The Flaw of Attraction

Research questions the value of tax incentives for economic development

The idea that a municipality must offer bait to lure new business to town is now common practice. Businesses have learned to play local governments against each other to gain favorable tax treatment. Last Summer, Ball State University economist Dr. Michael J. Hicks offered a contrarian view at a Westfield Chamber luncheon. Dr. Hicks consented to an email interview in this exchange conducted in December. It has been edited slightly for clarity and brevity.

Hamilton County Business Magazine: The gist of your presentation was that these incentives don’t work, at least not long-term. Can you elaborate?

Dr. Michael Hicks: There's no doubt that many factors play into business location decisions and effective tax rates are among those issues. Economic theory is very clear on this, but it is also true that few matters lend themselves so well to actually examining the numbers. And, as it turns out, businesses, like households, really care more about the value proposition between local services and taxation. Empirical research very clearly reports that the suite of capital based tax incentives does nothing to induce net employment growth or net business investment. The worst of these are abatements, followed by tax increment financing.

The reasons for this aren't too difficult to follow. First, abatements and TIF generally move tax revenues away from local government, or shift the cost to other local taxpayers. So, the special benefits that accrue to the recipient, actually come at the expense of other taxpayers. This alone dampens the net effect to the point that regional economies show no positive gains to tax incentives or TIF.

 

There's another reason as well, that should be obvious to everyone in the economic development business. The attraction of firms plays a vanishingly small part in net employment. Something less than two percent of net employment in Indiana since 1990 comes from relocation of firms. More troublingly, all the growth in employment in the past 40 years has been in non-footloose or non-attractable firms.

An inherent part of the problem is that the many consultancies, like Barnes & Thornburgh, who make their practice on selling bonds and negotiating abatements place great pressure on economic developers to continue the practice. It is an unpleasant reality that the fortunes made by bond attorneys plays a bigger role in the deployment of economic development dollars than does the welfare of citizens and communities in Indiana.

HCBM: But economic development officials insist that this is what world has come to: it's a hyper-competitive environment and unless a city is competing with this suite of incentives, it will lose businesses to other communities. Are you saying a city would be better off if it did nothing?

Hicks: So, there's three parts to this answer. Firstly, of course communities should do things. They should make themselves places where other residents would like to move, by crafting top flight schools, making their communities safe, offering public spaces where they can enjoy themselves, and if possible make their city squares the type of venues that a varied type of recreation and retail business would want to locate. But, as far as luring new businesses to a region, the benefit of a local community doing so will almost never outweigh the costs. Fewer than two percent of jobs net new jobs in Indiana have been caused by business relocation, and these jobs, in footloose industries, typically pay worse, are more sensitive to a business cycle, and are less likely to endure than the other 98 new jobs created by other firms.

There is a viable argument for business attraction to occur at a broad regional level (like say, greater Indianapolis), but for communities within Hamilton County for example it is a waste of money. In fact, spending money on attracting firms to the really fine communities in Hamilton County borders on the absurd. This is one of the fastest growing counties in the US, and should do nothing to lure new businesses that raises the cost on current residents and firms that have already invested in the community.

Hamilton county is successful because of investments in quality of place, not business attraction.

HCBM: This sounds fine in theory but if a firm is considering relocating and it has competitive offers from several communities, wouldn't you expect it to take the one that is offering the best financial incentive instead of the one that has the best quality of place?

Hicks: No. Oddly enough, in theory it would seem that the financial incentives make the most difference, especially if you are a commodity employer (low skilled low pay workers). But, for firms looking for better skilled workers to fill higher paying jobs, the availability of workers is the overwhelming location determinant, and has been so for several decades. Empirical research from decades of plant location studies give human capital the strongest edge in attracting and retaining business.

So, it's quite a juxtaposition; the economic developers who argue that it is all about incentives (or even a little bit about incentives) are really enthralled by economic theory that was discredited before many of them were born.

HCBM: I attended a Noblesville City Council retreat a few weeks ago that included an attorney extolling the virtues of single payer TIF's, where cities award a TIF to a single developer for one project instead of within a geographic area. These are the economic development tools of choice these days. How can cities be weaned off of them?

Hicks: No doubt the retreat you attended featured a consulting firm extolling the virtues of a single payer TIF. They have really had to step up their game since Ball State, LSA, USI and Purdue have all published studies that report the benefits of TIF are much smaller than their costs.

These studies do a lot to help legislators and other policymakers understand the overuse of TIF, and they give leverage to policymakers who wish to limit their use. But, in the end, the actual results speak for themselves. Together, TIF and tax abatements pull close to a billion dollars a year out of local government coffers. That is like one out of every seven dollars and for most communities it is more than property tax caps. The breathtakingly irresponsible use of development incentives has clobbered schools, libraries, and any local government except redevelopment commissions.

Under real pressure, some of the consulting firms are now reporting these losses in their studies, when just two years ago they adamantly claimed there were none. So, ultimately, the overuse of incentives is what is destined to cause the legislature and governments to slow their use.

Now, there are many good examples of TIF's, and if well informed taxpayers are happy to continue their use I would never complain. But, make no mistake about it: the need for Hamilton County to have to supplement school funding through property tax referenda is due to the excessive use of TIF and tax abatements.

I think the people of Hamilton Count largely get a good value for their tax dollars, and in most cases would support additional taxes. But, development incentives are not a free lunch, they cost real money and lost opportunities to do other things for their communities. All voters should understand this and hold consulting firms to task for making false claims otherwise.

By Mike Corbett