embedded in a state’s tax code versus discretionary incentives that are only offered through a negotiated agreement. It’s common to offer large cash incentives to attract out-of-state companies to move from one state to another, but the net outcome is a race to the bottom involving often-scarce state resources.

Under certain conditions, the U.S. Internal Revenue Service could treat an incentive tax benefit as income for federal corporate tax purposes. States could continue to offer whatever incentives they want — but companies would, in some instances, face federal tax liabilities in the amount of the incentive. As Levine points out, “The federal government contributes mightily to the finances of all 50 states and has no interest in whether a new project lands in one state or another. On the other hand, the federal government does have an interest in strengthening state finances overall and, therefore, has an interest in refereeing the interstate competition for jobs.” There is nothing wrong with states using tax policy to compete against one other. The point is to keep that competition above board, in the tax code, and available to all taxpayers, rather than leaving it in the hands of politicians who are often far too willing to approve large awards if it allows them to claim credit for a project. Dan Levine, Practice Leader, Location Strategies, Oxford Economics

How to Best Align Business Goals
Perhaps more important, governments and corporate site selectors alike should consider whether sometimes overly generous tax incentives are the best way to align their goals. So how can we better align government and business goals? For starters, nothing beats the basics — business climate, regulatory assistance, and workforce development. For corporate location decision-makers, looking at the strength of a community’s workforce — including whether there is an effective collaboration among the Workforce Investment Board and community colleges and universities — is often more critical than tax incentives.

Workplace change is accelerating, in advanced manufacturing in particular, with automation, artificial intelligence, the Internet of Things, and other technologies. Staying abreast of these changes with workforce development can help attract and retain businesses, while also creating a workforce better equipped for the future. Moreover, tax policies that treat capital equitably — whether it is used for manufacturing or technology — can also better prepare communities for the jobs of tomorrow.
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