The Double-Edged Sword of Economic Development Incentives: State and local governments can be in stiff competition with international locations, other states, and even neighboring jurisdictions for development.

Author:Barkley, Rachel
Position::Best Practices
 
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Economic development incentives are offered to some degree by almost every state and can play a key part in state and local government's ability to compete for business relocations and expansions. Lately they've been used to an increasing degree to spread economic activity to underdeveloped areas, diversify the economy or increase the concentration of a perceived in-demand industry with 12 states mentioning some type of incentive in their 2018 State of the State addresses. (1)

States and local governments can be in stiff competition with international locations, other states, and even neighboring jurisdictions. On a theoretical level, incentives lead companies to either expand or relocate in a particular area. On a local level, these companies generate jobs and pay property taxes, while they contribute to corporate income and sales tax contributions for states. Depending on the size of the companies and the concentration of the sectors in the area, they may also drive the location of similar companies or complimentary enterprises, such as suppliers, due to benefits from agglomeration.

This can, in certain cases, lead to an escalation or bidding war among competing jurisdictions, as seen on a grand scale currently with cities competing for the upcoming Amazon secondary headquarters (HQ2). It also occurs on a local level between neighboring jurisdictions, in instances that are not as widely reported. Frisco, Texas, was recently forced to increase its incentive package for Rockwell Collins, a defense contractor, with an additional $400,000 grant after the nearby City of Piano put in a competing offer to house the company's planned expansion. (2)

The amount of incentives granted in any year varies greatly, based on who is measuring them and what is included. The Upjohn Institute has found that incentives for exporting industries totaled $45 billion in 2015 alone, (3) while otherstudies have found total incentives to range from $65 billion (4) to $90 billion annually. (5) However they are measured, the general trend of incentives seems to be increasing, with incentives more than tripling since 1990. (6) In Texas alone, municipal economic development corporations increased their annual incentives granted increased by 53 percent from 2007 to $139 million in 2015. (7) Incentives may take the form of property tax abatements, job creation tax credits, research and development tax credits, grants, customized job training, and infrastructure, with property tax abatements and job creation tax credits being the most commonly awarded incentive in recent years. (8)

These incentives can have a direct impact on budgets. The State of Michigan's $454 million fiscal 2015 general Fund gap was driven by business tax credits. (9) The costs of these credits had increased by more than $200 million annually from original projections and are slated to continue until 2032, despite the program being closed since 2011. (10)

ARE THEY EFFECTIVE?

As these incentives affect government finances, it makes sense to study their effectiveness. Numerous academic studies have been undertaken to identify the impact of incentives on economic development. Unfortunately, the results are mixed, leading to no clear consensus. (11) (See Exhibit 1.)

The Upjohn Institute has found that incentives can positively influence corporate...

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