SUBSIDIES AND INCENTIVES

Evaluating incentive packages that lure businesses into a region is a particularly difficult task. For starters, the intraregional sample size is much too small to draw statistical inference; there simply are not enough comparable developments in a single region to statistically determine whether an incentive package has been effective. Secondly, it is difficult if not impossible, to determine what might have occurred had policy not been implemented.

While this problem exists when attempting to assess the effectiveness of any economic development strategy, it is particularly evident when considering incentive programs. Notwithstanding the problems associated with evaluating the effectiveness of incentives, researchers have undertaken a number of innovative approaches to measure their impact. Surveys, regression analysis and case study analysis are among methods used to evaluate incentives..

Surveys have been sent out to existing businesses, probing which reasons most influenced site location. For example, Schmitt et al. (1985) surveyed 950 companies that were randomly drawn from the membership of the Michigan Chamber of Commerce. Businesses were given a list of 34 factors that might be expected to influence a business expansion or relocation decision and were asked to rank the importance of each.

Researchers considered only results related to a location choice among communities within a metropolitan area. The survey found that a city's general business climate or attitude toward industry got top consideration. This comprehensive category encompasses the city's fiscal, zoning and regulatory climate, along with its propensity to "cut a break" for business. "Distance to customers" and "cost of property" were ranked as second and third most important factors. Ranked fourth were financial inducements.

Regression analysis offers a more objective and rigorous evaluation of the efficacy of incentives, though it too is imperfect. Bartik (1991) undertook an extensive examination of previous regression studies specifically examining the influence of particular economic development policies. He concluded that "enterprise zones, research parks, location incentives, such as property tax abatements, and export promotion programs make some difference to state and local economic growth."

Referring to economic development policy broadly, he stated that competition among state and local governments probably enhances the efficiency of the U.S. economy since the most depressed areas will adopt more aggressive policies. This should result in a geographic redistribution of economic activity to areas were it is most efficient.

Bartik also suggests that widespread economic development subsidies may encourage an expansion of national employment, leading to a lower average national unemployment rate. McHone (1984), examined 26 metropolitan areas in several states. He found that the presence of an industrial development bond program, property tax exemptions and accelerated depreciation of manufacturing equipment all positively influenced a county's probability of experiencing a competitive growth component greater than the metropolitan area's. He also found that local taxes, as a percentage of income, exert a statistically significant negative influence.

Anderson and Wassmer (2000) conducted a regression study on the influence of local property tax abatements in a metropolitan area. Their findings suggest that manufacturing property tax abatement will help to bring or retain industry, but that continuously increasing the number or magnitude of tax abatements will not continue to help grow the manufacturing base.

However, property tax abatements are not completely beneficial. A rise in local commercial property tax abatements decreases the value of local homes, decreases local expenditure per capita and increases the rate of grants/user charges. Anderson and Wassmer concluded that policymakers must also consider negative secondary effects when assessing the desirability of local property tax abatements.

The case study approach is distinct from regression analysis and survey research, though it may incorporate one, both, or neither into its method. Lynch, Fishgold, and Blackwook (1996) undertook a case study to determine the effectiveness of firm-specific state tax incentives provided by Industrial Development Agencies (IDAs) to promote economic development in New York State. They tracked total tax costs and bonding activity of IDAs between 1987 and 1991, showing that total tax losses exceeded $1.3 billion.

Little evidence exists that IDAs have encouraged firms to relocate to, remain in, or expand within New York state, they concluded. Furthermore, they suggested that other states currently employing or contemplating the use of firm-specific tax incentives to foster economic development should consider alternative methods.

Local economic development is a highly complex matter that lacks a clear conceptual model incorporating all of its potentially important dimensions (Smoke, 1997). The research addressing the broad impact of business incentives on the locational decisions of firms is contradictory on many of the most important issues; however, there has been agreement on some points.

Many argue that public policy is a more effective instrument of economic competition within metropolitan areas than between them, or between states or regions. (Bradbury, Kodrzycki, & Tannenwald 1997). There is also some consensus that a stable tax system is more important to ensure economic vitality than the availability of incentive programs.

Fisher & Peters (1997) found that incentives tend to accentuate basic tax differences, reinforcing the view that business location decisions are motivated largely by factors other than taxation. They suggest that small differences in labor and other costs can outweigh quite large differences in tax costs and incentive awards.

They propose that neither tax incentives nor non-tax incentives offset the effects of the basic state-local tax systems. This belief was echoed by Wylensko, who recommends that policymakers "pay attention to maintaining a stable business tax system with low rates and broad tax bases that can efficiently support the service levels preferred by businesses and residents of the state, rather than to ad hoc 'competitive' tax reductions possibly accompanied by cuts in service levels or rising deficits" (Bradbury, Kodrzycki, &Tannenwald 1997).

