Are tax incentives boons or boondoggles?

Tax incentives intended to attract and retain businesses have been around for decades. But while the use of such a tool has remained largely steady in recent years, huge mega-deals are at an all-time high.

“It used to be rare when a company wrested more than $1 billion from the public to open a facility,” Kasia Tarczynska, senior research analyst for Good Jobs First, wrote last December. “In 2022, … there were eight economic development deals in which companies received at least $1 billion in subsidies—for a single facility. That’s an all-time record.”

This has been the case even though an overwhelming amount of research has demonstrated that tax incentives are generally an unproductive way to attract and retain businesses. One of the best-known researchers in the field, Timothy Bartik, senior economist at the Upjohn Institute for Employment Research, wrote a few years ago, “Research suggests that typical incentives tip less than 25% of the location or expansion decisions of assisted businesses. Even without the incentives, the state or local area would have received at least 75% of these jobs.”

There are, of course, success stories. The California Competes program, which provides up to $180 million a year in tax incentives, is one such place. The secret sauce here has been a combination of total transparency and a rigorous process for making sure that the incentives are genuinely a decisive factor in making a location decision. In fact, California Competes carefully monitors awardees to ensure that the jobs companies have promised are still in place for three years after they have received their tax credit. According to a study by University of California, Irvine, “each California Competes incentive job in a census tract increased the number of individuals working in that tract by two.”

But California Competes is an outlier, says Nathan Jensen, professor in the Department of Government at the University of Texas, “It’s kind of the open secret that rarely are tax incentives the pivotal factor in shaping an investment.”

The truly pivotal factors are the presence of a well-educated workforce, good transportation and even the weather. Why then are incentives so popular?

One major reason is that elected officials can’t lay claim to the competency of the labor pool or the transportation system, and they certainly can’t tell potential voters that they’ve somehow interceded and created a temperate climate. But whether or not the incentives were the deciding factor in a corporate relocation, officials can stand at a factory opening and be happily praised by the corporate chiefs for the good work they did in landing the deal with tax incentives, whether or not that was case.

“One of the very few things a governor, mayor or city council member can use to show that they’ve caused economic development in their region or state are incentives,” says Jensen. “So, they’ll point to them to say that’s why the company came, even if it was coming anyway and the governor or mayor knew that.”

After years in which the issues regarding tax incentives have been raised again and again, it’s clear—given the political benefits perceived by elected officials—they’re not going away anytime in the foreseeable future. That being the case, the least a government should do is to try to ensure that the promises made in exchange for the expense are kept.

Some places have attempted to do so through co-called clawbacks, which are stipulations in the incentives that say that if various goals aren’t met, the taxpayer dollars will have to be returned. That sounds like a good idea, but in practice it often doesn’t work.

For example, sometimes companies inflate their job numbers, and without an audit, the government has no way to know they didn’t meet their goals. In other instances, when the promises aren’t kept, the government takes the expedient step of rewriting the contract. “Michigan regularly amends contracts,” says Jensen. “They’ll push out the timeframe or lower the number of jobs promised.”

Last October, the Georgia Department of Audits and Accounts pointed out that the Division of Economic Development “reported that productions filmed in Georgia in 2019 delivered $9.2 billion in total wages, but it did not disclose that those wages also included distribution jobs (e.g., movie theater workers) unrelated to production, as well as the indirect and induced jobs supported by them. Additionally, federal data showed approximately 10,700 Georgia jobs in film production in 2020, while the division reported ‘tens of thousands of Georgians’ were employed in film production.”

A superior approach, agree many, is to dole out incentives on a performance basis, so that companies don’t get any tax abatements until they’ve delivered on the promises made. Explains Ellen Harpel, founder of Smart Incentives, “If you’re using a claw back, then the money is already out of the door. [But for states] using performance-based incentives in which there are milestones, the payments are only made when they’re reached.”

Adds Greg LeRoy, executive director of Good Jobs First, “while politicians would hesitate to pull the trigger on a claw back, in part because it may be seen as kicking a company while it’s down, the performance-based structure doesn’t force them to deal with that. It’s clean.”

When Virginia, for example, struck a deal with Amazon to build its second headquarters in the state, the arrangement was made for Amazon to get $22,000 for each new job it created only after the job was filled. The goal was for the company to create some 25,000 new positions with an average annual salary exceeding $157,000.

Another approach that can be effective is to provide incentives in the form of infrastructure improvements. That way, even if a corporation goes out of business or leaves for another location, the infrastructure improvements are still in place and can be used to attract future economic development deals. Mary Elizabeth Wilson, general counsel of the North Carolina Department of Commerce, is a big advocate of this approach. “With infrastructure dollars, we mitigate our risk,” she says.

For example, Toyota is building a major facility in Randolph County, North Carolina. For its first phase, the state has appropriated some $135 million to be used by its Department of Transportation for site prep, roads, a highway interchange and other site improvements.

Many governments have tried to limit the potential overuse of incentives by capping the amount that can be spent on them. According to Josh Goodman, senior officer at the Pew Charitable Trusts, almost every state puts caps on some of their incentives, but most use them inconsistently, with caps placed on one program but not on others. He recommends that states use aggregate caps, citing Iowa as a good example. According to that state’s Department of Revenue, Iowa limited all tax credit awards to $258.9 million in 2022 up 15.9% from fiscal year 2021.

“Incentives always have indirect effects,” says Goodman. “If they limit tax revenues, then you’re spending less on something else. And if you’re spending less on education, then you could wind up with a less educated workforce and that could cost you more in terms of economic development than the incentives may have gained.”