Governments Increasingly Rely on Evaluations for Tax Incentive Reform

This article was written by the State Fiscal Health division of the Pew Charitable Trusts. 

The District of Columbia scaled back funding earlier this year for a tax incentive program targeting  technology companies by approximately $16 million after a statutorily required evaluation by the city’s chief financial officer revealed that, among other findings, several large companies had received substantial credits without evidence of new economic activity in the district.

In implementing changes to the Qualified High Technology Companies incentive, lawmakers used the evaluation findings to debate the budget trade-offs of continuing the program as it was structured. This process illustrates the growing frequency with which states and cities are translating strong incentive reviews into policymaking. Like its peers, the district followed a strategy that research by Pew has shown can lead to important reforms: Make a plan, measure the impact, and use the findings to inform decisions.

More States Plan to Evaluate Incentives

Kansas and Montana both put requirements in place in 2019 to regularly evaluate economic development tax incentives, bringing the total to nearly two-thirds of U.S. states.

In Kansas, lawmakers created a framework for reviewing each economic development incentive once every three years. Evaluations will address important questions, such as the extent to which incentives affect business behavior and whether they are achieving their goals. The state’s Legislative Division of Post Audit, which has produced several one-time evaluations of economic development programs, will conduct the reviews.

Montana’s newly established process takes a different approach, relying on reviews by lawmakers. State law requires legislators to evaluate select incentives on several measures, including whether they benefit some taxpayers at the expense of others and the effects on the larger economy. In North Dakota, lawmakers play a similar role in evaluating state programs.

Not all efforts to expand incentive evaluations proved successful this year. Georgia Governor Brian Kemp (R) and Nevada Governor Steve Sisolak (D) each vetoed evaluation bills, leaving both states to reconsider the issue in future sessions and to continue legislating tax incentive policy without the benefit of ongoing, independent analysis.

New Evaluations Measure Incentive Impact

Pennsylvania’s Independent Fiscal Office (IFO) published its first evaluations on three of the commonwealth’s credits at the start of the year. Each recommends how the Legislature could improve the programs and includes metrics that can help the state better judge future program effectiveness. For example, IFO suggests switching the Historic Preservation credit application process from a lottery to a scoring system to increase administrative transparency and better align the program with intended outcomes.

In September, Philadelphia released an evaluation of its economic development incentive programs. The study made several crosscutting recommendations, such as eliminating redundant programs, creating portfolio-wide metrics so the city can compare effectiveness, and strengthening data-sharing across agencies.

Legislatures Demonstrate that These Reviews Matter

Evaluations offer evidence to help states and cities make informed decisions about incentives that can lead to improvements in program performance. For instance, Oklahoma altered eligibility provisions for its Quick Action Closing Fund as a result of a state program evaluation to help the incentive meet its goal of attracting high-impact businesses. Based on recommendations in a review by Virginia’s Joint Legislative Audit and Review Commission (JLARC), policymakers expanded a provision in the state’s Small Business Investment Grant Fund to reclaim credits from companies that move out of state within a certain period of time or close because of a criminal conviction.  

Incentive reviews also can identify issues involving unclear or confusing program guidelines. That was the case when Nebraska clarified eligibility and refundability provisions for the state’s Beginning Farmer Tax Credit based on findings from the Legislative Audit Office. In another example, Minnesota added transparency measures to its housing grant and loan application processes to give applicants more information on the scoring system used to select beneficiaries. The reform aligned with an evaluation conducted by the state’s Office of the Legislative Auditor.

Evaluations also can highlight unused or ineffective programs. Virginia ended the state’s Telework Expenses and the Worker Retraining tax credits, which a JLARC program evaluation found were rarely used or ineffective. Pennsylvania closed its New Jobs Tax Credit to new applicants following conclusions from the Independent Fiscal Office that the program was likely not influential in business decisions to hire new employees. Oklahoma did the same based on a recommendation from an evaluation when it eliminated an ineffective portion of the state’s Small Business Incubators Incentives Act. Indiana, meanwhile, repealed a collection of rarely used energy and transportation-related incentives, among others, following evaluations by the state’s Legislative Services Agency.

In addition to altering or eliminating existing programs, lawmakers can use the evaluation process to develop new strategies for bolstering state economic development tools. For instance, North Dakota created a new incentive after an interim committee charged with evaluating state tax incentives identified a need to better support the state’s manufacturing sector when companies reported they were struggling to find qualified workers.

Much has changed in recent years regarding how states weigh decisions about their tax incentives. The likelihood that tax incentive policies will be accountable and informed by evidence is increasing as more state and local governments produce regular evaluations with greater depth.