Are Local Tax Incentives for Businesses Worth Their Cost?

For my senior thesis, I examined how cities react to economic decline. An all too common reaction by local governments is to offer more and more tax rebates and monetary incentives to try to attract large businesses. These incentives can range from sales, corporate, and property tax reductions, to guaranteed loans, and in some cases straight up cash. In total, local governments in the US spend $80 billion a year on business incentives. An article in the New York Times from 2012 paints a good picture of the problem.

Now you may say, “Well isn’t it worth it in some cases for cities to spend money to attract businesses that will create jobs and new tax revenues?.” The blunt answer is no. In researching for my thesis, I found at least a dozen academic articles that all found that business incentives have no effect on job growth, and in some cases even decreased employment. The most optimistic article found that it increased local manufacturing investment marginally, but had no effect on job creation. In the Public Administration literature, the ineffectiveness of these incentives is almost treated as a given.

With the ineffectiveness of these incentives well documented in the literature going back several decades, you might now wonder why local governments still spend so much money on them. The answer lies heavily in the political motivations of our local government leaders. When unemployment is high, municipal leaders face pressure to “create jobs,” and a bad jobs report can doom an incumbent’s chances of re-election. The truth is that real, sustainable economic development takes time, effort, careful coordination and investment, and often a little bit of luck. And with election cycles the way they are, local leaders simply don’t have that kind of time. So, a quick and very visible way for local leaders to “create jobs” is to lure businesses to their city by offering these tax incentives, making it more profitable for the firm to do business. In doing so, local leaders can spout off on how many jobs this new business will create and all the investment it will generate and blah blah blah. They paint a picture as if economic development and job growth happens in a vacuum. It doesn’t.

Now, to be fair, in many cases cities are in a sort of prisoner’s dilemma when it comes to offering incentives to attract businesses. An Oklahoma University article here goes into further detail. The main problem is that the practice has become so commonplace, that for a city to not offer any incentives would put it at an extreme disadvantage. Firms have the upper hand in negotiations because they know what they want in a city, whether it be urban amenities, highly skilled workers, or whatever they prefer. But cities competing for them don’t know exactly what the firm is looking for. A firm could be dead set on, say, Tacoma for whatever reason, but the city of Tacoma doesn’t know that, and might assume that this firm is closely considering a whole host of other cities to locate in. So Tacoma offers the firm generous tax breaks, not knowing that the firm was set to locate here regardless.

Even the CEO of Hallmark Corporation has said:

If you’re looking at the competitiveness of a region, the most important thing a region can do is to focus on education. And this use of incentives is really transferring money from education to businesses.

And this really gets at the main point in my mind. It’s not just that these incentives are ineffective at promoting economic development, it’s that they come at a cost of far more worthy and effective public services; Public services that might actually make a city more economically competitive in the long run. In an era where many cities are still recovering from extreme budget cutbacks due to the recession, local governments and their constituents can ill afford these business incentive practices.

 

 

 

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