Researchers have also cautioned planners about the use of tax incentive programs. First, tax incentives may foster development by reducing business costs, but they can indirectly impede development if they reduce expenditures on public services that businesses value. (Bradbury, Kodrzycki &Tannenwald 1997). Second, it may be unrealistic to expect incentive programs to lead to job creation.

Fisher and Peters refer to the work of Netzer, who pointed out that economic development incentives generally reduce the cost of capital rather than labor, yet believes it is unlikely that the reduction in the cost of capital will lead to employment increases. Instead, Netzer asserted, we should expect some substitution of capital for labor, given that "the new capital induced by cheap credit or state corporate tax credits is likely to be largely exempt from local property taxes, it may be no great success from a local standpoint if the labor intensity of a new plant is quite low (often the case with the more spectacular industrial development bond issues of past decades). So it is important to distinguish between capital and labor subsidies." (Fisher & Peters 1997).

The inconsistent findings regarding the effectiveness of incentives can also be seen in studies of enterprise zones. A majority of states have adopted enterprise zone legislation and several evaluations have been conducted to study the usefulness of this strategy. Because enterprise zones generally employ a number of incentives, they add to the body of literature assessing the value of incentives in promoting economic growth. In most cases, researchers found the benefits to be modest at best.

Dabney (1991) studied enterprise zones in eight states. He determined that tax incentives were often offset by higher economic costs such as insurance, transportation and access to raw materials. The only significant change was for small independent firms and firms in a few specific industries.

However, there was no significant difference in the rate of growth among those or other classifications in the zones when compared to the city as a whole. Furthermore, Dabney reported that the impact of incentives on business locations was marginal except in those cases where the value of the incentive is large relative to the amount of investment. As a result, small businesses were most attracted to enterprise zones.

He suggested that the typical enterprise zone program consisting of limited tax incentives and regulatory relief is unable, by itself, to address adequately the necessary factors found to be important in most business location decisions. Dabney concluded that enterprise zone incentives are unlikely to make up for the significant locational disadvantages presented by inner-city enterprise zones.

Wilder and Rubin (1996) examined 21 studies that covered enterprise zone programs across the country. They found little evidence of program success, but point to scant research on the effect that land use and community planning has on the success of geographically targeted economic development programs. They suggest that the lack of effective planning may be an important missing element in enterprise zone programs.

Boarnet and Bogart (1996) studied New Jersey's enterprise zone program and found no evidence of job growth or increased real estate value attributable to the program. One study, conducted by Sridhar (1996), reported large net benefits for a sample of 68 enterprise zones in Illinois. However, her conclusions were criticized because her research assumed that program incentives were responsible for all employment generated in the zones (McDonald 1997).

Dowall (1996) analyzed 13 zones in California between 1986 and 1990. Using shift-share analysis, he found that virtually all of the actual employment growth over the time period could be explained by countywide growth and industrial mix components. In fact, Dowall concludes, after these two factors are accounted for, the total residual-effect component for the 13 zones was negative.

Dowall summarizes his assessment of enterprise zone programs as having produced modest economic benefits and concludes that there is little evidence to suggest they have strengthened the economic advantages of economically sluggish neighborhoods.

A recent study of Louisville's enterprise zone (Lambert & Coomes 2001) further supports the argument that zones offer limited benefits. The study found little evidence of either economic or neighborhood revitalization benefits that could be attributed to the enterprise zone program.

Lambert and Coomes estimated that a minimum of $55 million in forgone tax revenue and fees and administrative costs was attributable to the program, but the number of jobs and employed residents within the zone actually fell even as the rest of the county experienced growth in both measures. While they admit being unable to determine precisely the costs and benefits of the enterprise zone program, they believe the benefits have been modest while the costs have been significant.

Tannery (1998) studied the effect of the Targeted Jobs Tax Credit (TJTC) on the earnings and labor force participation of welfare recipients and disadvantaged youths. The TJTC granted the employer of an eligible worker a tax credit equal to 40 percent of the worker's wages in the first year of employment or $2,400 per employee, whichever was less. Workers were eligible if they belonged to one of several groups, such as welfare recipients and youths aged 18 to 22 from economically disadvantaged families.

These two groups account for about 80 percent of the available data and therefore served as the focus of Tannery's study. The analysis was based on 17,000 workers in Pennsylvania. He compared their earnings with individuals who applied for the program and therefore had similar circumstances, but were denied participation because of paperwork or other application problems.

Tannery found that eligible workers--welfare recipients and disadvantaged youths alike--accrued substantial earnings gains. Moreover, the cumulative income gains to program participants exceeded the $2,400 maximum per worker cost of the program. His results also suggested that certified workers were more likely to be employed than those in the uncertified comparison group; the greater on-the-job experience attributable to the subsidized employment explained at least part of the earnings differential.

Tannery determined that the earnings differential remained after the program ended, providing evidence that the program's gains are long-term. Critics allege the TJTC program did little to create jobs because workers were certified after being hired. Tannery responds that the program incites employers to lengthen the tenure of otherwise short-term jobs.

see corresponding section in Strategies & Tools