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Research & Commentary: Targeted Tax Incentives Do Not Encourage Growth

January 23, 2019

In this Research & Commentary, Matthew Glans examines targeted tax incentives and how they fail to encourage economic growth at a high cost to taxpayers.

In cities and states across the nation, state and local governments are scrambling to attract new and relocating businesses through corporate welfare schemes, including tax incentives, abatements, credits, exemptions, and deductions. Over the past three decades, the number of cities and states offering businesses tax incentives has tripled.

The goal is to improve their economies while creating jobs within their state and municipal borders. However, there are two main problems with targeted-benefit tax policies: they misallocate tax resources and they allow the government to pick winners and losers in the economy, encouraging rent-seeking and cronyism.

The most prevalent incentives used by state and local governments are job creation tax credits and property tax abatements, which together accounted for more than 70 percent of all incentives given across states according to Richard Florida of CityLab.

Unfortunately, these incentives do not always generate the jobs and economic development their designers promise. In a 2002 study, Todd Gabe of The University of Maine and David Kraybill of The Ohio State University examined 350 companies that received incentives and found a negative effect on their ability to create jobs. Gabe and Kraybill found that companies receiving incentives expanded more slowly than others. In fact, the effect of the incentives was a reduction of 10.5 jobs per establishment. Another study found that many of the new jobs created in tax incentive zones went to people moving in from elsewhere, not local residents. The study found this number to be as high as 30 percent of new jobs created.

In a 2012 study in CityLab, Richard Florida and Charlotta Mellander examined if a positive correlation existed between economic development incentives per capita and economic variables like wages, income, poverty rates, and education levels. Their findings challenge many of the supposed benefits of tax incentives: “We found no statistically significant association between economic development incentives per capita and average wages or incomes; none between incentives and college grads or knowledge workers; and none between incentives and the state unemployment rate,” wrote Florida.

According to a 2012 study by the Pew Center on the States, many of the states offering incentives have not created effective and transparent mechanisms to gauge their effectiveness over time. These programs are often far most costly than expected. One example cited by Pew was Minnesota’s Opportunity Building Zones program. Although Minnesota’s Department of Employment and Economic Development estimated the cost per job at $5,000, a subsequent evaluation by the legislative auditor’s office put the program’s cost per job between $26,900 and $30,800.

Dangling state and local tax incentives is a flawed method of promoting economic development. Much too often, these examples of crony capitalism fail to generate the economic benefits promised by politicians and business owners. Even worse, this rent-seeking is perpetuated by businesses and industries with the most political influence, not the businesses best suited to thrive in a free-market environment.

Instead of choosing winners and losers and further complicating byzantine tax codes, lawmakers should focus on creating a sound and robust economic environment that attracts businesses. In other words, instead of offering taxpayer-subsidized goodies to attract businesses, lawmakers ought to roll back regulations and reduce tax rates, which would benefit all residents.

The following documents examine economic tax incentives and how they have failed to achieve substantive growth in greater detail.
 

Evidence Counts: Evaluating State Tax Incentives for Jobs and Growth
http://www.pewstates.org/uploadedFiles/PCS_Assets/2012/015_12_RI%20Tax%20Incentives%20Report_web.pdf
In this report, the Pew Center on the States reviewed nearly 600 documents and interviewed more than 175 government officials and experts to examine how—and how well—states gauge the effectiveness of their tax incentives, if they do so at all. The report also outlined how to identify promising approaches to doing it right.

Study: Tax ‘Incentives’ Don’t Bring Jobs
https://www.heartland.org/news-opinion/news/study-tax-incentives-dont-bring-jobs?source=policybot
Travis Perry writes for Watchdog about a new study from the McQueeny group that examined the effectiveness of Kansas’ tax breaks provided through Promoting Employment Across Kansas program. “Through statistical research, Jensen discovered that PEAK tax breaks had little to no effect on whether a company created new jobs,” wrote Perry.

The Impact of Tax Incentives on the Economic Activity of Entrepreneurs
https://www.heartland.org/publications-resources/publications/the-impact-of-tax-incentives-on-the-economic-activity-of-entrepreneurs?source=policybot
This paper, authored by Finnish government researchers Jarkko Harju and Tuomas Kosonen, examines the effects of tax reforms enacted in Finland on small business owners’ business activity.

The Political Economy of State-Provided Targeted Benefits
https://www.heartland.org/publications-resources/publications/the-political-economy-of-state-provided-targeted-benefits?source=policybot
In this Working Paper, Christopher J. Coyne and Lotta Moberg of the Mercatus Center at George Mason University examine he unseen and unintended negative consequences of targeted-benefit policies. The paper analyzes two major downsides of these policies: (1) they lead to a misallocation of resources, and (2) they encourage rent-seeking and thus cronyism. Coyne and Mobery argue that these costs, which are often longer-term and not readily observable at the time the targeted benefits are granted, may very well outweigh any possible short-term economic benefits.

Tax Breaks for Businesses Usually Don’t Work
https://www.heartland.org/news-opinion/news/tax-breaks-for-businesses-usually-dont-work?source=policybot
In this article, William Ahern of the Tax Foundation argues lawmakers seeking to foster economic growth should focus on good tax fundamentals in their states, rather than short-term tax abatements and exemptions designed to lure prestigious companies, professional sports teams, and auto plants from other states.

Chapter 312 and 313 Property Tax Abatements Help the Wealthy and Connected at other Texans’ Expense
https://www.heartland.org/publications-resources/publications/chapter-312-and-313-property-tax--abatements-help-the-wealthy-and-connected-at-other-texans-expense?source=policybot
In this paper from the Texas Public Policy Foundation, Stanley Greer examines how property tax abatements under just two programs are costing Texas -especially school districts - more than $1 billion a year in revenue, with more than half of those abatements being granted to renewable energy projects.

The Pros and Cons of Selective Property-Tax Abatements
https://www.heartland.org/publications-resources/publications/the-pros-and-cons-of-selective-property-tax-abatements?source=policybot
In this Indiana Policy Review article, Cecil Bohanon examines the arguments for and against tax abatements and concludes that tax abatements do not in general promote fairness or efficiency, particularly if they are selective.

Avoiding Blank Checks: Creating Fiscally Sound State Tax Incentives http://www.pewstates.org/research/reports/avoiding-blank-checks-85899433960
This analysis of state tax incentives from Pew illustrates how tax credits, deductions, and exemptions do not promote job creation and economic growth, in many instances they increase the risk of budget shortfalls.

Targeted Economic Incentives: An Analysis of State Fiscal Policy and Regulatory Conditions
https://www.mercatus.org/system/files/calcagno-targeted-economic-incentives-mercatus-working-paper-v1.pdf
Peter T. Calcagno and Frank L. Hefner of the Mercatus Center examine why states choose to provide targeted incentive packages to companies despite a lack of success for such programs. Calcagno and Hefner argue these decisions are made for political and not economic reasons.

 

Nothing in this Research & Commentary is intended to influence the passage of legislation, and it does not necessarily represent the views of The Heartland Institute. For further information on this and other topics, visit the Budget & Tax News website, The Heartland Institute’s website, and PolicyBot, Heartland’s free online research database.

The Heartland Institute can send an expert to your state to testify or brief your caucus; host an event in your state, or send you further information on a topic. Please don’t hesitate to contact us if we can be of assistance! If you have any questions or comments, contact the government relations team, at governmentrelations@heartland.org or 312/377-4000.

Author
Matthew Glans joined the staff of The Heartland Institute in November 2007 as legislative specialist for insurance and finance. In 2012, Glans was named senior policy analyst.
mglans@heartland.org @HeartlandGR