Fisher, Peter S.

Peters, Alan H.

English

Upjohn Research

Employment Research Newsletter Volume 5 Number 2 Article 1 10-1-1998 Industrial Incentives: Competition among American States and Cities Peter S. Fisher University of Iowa Alan H. Peters University of Iowa Follow this and additional works at: https://research.upjohn.org/empl_research  Part of the Regional Economics Commons Citation Fisher, Peter S., and Alan H. Peters. 1998. "Industrial Incentives: Competition among American States and Cities." Employment Research 5(2): 1, 3–4. https://doi.org/10.17848/1075-8445.5(2)-1 This title is brought to you by the Upjohn Institute. For more information, please contact repository@upjohn.org. W.E. Upjohn Institute for Employment ResearchEmployment Research B Fall 1998Peter S. Fisher and Alan H. Peters, University of IowaIndustrial Incentives: Competition Among American States and CitiesIn recent years, there has been much "revisionist" research on the effects of economicdevelopment programs at the state and local level. There is now substantial evidence thateconomic development programs can help local economies by reducing unemployment andincreasing earnings. Some, such as Bartik (in his book Who Benefits from State and LocalEconomic Development Policies?), have gone beyond this to argue that such local policiesmay benefit the nation if the incentives are concentrated in low-growth or high-unemploymentregions, because the benefits of jobs created there will exceed the benefits lost by not creatingjobs in low-unemployment areas.Are the economic development incentives offered by states and cities significantly higherin high-unemployment places? This article summarizes the results of a study, sponsored by theUpjohn Institute, that uses new data to examine the spatial pattern of incentive offers. In our research, we measured competition among places based on the dollar value of alocality’s standing incentive offer to industrial firms expanding or locating in that locality. Thestanding offer included the whole range of competitive incentives over which state or localgovernments have some direct control: income tax investment and jobs credits, property taxabatements, sales tax exemptions, grants, loans, loan guarantees, and firm-specific job-trainingand infrastructure subsidies. Because incentives may be embedded in tax codes, and because the value of incentives toa firm must be measured net of income tax effects, we also modeled the federal corporateincome tax, each state’s and city’s corporate income and net worth taxes, the major state andlocal sales taxes paid by business, and local property taxes. We used the hypothetical firm method to measure the value of competitive incentives.We constructed financial statements for 16 hypothetical firms, representing the characteristics ofa typical large and small firm in each of eight fast-growing manufacturing industries.  The model then measured the net returns on a new plant investment, after all taxes andincentives. The new plant is located in one of 24 states, the 24 that account for the mostmanufacturing employment in the United States (combined, they represent 86% of the total), andin one of 112 cities, randomly selected from within these 24 states.Is There Significant Variation in Returns across Locations?Is there sufficient variation in returns on investment across states and cities that tax andincentive differences could affect location decisions? If incentives have little effect onprofitability at different sites, there is little reason to worry about their effects on redistributingemployment.We found large differences between the returns available at the "best" locations and returnsavailable at the "worst" locations, considering state and local tax systems and tax incentives (butnot other incentives). Even when we ignored variation within states by focusing on arepresentative city in each state, we found effective state/local tax rates on new investment thatranged, for example, from 1.7% to 10.2% for a small but profitable manufacturer of soaps andtoiletries, and from 4.1% to 23.8% for a large but low-profit automobile manufacturer.  These are the extreme cases; for the typical sector, the highest-tax state placed a taxburden on manufacturers that was about three times as large as that in the lowest-tax state.Another way of examining the magnitude of incentives is to measure the differencebetween the best and the worst standing offers among our sample of cities and then to convertthis difference to an hourly wage equivalent. For some firms, the results were startling. For the large drug firm, the difference betweenthe best and worst sites translated into an average hourly wage difference of  $1.82. For mostfirms modeled, the equivalent hourly wage difference between the best and worst sites wasbetween $0.65 and $0.95 per hour. Moreover, the spreads between cities at, for example, the 80th and 20th percentiles or the75th and 25th percentiles remained large. Thus, it seems reasonable to conclude that, at least atthe extremes, taxes and incentives are potentially large enough to influence location decisions.The inclusion of non-tax incentives very often did little to change the majority of cities inthe top 20 or bottom 20.  