Tax Incentives: High Risk, Pending Reward for Some Cities

August 4, 2019
Author: ThinkWhy Analyst

A 10-month research project by the New York Times found that tax incentives given to U.S. businesses by states, counties and cities total roughly $80 billion per year. Incentives, such as tax credits, help offset a company’s financial obligation to federal and state governments, and in some instances, small metros can ante up a larger package for businesses.

Tax Incentives for Businesses

Much in the same way unsuccessful teams get next year's first-round draft pick to improve their rankings, policymakers can use economic development incentives to bolster the economy of smaller metropolitan areas with hopes of landing an all-star business. Local governments offer incentives when they think a company’s presence and growth will boost the local economy.

An (Amazon) prime example of this would be the aforementioned company’s quest for a new HQ2 location. The company set the business world on fire as it searched for a second headquarters to house 50,000 workers. The nationwide competition from 2017-2018 had Amazon soliciting proposals from over 200 large and small metros before eventually selecting New York and Washington, D.C.

While smaller cities like Columbus did not win the competition, they showed what they were willing to wager to bring a global firm to the city. It became a business deal between Amazon and the City of Columbus, but if not careful, the more willing party could have been thrown for a financial loop.

As such, Columbus made the top 20 of 238 cities with a sizeable offer consisting of:

  • 100% property tax abatement for all Amazon sites, for 15 years
  • Up to $400 million of paid employee taxes earmarked for a Jobs Growth Incentive to be achieved over 15 years
  • 25% of Amazon employee city taxes funneled into a Transit and Mobility Fund
  • Additional incentives totaling over $100 million

So, do these incentives drive the economic and job growth the cities hope to see?

A detailed study, published in the Journal of Regional Science of more than 350 companies, found firms that received tax-based incentives had negative results when looking at the company’s ability to create jobs. In addition, research indicated that these businesses expanded more slowly than others and the overall effect of incentives was a reduction of 10.5 jobs per establishment. Future employment at these companies was overestimated by businesses at an alarming 28.5 jobs. The study hypothesized that not only do businesses overestimate the jobs they will create, but they may do so intentionally to receive more lucrative packages.

Some economists also speculate that incentives can be counterproductive. Jobs created in one community come at the expense to another city. The tax breaks may leave holes in the city budgets with less to spend on infrastructure improvements and education. Other incentives are cut to make way for new businesses with hopes that the benefits will even out over time. At times, they do. In 2017, Wisconsin pledged $3 billion in incentives for Foxconn to build a plant in Racine County. According to Wisconsin’s estimates, the cost to taxpayers per job is $230,700, and the investment won’t be recouped until 2043.

Similar to the ‘winners’ and ‘losers’ of the Amazon hunt, a joint study conducted by economists at MIT and the University of California, Berkeley, examined the economic effects of site selection winners in manufacturing plants on community economies. Researchers found that the selected city did in fact see small increases in wages, productivity and property values when compared to the losing locations.

Ultimately, new businesses bring new jobs to cities and local economies. New jobs attract more people, thus, making housing availability a factor. If a city is not equipped to handle the expansion, it will experience issues similar to what San Francisco, California faced, an economy that adds residents faster than affordable places to live. When housing supply is lo and rent rates increase, that which was meant to solve an issue can possibly create a larger one down the line.

If the right steps are taken, incentives can absolutely bolster the local economy, providing jobs and creating a positive impact on the state’s GDP; however, in some cases, businesses can take advantage of a city’s willingness to offer breaks and make substantial net gains in the process. Both parties involved in the business deal should examine the risks involved before committing to a plan.