A Better Way to Boost Economic Development

Iowa Gov. Kim Reynolds, a Republican, signed a bill this month

doubling a state tax credit

to help chip in nearly 10 percent of the cost of a new $15 billion steel mill in the state. Pennsylvania Gov. Josh Shapiro, a Democrat who has described himself as “competitive as hell” when it comes to economic development, announced $50 million in loans and grants to help

attract a yogurt company

last month. Those are just a few examples of states giving out cash and other incentives to spur economic development, efforts which can add up to nearly $100 billion a year around the country.

But according to

a new paper

from the W.E. Upjohn Institute for Employment Research, cash incentives aren’t very cost-effective. If states want to see a fiscal return on their investments in economic development, in terms of higher tax revenue that would allow them to invest in services or cut taxes, they should think about incentives differently, the paper argues. That means investing more in services and less in cash.

“Handing out cash incentives is easier to do, and frequently the press coverage is quite positive. It associates a governor with a job-creating project,” says Timothy J. Bartik, a senior economist at the Upjohn Institute who has studied economic development incentives for decades and who authored the recent paper. “You can see why people are attracted to this. It’s a way of demonstrating you care.”

But cash incentives have a fairly low rate of economic return. A typical state incentive generates only about $1.75 in total economic gain per $1 spent, and only about 17 cents on the dollar in terms of tax revenue, according to the paper. Currently, cash grants and tax credits account for about 85 percent of state spending on incentives, while investment in services like job training or site development only accounts for about 15 percent. Flipping that ratio around could deliver more benefits to states, because spending on services tends to deliver more jobs and economic benefits per dollar. At the same time, targeting incentives to distressed places, and building housing near the targeted economic development areas, can improve the cost-benefit ratio.

“In order to have large economic effects, [an incentive] really does need to have benefit-to-cost ratios that are much higher — 8 to 1 or 10 to 1,” Bartik says. “You need to figure out very high-leverage policies.”

In

another paper

published this summer, Bartik found that economic incentives in Chattanooga, Tenn., could create significantly more benefits if they incorporated training, which increases the likelihood of new jobs going to local residents. That paper estimates that adding job training to existing incentive programs could dramatically improve the area’s per-capita income over time. Bartik, who developed his

own model

for calculating incentive impacts, says this is a better way of measuring the benefits of incentives than simply counting up the number of jobs they create. It accounts for things like the employment-to-population ratio, and how many local residents get access to new jobs, versus job creation attracting outsiders.

“You’ve got to look at whether people’s standard of living is getting better,” he says.

In addition to emphasizing training, Bartik argues states should direct incentives to distressed areas, either using a sliding scale to provide higher incentives to projects in those areas or by limiting some incentives to those places. Incentives in distressed areas tend to result in more jobs for people who weren’t previously working. They should be paired with efforts to build new housing in these areas, so that housing prices don’t grow out of reach for local populations because of economic development projects that were supported with public money.

“If you’re at the same time [offering incentives and] making it impossible to build housing, your policy is somewhat schizophrenic,” Bartik says.

Economic development incentives are a source of perennial controversy. Big stadium deals that draw down generous public subsidies often spark a backlash from residents and taxpayers. Recently there’s been a groundswell of opposition to data centers, focusing partly on their environmental impacts but also highlighting the incentives that data-center builders have received from states, like sales-tax credits for equipment they buy. Such moments of public focus on state incentives create opportunities for reformed policies that emphasize more significant benefits to residents and taxpayers. Bartik says cash incentives have to be very large to motivate businesses to locate somewhere they wouldn’t otherwise consider, and often states give tax credits to incentivize a decision that would have happened anyway. Smaller investments in services might not get policymakers the same headlines, but he says they could have a better payoff in the long run.

“I do think that states have to pay more attention than they might have in the past,” Bartik says. “If we have a policy, to what extent does it have fiscal benefits?”