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How Does Economic Development Legislation Affect Your Bottom Line?

A company’s final location or expansion decision hinges on a financial analysis that may be closely tied to the winning state’s economic development legislation.

Q4 / Fall 2013
In the never-ending quest to spur economic development, states have left almost no stone unturned. Most have amended tax policy to make themselves more competitive — some by eliminating onerous, low-impact tax programs, others by creating new incentive programs. Either way, the result has been a legislative flurry of activity.

But as states develop legislation to promote economic growth, they must make certain they are peering through the correct lens. That means, how will this legislation look to the companies they seek to attract? Legislators and economic development officials must remember that from any company’s viewpoint, the most fundamental question about any tax and incentive program is, “How is this legislation going to affect our financial statements?”

As companies review the various alternatives of expansion or consolidation, each of these decisions fundamentally comes down to a financial analysis. While there are always qualitative considerations, such as quality of life and other community factors, most of these variables come into play only after the quantitative analysis has narrowed the field of sites.

Even so, some states inevitably pass economic development legislation with questionable objectives. We call this “feel good” legislation, which on the surface sounds effective or “feels” good. A subset of this is “perception” legislation that is intended to change opinions about the state. In reality, “feel good” and “perception” legislation has little to no meaningful impact on profitability.

A second type of legislation, which we call “middle-of-the-road” legislation, much better serves states —and the companies they are trying to attract. Over time, and with continued positive changes, this type of legislation creates significant, positive impact for companies. And, finally, there are what we call “bold moves.” These legislative measures have a significant effect on a company’s bottom line and thus positively impact a state in terms of jobs and investment within the first several years of enactment.

Let’s examine each strata of legislation with an eye on how it will be viewed in the corporate boardroom — and what state economic development leaders must keep in mind as they push for legislative reform.

“Feel Good” Legislation
  • Corporate fee or “processing” legislation reduces the amount of fees charged or eliminates onerous steps for companies locating in a state. Although this legislation has broad effect, it has very little impact on a company’s bottom line and is never a major issue in a site selection analysis.
  • Special interest legislation comprises tax benefits or incentives for companies to grow within a very specific, non–high-value-added (or non-high growth) sector of the economy. Special interest legislation often includes incentives for recreational or retail businesses in which specialized districts are created that impact only one region of the state and that support special interest groups.
  • “Perception” legislation is typically enacted by legislators to address a “perceived” problem in the state or region. Examples of this would be changes in ethics codes and tort reform. While this type of legislation can help overcome the perception of political wrongdoing in a state, or perhaps counter an overabundance of frivolous lawsuits, it generally does little to impact a company’s quantitative site selection evaluation.
  • Alliance legislation forms new alliances to promote a region or a specific industry. While on the surface it looks good for a state to coordinate its economic efforts, the simple enactment of legislation to create the specific entity in and of itself does not do that. Instead, alliances should be formed naturally through the hard work and efforts of local leaders banding together to pool their resources.
“Middle of the Road” Legislation
  • Enhanced job creation credits are available in most states. This has always been a key selling point for economic developers, but the leading-edge states now not only create a one-time credit, but also provide a per-head sum or, better yet, a percentage of total payroll over an extended period of time. Without a doubt, a long-term tax credit has substantial effects on the bottom line and can play a significant role in site selection.

