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Partners, Not Handouts: A Winning Model for Manufacturing Innovation

When economic development policymakers are viewed as collaborators, everybody wins.

Q2 2016
The journey to manufacturing innovation is long — and costly. Economic development incentives can curtail the costs, add other types of value, and generally make it possible to invest in new products and production processes. Often, the ability of a company to explore increased use of high-tech robotics and automation on the production floor depends on these incentives, so it’s critical to understand the environment before entering into a negotiation.

Think you know everything about incentives? Think again. The programs you used to know may no longer exist. Programs are constantly shifting, and many state budgets are stressed by pension obligations and other budget pressures. Other programs may have evolved as policymakers uncover best practices or establish new programs to drive job creation and local innovation.

The moral of the story: know what’s out there before you choose where you should locate and innovate.
Incentives made headlines in Tesla’s 2014 decision to build its gigafactory in Nevada.
Incentives made headlines in Tesla’s 2014 decision to build its gigafactory in Nevada.
Beyond “How Much”
Contrary to popular perception, a partnership attitude is the best approach to garnering incentives of any kind. It’s more than haggling for “how much” — it’s about creating a win-win for both the community and the company. Organizations that focus solely on a specific financial incentive are likely to miss out on larger opportunities. For example, a company that requests a subsidy or tax abatement for renovating a property might inadvertently forego an opportunity to build a new facility with state-of-the-art features — something a state might have offered in a different negotiating environment.

Economic development authorities generally encourage innovators and support the promise of future jobs and economic value. However, they want to know how a company plans to build its success; they want to envision the end game, not just the short-term. Furthermore, economic development agencies often are in a position to consider a wide range of options to support growth, so companies may leave the table with even more than they imagined before engaging in negotiations. Incentives are more than tax rebates, and can include valuable workforce training, fast-track permitting, export assistance, or other valuable programs.

Whether new or established, a manufacturing innovator should come to the table with a well-prepared business plan focused on benefits for the state or city. The company should be able to show how it plans to bring new products to market and provide a detailed look at the local economic impact. From that perspective, seeking government investment is similar to seeking private-investor dollars, in that both parties can gain from sharing information.

Start At the Beginning: the U.S. Federal R&D Tax Credit
One of the most popular incentives, the federal R&D tax credit, still applies no matter where a company is located within the U.S. Surprisingly, only one of 20 small- and mid-sized manufacturers eligible for this credit actually takes advantage of it, even though it is not tied to performance.

First enacted in 1981, the federal R&D credit was permanently extended in December 2015. Qualifying costs include in-house labor wages, 65 percent of contract research, and supplies used in the research process.

Beyond the Feds: State and Local Programs
State and local government agencies offer an estimated 2,000 to 3,000 tax credit and incentive programs, including property tax exemptions that are particularly important to manufacturing innovators. Nearly all rely upon conditional performance-based contracts in which the manufacturer does not receive the grants or rebates unless it creates a certain number of jobs or meets capital investment targets. Incentive programs have evolved as policymakers uncover best practices to drive job creation and innovation.

These programs include state-level versions of the federal R&D tax credit; nearly all states offer their own, typically at a lower level than the federal program. Additionally, some states participate in the U.S. Economic Development Administration’s Investing in Manufacturing Communities Partnership (IMCP) program, which funds state-level programs to support investment in startups and established manufacturers.

In general, state and local incentives fall into five major categories, ranging from income, sales, or property tax rebates to direct grants, utility discounts, or contributions of land. According to the Tax Foundation’s 2015 Location Matters report, 16 states offer withholding tax rebates, 24 offer investment tax credits, and 24 states offer payroll tax credits for new labor-intensive manufacturers.