In most cases, cities that were highly competitive after taxes and taxincentives were also highly competitive after the inclusion of non-tax incentives. Overall,non-tax incentives did not ameliorate, but actually accentuated, the tax differentials between thebest and worst cities.Three tentative conclusions emerge: 1) the differences in investment returns across statesand cities due to tax and incentive differences are quite substantial, and it is certainly plausiblethat these differences are large enough to influence location choices; 2) the magnitude ofincentives, relative to returns after taxes but without incentives, is substantial; and 3) incentivecompetition per se is not producing convergence across sites; if anything, it is increasinginter-site differences. Are Returns Higher in High-Unemployment Cities? We focus here on the results for the sample of 112 cities, using actual local tax rates andincentive programs as well as state taxes and incentives.  Almost all of the correlations betweenunemployment and taxes or incentives are of modest size.There is a consistently negative relationship between unemployment and returns afterbasic taxes (without any incentives); the highest-unemployment places have the highest taxburdens. There is a consistently positive relationship between unemployment and tax incentives:the highest-unemployment places offer the largest state and local tax incentives.  This result is dominated by local property-tax abatements and by enterprise-zone (EZ)incentives; we deliberately allowed the largest incentives available in a city (which would beenterprise-zone incentives in the 40% of our cities with such zones) to represent the city as awhole. Considering non-tax incentives, there is no clear pattern of providing inducements toshift jobs either towards or away from high-unemployment places. Figure 1 illustrates the lack of any consistent pattern by focusing on a firm that wastypical in terms of the correlation of taxes and incentives with unemploymentCthe instrumentsmanufacturer building a $180 million plant. We show only the top 25 cities (those with thehighest return for this plant after taking into account all taxes and incentives) ordered byunemployment rate. For each city, the graph shows the rate of return after basic taxes and how this rate ofreturn is improved through the provision of enterprise zone incentives and other (tax andnon-tax) incentives. Some cities that ranked poorly after basic taxes improved their positiondramatically through non-enterprise zone incentives; others did so through enterprise zonecredits. Some cities, including some with relatively low unemployment, were very competitivewithout incentives and enhanced their position further through incentives. But incentives are notprimarily compensating for high basic taxes.While incentives do modestly favor places with higher unemployment, these incentivesonly offset the tendency of basic state taxes on business to be higher in high-unemploymentstates. The end result is a spatial pattern of returns on new investment that is essentially random:there is no discernible tendency for returns to be more attractive in high-unemployment or inlow-unemployment places. It appears that, after at least a decade and a half of intense competition for investmentand jobs and the widespread adoption of pro-development tax policies and developmentprograms, states and cities have produced a system of taxes and incentives that provides no clearinducement for firms to invest in higher-unemployment places. It is true that in the absence ofthat competition the pattern of returns might well favor the least distressed places. However, thisis difficult to say for certain, because some of the "perversity" we observed in state taxes mayitself be the result of competitive pressures that produced changes in the underlying tax codes ofcertain states. Some incentives are embedded in what we modeled as the "basic" tax system. Conclusions: The National Benefits of Competitive Economic Development PolicyThese results are consistent with the following arguments (though they certainly cannotbe taken as proof): 1. State and local tax reductions and development incentives are adopted for a variety ofreasons, high unemployment perhaps being one, but slow growth and simple imitation ofothers being more important reasons.2. Even where economic distress, as measured by high unemployment, may have providedthe original political impetus to cut business taxes or adopt incentives, these measures arelikely to persist even if state economic performance improves.To the extent that tax and incentive competition results in a redistribution of jobs, ourresearch lends little support to the argument that this redistribution has beneficial effects for thenation as a whole (by shifting jobs from places with low unemployment to places with highunemployment). Neither can we say that it is clearly harmful (i.e., by providing inducements toredistribute jobs in the opposite direction). Of course, one can only speculate what the spatial pattern of returns on investment in1992 would have looked like had states and cities never undertaken to influence their economicfortunes by offering inducements to industry in competition with one another. Only if thispattern would have been distinctly counterproductive (with higher returns inlower-unemployment places) could one conclude that competition has been beneficial, bynullifying such effects.This article describes research published in the Upjohn Institute book of the same title. Drs. Fisher and Peters areprofessors of urban planning at the University of Iowa.

Industrial Incentives: Competition among American States and Cities

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Industrial Incentives: Competition among American States and Cities

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