    For example, Colorado employers receive a 50 percent credit for five years on the amount the employer is required to pay in federal Social Security and Medicare taxes on jobs created. Similarly, Arizona offers $3,000 for each full-time employee hired in a qualified employment position for up to three years of continuous employment.
  • Development of industrial parks and technology centers helps communities in positioning for the emergence of knowledge-based careers. During the most recent downturn, a substantial number of industrial sites became available. Now, as the economy rebounds, scrutiny of site availability is increasing. In order for states to capitalize on this competitive dynamic, they must ensure their sites are well prepared, available (with on-line visibility), and cost-effective. Similarly, states that make a concerted effort to either refurbish facilities and/or invest in new state-of-the-art industrial parks have a better chance to make the final cut. For example, the North Carolina Global TransPark has seen a recent wave of funding and legislative support despite its creation decades ago. Further, states that have developed centers to capitalize on technological innovation have an added competitive edge. Michigan, for instance, has ramped up efforts to promote innovative technologies in the Centers for Innovation Program, which focuses on public-private partnerships and provides consulting and funding to Michigan businesses.
  • Formation of deal-closing funds addresses the “gap” between what the company is expecting on total operational costs and the final site analysis. To fill this gap, some states already have deal-closing funds in place. States without such funding in place are forced to rush through new legislation. While both scenarios can work and meet a company’s timeline, the former scenario sends a much stronger signal about the state’s focus and ability to prepare and plan for deals. In addition, deal-closing funds provide a cash infusion to the company, which can substantially improve the bottom-line analysis for the project. Many states have recognized the importance of such funds. Among the largest such funds are the Texas Enterprise Fund, the One North Carolina Fund, and the Florida Quick Action Closing Fund.
  • Business retention programs and incentives strike a balance between incentivizing relocations and expansions with maintaining a competitive environment for existing businesses and providing incentives to struggling in-state businesses. For example, Oregon provides consulting services through its Business Retention Program to in-state businesses undergoing financial or organizational distress.
Another method is to provide job retention tax credits, such as in California, where in 2013 the legislature provided the Governor’s Office of Business and Economic Development with the authority to enter into an agreement with a taxpayer to retain a certain number of jobs in exchange for a corporate income tax credit. These retention policies have the potential to substantially impact an existing business’ financial position and improve the business case for operating units of companies that have a multi-state portfolio to stay and expand as they internally compete for limited CAPEX dollars.

“Bold Moves”
  • Single sales factor apportionment formula promotes interstate and international export and can, over the long term, have a great positive effect on a state and its corporations. As of 2013, over half of the states use some combination of a weighted apportionment formula to calculate corporate income tax (based on property, sales, and payroll), while four states have no corporate income tax (Texas has a franchise tax calculated similar to an income tax).

    Twenty-four states either have a pure single sales factor, are phasing in a pure single sales factor, or have an election of a single sales factor for certain businesses. In fact, by the end of 2014, California, Louisiana, Minnesota, New Jersey, New Mexico, Pennsylvania, and Virginia will either end phase-ins, expand the availability of the election, or move completely to a single sales factor.
  • Fully utilizable double-digit incentives represent another “bold move.” On the initial screen in a siting project, companies calculate the overall cost of taxes minus incentives. When a state has incentives that offset over 10 percent of payroll or investment, the entire industry takes notice. Once the incentive is noted, the next review is whether a company can take full advantage of the benefit. A great way to gain immediate attention is to enact legislation that incentivizes payroll and/or investment in either annual cash rebates or tax abatement. In scenarios where the abatement is larger than the tax owed, states can allow for the unused portion of the incentive to either be sold or, better yet, provided in the form of a rebate check at year-end. Typically, these credits are more targeted toward specific industries, such as film production or other technology-based industries. For example, the Louisiana Digital Interactive Media and Software Tax Credit provides a 25 percent credit on the base investment with an additional 10 percent for Louisiana payroll; any excess amount of the credit is both transferable and refundable.
  • Rapid response recruitment, screening, and training programs are evolving. One of the largest and most variable factors in getting a new facility up to full capacity is the availability of trained personnel. While all economic development projects have a training component, the simple answer of providing training dollars and/or creating a task force of regional educational providers isn’t enough anymore. In order to be most effective, states must create a dedicated training team to assist companies through the initial start-up stages. However, such teams remain rare. Alabama Industrial Development Training, Georgia Quick Start, and Louisiana FastStart are among the most well-known and successful.
Companies need to look for programs that impact their bottom line. And, as the battle between the states for economic development dollars rolls on — and the competition and stakes grow — states must be more committed than ever to developing such programs, which will also affect their bottom line. Legislation is inevitable in this process. Whether states opt for “feel good,” “middle of the road,” or “bold” initiatives, they must never lose sight of how their efforts are viewed in the corporate boardroom, where the question is asked, “Does this state’s legislation financially benefit our firm?” If the answer is an unequivocal “yes,” that state will go a long way in differentiating itself from the competition.

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