Incentive Trends of Tomorrow
Traditionally, states have taxed manufacturers on the basis of their in-state sales income, employee payroll, and property, and offered incentives accordingly. However, many states are adopting a new commonsense approach. The following are key trends in how states are considering incentives today:

Trend #1. Corporate income tax credits are on the way out. Corporate income tax credits are not very valuable for manufacturers who make most of their income through out-of-state sales, and many states are phasing them out. Some states are making corporate income tax credits refundable or even tradable to companies with in-state sales.

First enacted in 1981, the federal R&D credit was permanently extended in December 2015. Trend #2. Equipment is becoming exempt from property tax. Traditionally, states have taxed corporate real estate, equipment, and inventory in the general category of property taxes. Given the enormous capital investments involved in retooling for new products or production processes, 39 states offer property tax abatement or offsets, often making equipment purchases exempt.

In one striking example, Nebraska waives 100 percent of property taxes for new manufacturing and shipping facilities for the first 10 years. The reasoning is that encouraging a manufacturer to retool or to build a new plant increases the likelihood of retaining or gaining jobs for the state — and it is easier to grow with the manufacturer you have than the one you have yet to recruit.

An equipment tax exemption can translate into millions of dollars in savings on deployments of high-tech, robotics-enabled production lines. For multi-state manufacturers considering selective retooling of only certain plants, a state can use the equipment tax exemption to help ensure that its plant is selected.

Trend #3. Payroll tax rebates reward hiring. As manufacturing becomes more technology-enabled, with rising wages for highly skilled workers, payroll taxes become more meaningful. While states like Texas and Florida do not even have payroll taxes, a handful of the many states that do have begun to offer payroll tax rebates. In Arkansas, for instance, a manufacturer that hires 500 employees, each paid $25 per hour, will receive a rebate of 5 percent on its payroll tax. The more people hired, the larger the rebate — and it’s cash.

Trend #4. Sales tax rebates are becoming more common. With state sales taxes averaging 8 to 10 percent, the impact on a plant retooling could be as high as $10 million. Recognizing that penalizing capital investment is counterproductive and discourages hiring and investment, many states have begun offering sales tax rebates.

Sales tax rebates or exemptions for electricity and natural gas purchases are also important incentives, particularly for manufacturers whose new productions and processes are highly automated. Some states offer incentives to reduce the electric bill for the first years or possibly longer to help manufacturers focus on expansion and hiring. However, states like Texas require a company to document that its predominant business is manufacturing to be eligible for a tax break.

Trend #5. Direct grants are still available. Since manufacturers have a strong multiplier effect on local economies, direct grants for jobs are a win-win for communities and companies alike. For instance, a state may offer a seed grant that requires a company to document that it is meeting certain employment and investment benchmarks. Budget crises have stymied a few state-level direct grant programs, but certainly not all.

The Texas Enterprise Fund, for example, funds $2,000 to $10,000 per new job, but a company must refund the state if it does not create the negotiated number of jobs. From an implementation standpoint, cash grants are very attractive to economic development administrators as well because the outcomes are measurable — number of jobs added, export dollars, economic multipliers, and the like — and make it easy to justify the grants to taxpayers.

Smarter Location Decisions
Undoubtedly, the right tax credits and incentives — combined with the right attitude — can improve the prospects for a manufacturing innovator whether large or small. Incentives play a particularly significant role in finalizing the shortlist for manufacturers, according to JLL’s 2015 Global Incentives Landscape report. Most notably, for instance, incentives made headlines in Tesla’s recent decision to build its gigafactory in Nevada.

Location incentives will always be a valuable part of site selection, but should not overshadow the larger picture. Industry clusters can be fertile ground for manufacturing innovators, whether startups or established companies looking for the next breakthrough. Clusters like Kansas City for food manufacturing, Detroit for automotive industries, or Ontario for aerospace development provide a network of suppliers and access to R&D partners, qualified workers and training resources, and laboratories and universities with compatible research agendas. A productive partnership with economic development authorities can enable an innovative manufacturer to make the most of these assets.

May the smartest manufacturer (and its community) win.

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