Understanding Economic Incentives in Site Selection
Site selectors need to understand a state or community’s incentives philosophy, how the incentives are deployed, and the risks involved.
These 40 factors may be influenced, more or less, by variables as large as the industry or operation of the company, to variables as small as the individual (or division-wide) preference of the employee charged with site selection. For instance, if I am deciding to locate an office, I may be less likely to emphasize transportation costs or proximity to major highways as I would with a manufacturing plant. If, as a site selector, I am the HR manager, I may be more inclined to care about a state’s union profile than about utility costs.
From a policy perspective, states spend anywhere between 2 percent and 50 percent of their total budget on economic incentive programs (anywhere from $25 million to $20 billion).
In any event, in light of all the site selection factors A through Z (airport proximity to zoning), the goal of this article is to provide a better understanding of the “I,” being incentives.
The Origin and Rationale of Incentives
The word incentive originated from the Latin incentivum, “something that sets the tune or incites,” which originated from incantare, “to chant or charm.” I will try to deviate from using the term through the lens of witchcraft or trickery, and rather define the word “incentive” as something that “changes behavior.”
Oftentimes, when I’m advising a corporate client in potentially obtaining incentives during a site selection process, or a government client in administering or creating incentives, I try to emphasize that very point, “changing behavior.” What behavior do I, as a government entity, want to encourage in meeting my quality-of-life or standard-of-living goals? What behavior do I have to conduct as a corporation to obtain this “incentive”? This is the very crux on which decisions are made to create incentive programs, which typically take the form of grants, loans, and tax credits (including abatements).
What Is Typically “Incented” or Not “Incented”?
Governments at the federal, state, and local levels will typically “incent” job creation, employee training, real and personal property investments associated with some sort of corporate expansion, new facility location, consolidation of operations, or relocation. Other categories are more discretionary (or more competitive) in nature, including site preparation, building acquisition, infrastructure improvements, research and development, commercialization, energy efficiency, water and air quality, and even production
Arguably the most commonly awarded incentive is a jobs-based tax credit. Put simply, a jobs-based tax credit refunds a company a percentage of its new payroll creation.
Assuming specific job, wage, and capital investment requirements are met, there are two primary scenarios in which a “project” may not be “incented,” but both primarily revolve around the same concept: the project would have taken place without the incentives. The first scenario would be in the event the project has already moved forward or a company cannot effectively communicate that the incentives were a major factor (or the major factor, depending on the state) in the project moving forward.
The second scenario relates to state-level incentives as they pertain to retail. A common philosophy with retail projects is that they depend on the needs of the surrounding population, consumer market, and business community, and that such operations would still exist (and potentially thrive) without state assistance. While this may not always be the case, and there are many types of retail that do not have a high level of dependence, policymakers have stayed relatively consistent with this stance around the country.
The Domestic Philosophy of Incentives
State governments differ vastly in how they decide to change the behavior of industry with incentives. From a policy perspective, states spend anywhere between 2 percent and 50 percent of their total budget on economic incentive programs (anywhere from $25 million to $20 billion). Put simply, economic incentives are subject to differing philosophical viewpoints.
One of the ways I try to understand a state or regional philosophy in awarding incentives is by analyzing those commonly awarded. Arguably the most commonly awarded incentive is one nearly every state possesses in its toolbox — a jobs-based tax credit.
For a company, it is important to understand that in whatever state you are potentially locating your facility, your mindset in a negotiation is typically the same.
Put simply, a jobs-based tax credit refunds a company a percentage of its new payroll creation. It is seen as a relatively low-risk incentive, because in nearly all cases a company does not receive the benefit until the job is created and the employee has been compensated. The way jobs credits are offered and structured, however, differs from state to state, but this often can provide some clarity on a state’s economic development philosophy, as follows:
Location-based (federal distress) — The credits are only awarded, or only awarded at a high value, if the site is located in an area of federal distress, or the proposed employee wages exceed the average wage of the area.
Gap-filler — The economic development staff has the ability to negotiate a specific amount of the credit in order to fill an identified gap in the company’s project cost.
Formulaic — The credit is awarded in a formulaic manner based on a government’s return-on-investment calculation, where typically the amount awarded does not exceed the amount expected to be received in tax revenue.
Industry-specific — Credits are only awarded, or only awarded at a high value, if the project is within a specific industry, usually an industry determined by the state or region as key to its current or future economic success.
In a sample of 11 states that was undertaken for a presentation, eight states had clawback provisions associated with their key incentive programs.
Another important consideration is the way in which incentives are deployed. Some states require an in-depth application and eligibility-validation process, offers from competing locations, and numerous negotiation meetings. Others have a relatively automated, self-qualification process with pre-determined values based on numeric project metrics.
At each end of the spectrum, there is an associated cost. States with required negotiation may save money because they are investing in a much more methodical manner (and may not always have to invest), but an automated, pre-determined process creates business certainty and saves the taxpayer costs associated with staff negotiation time. In any event, it is very important for the site selector to be aware of the process.
For a company, it is important to understand that in whatever state you are potentially locating your facility, your mindset in a negotiation is typically the same. The incentives that state and local governments give to change behavior reflect demand for a product. The product the state is buying from the company is tax revenue, quality of life, standard of living, and any other associated benefits, indirect or induced by job creation and the merits of the company’s project. While incentive programs and processes may differ, that ideology remains the same.
Key Risk Considerations
Penalties and clawbacks — One of the first questions that should always be asked pertains to compliance. Clawbacks represent the most extreme penalty, because rather than terminating the incentive or reducing the benefit, the company is required to pay back the money it received, and depending on the state and collection process, it could come with penalties and interest.
In a sample of 11 states that was undertaken for a presentation, eight states had clawback provisions associated with their key incentive programs. Some companies set aside a portion or all incentives received into some sort of clawback reserve, until the company is released from its statute of limitations with a state or local government.
Refundable vs. non-refundable credits — In some cases, this can represent a difference of hundreds of thousands of dollars in expected value vs. actual value for a tax credit. This is primarily because not all job credits are calculated by the tax that they are applied against.
For instance, if a company receives a jobs credit that is worth $100,000 annually (let’s say 5 percent of its project’s $2 million in new payroll), it may get an initial tax credit award estimate from a state or local government of $100,000. Let’s say that the credit is actually realized against that state’s corporate income tax, and because of the type of company operation, it only pays $50,000 of that tax annually. If the credit is non-refundable, it is only worth as much as the $50,000 tax that the company pays. If it is refundable, the company will realize the entire $100,000 value. In the aforementioned 11-state sample, six states had refundable jobs credits, and the others were non-refundable.
Public relations — Public relations may be one of the single-most-overlooked considerations when obtaining incentives for a site selection project. A premature announcement of a project moving forward, prior to a formal approval of incentives, can actually jeopardize the ability to obtain incentives in many states. It is important to understand that government incentives are paid for by the taxpayers and, as such, they are almost considered investors in a project.
This being the case, a large portion of the information submitted to state and local governments is a matter of public record. In addition, many states require company performance on incentives to be reported in a public document each year. In any case, it is always beneficial to understand the public nature and risk exposure of the information that your company provides.
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