by Kathryn Bailey
States across America routinely seek to grow their economies by luring companies to establish or expand their state presence in exchange for incentives, usually in the form of tax breaks. Politicians are eager to use economic development programs to create jobs within their state or retain existing ones. Every state runs some type of development program, and about 45 offer tax incentives for corporations. Tax experts estimate that state and local governments distribute about $50 billion per year in targeted incentives to business.[i] The promise of tax incentives lies in their purported ability to result in net gains for state economies through corporate reinvestment and hiring. However, in light of budget shortfalls in at least 40 states in the coming fiscal year (2012)[ii], including many states with generous incentives, a closer look at the costs and effectiveness of these policies is critical.
The state of Texas has traditionally been very business and investment-friendly, offering generous incentives for research and development and low corporate taxes. In recent years, Texas has touted its desire to attract companies to establish a presence in the state with aggressive incentive programs. By some accounts, Texas’ strategies for economic growth have been highly effective. According to the National Bureau of Economic Research, the U.S. economy peaked in December 2007 before entering a recession. Texas’ economy, however, continued to grow throughout most of 2008 and declined more slowly than the entire U.S. economy during the recession (-1.4 percent versus -2.4 percent).[iii]
Texas’ most prominent laws impacting economic development include the Texas Enterprise Fund and Emerging Technology Fund. While state leaders, including Governor Rick Perry, are eager to continue to enhance Texas’ competitiveness, the state is facing a projected budget shortfall of as much as $24 billion over the next two years, and economic development incentives will undoubtedly have to compete with other programs for state dollars. The question of whether the programs are paying off in terms of employment and economic growth is one that the state will be forced to examine closely in the coming months.
How State Economic Incentives Work
The general goal of economic incentive programs is to create jobs and increase incomes by using lower taxes to stimulate capital investment and economic activity. A favorable tax incentive could work to attract investment from companies outside the state. In a recruitment letter sent by Governor Perry to California businesses in December of 2010 he stated, “As the State of California continues to support legislation and initiatives that cause undue burden and taxation on companies doing business within the state, I invite you to consider your future in America’s new land of opportunity: the State of Texas.”[iv]
A successful set of incentives that leads to new investment by businesses can create jobs and increase wages and incomes, thereby increasing aggregate consumption and driving up the gross state product. These incentives largely involve lowering the total cost of operating businesses by offering favorable tax treatment (such as tax credits). The costs of the tax preferences offered may be partially offset by an increase in state income, sales or corporate tax revenues due to the new business activity (depending on which taxes are levied by the state).
Effectiveness of Texas Programs
There are a range of policies in Texas meant to influence job creation and capital investment, and the forthcoming budget balancing challenges are spurring a closer look into what policies have demonstrated convincing returns. On December 10, 2010, the Texas Comptroller, Susan Combs, released a report evaluating the state’s economic incentive programs that called for increased scrutiny of their benefits and costs. “While incentive programs create jobs for the Texas economy, the total number of jobs directly attributed to incentive programs represents a small segment of statewide employment. Incentives can be beneficial for targeting specific industries or achieving specific goals, but should not be relied on for overall economic growth.”[v] According to the report, only 0.8 percent of the jobs in Texas can be directly attributed to its economic incentives programs.[vi]
Lawmakers on both sides of the aisle are criticizing these incentives programs; Rep. David Simpson (R) has announced plans to target the Enterprise and Emerging Technology Funds. Rep. Mark Strama (D), Chairman of a House committee studying the incentives, predicted that the two funds would receive less money in the next two-year budget. He said that he believes the technology fund in particular, has strayed from its original mission of creating a market for innovations coming out of higher education institutions, and instead is now an avenue for companies that are unable to raise private capital.[vii]
Aside from the Texas Enterprise and Emerging Technology funds, another major policy meant to increase economic growth and employment is the school property tax break. Property taxes comprise a major portion of operating expenses for capital-intensive companies that have a large physical footprint, such as energy (both oil refineries and green energy projects such as wind farms). In an effort to recruit these types of projects to Texas, legislators in 2001 authorized school districts to grant property tax breaks, for which the state government would reimburse the districts in per-pupil funding.
In her report on economic incentives, Ms. Combs wrote that those tax breaks have helped the state to attract industries with significant employment, but have also been “increasingly used to over-incentivize projects that create few or no jobs.” Of the 98 investments that have received tax breaks, 63 are for wind farms. The cost per job for the wind power projects is about 10 times the cost of a manufacturing job and 30 times the cost of research and development job under the school district allowance.[viii] If the school property tax break continues, it will cost the state about $400 million in revenue lost by Texas school districts in the coming two-year budget.
Debates Over Economic Incentive Programs Extend Beyond Texas
While Texas may soon be forced to reevaluate its tax incentives, other Governors have indicated that they intend to continue policies that ease the corporate tax burden. In his inaugural speech, Florida Governor Rick Scott asserted that “the only path to better days is paved with new private sector jobs.”[ix] He described a program of eliminating business taxes as part of his plan to create jobs, dubbing them, along with regulation and litigation as the “axis of unemployment.”[x] Research suggests, however, that this policy may not be an effective strategy. A study published by the Heartland Institute in 2006 examined the failure of a Michigan corporate incentive policy to create jobs. The authors suggest the decisions which companies should receive incentives were made not on the basis of long-term economic development goals, but were instead based on political considerations. As a result, the author believes policymakers overestimated the potential job impact of the incentives.[xi] Regardless of the incentives’ impact on jobs, Texas and Florida both face massive budget deficits and their revenue losses from current or proposed tax structures are particularly impactful in light of their lack of personal income taxes.
While tax incentives to attract employers and encourage economic growth have long been a key element of economic development strategies for state elected officials, these policies merit closer cost-benefit analysis and impartial evaluation. This would undoubtedly lead to heated political debate and may entail reexamination of widely accepted truths. Nonetheless, as states prepare to make sweeping and painful cuts to government programs to balance their budgets, a second look at the results of these incentives programs is warranted.
[i] LaFaive, Michael. “Analysis: Targeted Tax Incentives Unnecessary, Ineffective.” The Heartland Institute. July 2006.
[ii] McNichol, E.; Oliff, P.; Johnson, N. “States Continue to Feel Recession’s Impact.” Center for Budget and Policy Priorities. Updated 16 Dec 2010. Available at: http://www.cbpp.org/cms/?fa=view&id=711.
[iii] Comptroller’s Economic Outlook, updated Oct. 22, 2010. Text available at: http://hlrgazette.com/2010-articles/114-may-8-2010/921-texas-economic-outlook.html.
[iv] Register, Jan. “Texas tries to recruit California businesses.” Orange County Statesman. 15 Dec 2010.
[v] Combs, Susan. “An Analysis of Texas Economic Incentives 2010.” 10 December 2010. Available at: http://www.texasahead.org/reports/incentives/pdf/EconomicIncentives.pdf.
[vii] Copelin, Laylan. “Report adds fuel to debate about Texas incentive programs.” The American-Statesman. 22 Dec 2010. Available at: http://www.statesman.com/news/texas-politics/report-adds-fuel-to-debate-about-texas-incentive-1141330.html
[ix] “Florida Governor Rick Scott Inaugural Address.” 4 Jan 2011. Available at: http://www.flgov.com/2011/01/04/florida-governor-rick-scott-inaugural-address/.
[xi] LaFaive, Michael. “Analysis: Targeted Tax Incentives Unnecessary, Ineffective.” The Heartland Institute. July 2006.