Ranked #4: State & Local Incentives
The high ranking given to this factor by the respondents to Area Development's Annual Corporate Survey confirms the impact of state.
Many factors are primary in site selection. Site decision-makers will often evaluate factors such as labor markets, transportation infrastructure, tax burden, utilities, and others that they deem primary influences upon the success of proposed operations. Decisions regarding the most viable location for investments cannot be made without careful analysis of most or all of these factors. For many decision-makers, incentives are among the many primary factors that must be evaluated before a project proceeds.
We have worked directly with corporations where mandates from boards of directors or capital expenditure committees have been implemented company-wide requiring an evaluation of available incentives before an expenditure request will be considered. This typically applies to constructing new facilities, as well as to capital investments made to existing operations. The reasons that incentives are given such weight in the decision-making process are severalfold:
• Incentives are looked at no differently from other economic factors. They have a direct financial impact on the outcome of a proposed investment. Incentives affect the return that a company realizes when undertaking capital investment in a project and may be a determinative of the proposed project's meeting return-on-investment requirements. These include both project startup costs and ongoing operating expenses. The decision-maker must ask, "Would the company realize a higher return on its capital if the capital were invested elsewhere?"
• Incentives have a direct impact on other primary location factors. For many companies, the burden of state and local taxes is of great importance in their location decision-making. Incentives have a direct impact on the long-term tax liability that a company will face at each location being considered. Tax incentives may enable a location with a decided tax disadvantage to fare better than competing locations that have an initial tax advantage.
• Incentives provide a definite competitive advantage to companies that are able to secure state and community support. More companies are realizing that competitors that secure incentives have lower project startup and operating costs. This provides a competitive advantage to these companies that decision-makers should not ignore.
Incorporating Incentives into the Site Selection Model
The evaluation of state and local incentives has become a greater part of the location analysis model for companies seeking to identify the optimal location to site new facilities. It has also become an integral part of companies' decision-making with regard to the expansion of existing operations. But how do decision-makers incorporate incentives into their analyses?
First, it is important to differentiate between three general types of incentives: tax incentives, which account for a majority of incentives provided by state and local governments; financial incentives, which include grants, bond financing, and loans; and other non-tax incentives that cover a wide variety of offerings ranging from land and utility-rate subsidies to in-kind services. Since tax incentives play a significant role in state and municipal offerings, it is beneficial to look at these first.
Tax incentives have been primarily developed by state legislatures as a means to aid state and local governments in addressing greater tax burdens that businesses would face when undertaking operations within their jurisdictions vis-à-vis other jurisdictions. In this respect, lawmakers have recognized that their tax structures are less competitive when attracting or retaining business investment. Likewise, corporate decision-makers recognize these differences in tax burdens among states and municipalities.
The impact of taxes over the long term is, in many cases, substantial enough to warrant evaluation within location analysis models. Typically, the tax burden analysis includes a projection of state and local tax liabilities over a 10- to 20-year period. This analysis will include state and municipal income/ franchise taxes, sales and use taxes, real and personal property taxes (including inventory taxes), utility taxes, unemployment taxes, workers' compensation, and other applicable taxes. The goal of the analysis is to understand and compare, when appropriate, estimated long-term tax liabilities at different locations, as well as the corporate-wide tax impact of placing a project in a given location, i.e., the evaluation of the tax impact that undertaking business investment in State A has upon existing operations in all other states.
One of the keys to a meaningful tax burden analysis is the formation of reasonable assumptions. Since the analysis is a projection of tax liabilities under the condition of many unknowns, it is extremely important that these unknowns be tempered with acceptable assumptions. A reasonableness test must be applied to those factors that are likely to change over the term of the analysis. These include future corporate taxable income, property values, tax rates, inflation, changes to tax statutes, changes and challenges to incentives programs, and other variables. The sources of data must also be acceptable to the location decision-makers so that there is confidence in the analysis.
In order to fully understand the tax burden at a given location, it is necessary to determine if it is possible to secure state and local incentives for the operations and to what extent such incentives will lower the tax burden. The value of potential incentives is determined by identifying both "as-of-right" incentives - whose value is based upon the ability of the company to be aware of these incentives - and discretionary incentives whose value is a function of negotiations between the company and the granting authority. States and municipalities specifically use discretionary incentives as economic development tools that can be targeted toward projects that will achieve economic growth goals. Since the value of discretionary incentives is based upon negotiations, these values will be fluid as discussions proceed. It is, therefore, necessary to utilize a model that is flexible so that the impact upon the tax burden analysis can be updated accordingly.
We have seen notable shifts in state and local tax liabilities that companies are likely to incur at a given location based upon the incentives that have been identified and secured for a project. In some cases, discretionary tax incentives have lowered the projected tax burden by tens of millions of dollars over a 20-year period, even exceeding a hundred million dollars for some larger projects. Therefore, if the impact of taxes is a primary factor influencing a company's location decision, then evaluation of tax incentives should be considered a key criterion in due diligence of the project.
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