Corporate Incentives: Five Keys to Success

December 27, 2022

By Randall Bauer, Director, Management and Budget Consulting, PFM Group Consulting, LLC

For a long time, there has been a vigorous debate over whether the provision of incentives from state and local governments to corporate America is money well spent. Although there’s no clear data showing exactly how much is being spent to attract and retain businesses – and the jobs they produce – the numbers are undoubtedly huge; estimates range from $30 to $95 billion a year. There are plenty of pros and cons about incentives, but one thing is clear: They’re not going away. With that in mind, I believe that it’s critical that we focus on how to make them as effective as possible.

For the past several years, PFM Group Consulting and Smart Incentives have collectively conducted dozens of evaluations of business incentive programs in multiple states. Having observed many that work as intended as well as many that do not, I’ve come up with five ways to design and administer incentives in a way that can help to improve the results they produce in ways that will help make best use of taxpayer dollars.

Write them to keep up with the times. In many instances, incentives come with requirements, such as minimum capital investment or minimum wages for new jobs. If written in a way that specifies a dollar amount, they can lose relative value over time because of inflation.

An example is Oklahoma’s Investment/New Jobs Tax Credit. The program was created in 1980 with a $7,000 minimum salary required for the credit. That requirement hasn’t changed. Now, 42 years later, it is irrelevant, as any job paying even the minimum wage would qualify.  If hard dollar values are used, they should be regularly indexed for inflation.

An even better approach is to tie required wage rates to the prevailing local wage rates. To qualify for incentives under Iowa’s High Quality Jobs Program, for example, wages must reach 120 percent of the average within the labor shed where the jobs are located.

Identify a stated purpose, get there, and get out.  A notable complaint about incentives is that they become little more than an ongoing subsidy to a particular business or industry. That is a valid concern – one of the arguments against film tax credits is they benefit a nomadic industry that doesn’t really ‘take root’ and create ongoing jobs absent the incentive.

Oklahoma now requires that its legislature identify the purpose of an incentive when it is created, and that appears to be a good practice. An example of how that allowed the state to ‘declare victory’ and move on was a production tax credit that primarily benefited wind turbines for generating electricity. The cost of that credit increased from $4 million in 2010 to $113 million in 2014 – with likely continued growth. While the cost was significant, it had helped the state achieve a legislative goal of 15 percent of the state’s energy being produced by renewable sources. In fact, in 2015, the state was at nearly 20 percent and growing. As a result, on our recommendation, the legislature eliminated the incentive program, as the goal had been achieved.

It’s a carrot, not a cookie. A well-designed incentive will encourage economic or other positive activity that would not have occurred otherwise – that’s the carrot. If it merely rewards activity that would have likely occurred otherwise, it is the equivalent of giving out a cookie. This ‘but for’ test is a subject of ongoing discussion and debate. Many in-depth studies with complex models have been constructed to prove/disprove the ‘but for’ test, but in the words of Bob Dylan, ‘you don’t need a weatherman to know which way the wind blows.’ Several years ago, PFM did an analysis for the City of St. Louis that found that its primary incentives, tax increment financing (TIF) and tax abatement had largely been used in the city’s wealthier and faster growing areas, where it wasn’t necessary. To its credit, the City revised its policies to limit the value and duration of tax abatements in these areas.

It’s the economy, stupid. Incentives should be tailored to the state or local economy. Oklahoma has a growing aerospace industry, and they have tailored some incentives to grow the aerospace engineering labor force. That’s smart. On the other hand, the State also offers an incentive for motorists to purchase ethanol-blended motor fuel. Oklahoma is not a major corn growing state, and it has no ethanol refineries. Oklahoma is a major oil producing and refining state. The state is incenting consumers to buy non-Oklahoma goods, at the expense of a major native industry – not so smart.

Rifle shots are better than shotgun blasts. In many instances, using the tax code to incentivize a wide range of activities will diffuse the benefit (the shotgun approach) and create complexity. This is particularly problematic because tax departments are generally focused on tax collection and not equipped to run application programs for tax benefits.

The alternatives, including well-crafted rebates, forgivable loans, or tightly controlled contract grant programs will better target public funds (the rifle shot approach). Economic development departments can be effective at appropriately implementing these incentives, so it makes sense to develop application and scoring processes that fit in their purview.

Economic incentives will continue to create controversy, and their benefits will remain an open question. Regardless, focusing on the concepts presented here should help. These will not make these programs perfect, but they should make them better.

The contents of this blog post reflect those of the author, and not necessarily those of the GFRC.