Evaluating State Incentives for Business

Author: Ben Zimmer, Connecticut Policy Institute, New Haven, Connecticut

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To one degree or another, every state, and even the federal government, does it: provides incentives to private companies to create or import jobs or to keep them from moving jobs offshore or out of state. Annually, the collective cost to our state and federal governments in direct benefits paid to companies and foregone tax revenues is $80 billion.

Recently, a number of high profile cases has demonstrated the, at best, intermittent success of government incentives as a tool for generating job growth. Even when successful, the costs for states are often exorbitant, as the Oklahoma Tax Commission determined in 2009 when it calculated that the state’s “Small Business Capital Formation Incentive Act” had generated only 21 new jobs at a cost of $17 million.

To help state governments determine the efficacy of proposed incentives, and to help rein in the fraud and waste that are the result of incentives proposed for political rather than economic reasons, the Connecticut Policy Institute has developed a three-part test for distinguishing jobs incentives that are likely to be net contributors to the economy from those that are merely handouts.

Part 1: The total cost of any incentive should not exceed the amount that would be paid back through incremental tax revenues over 10 years. In most states, the tax revenue generated from a job is 5% of compensation. The threshold for a 10-year return would be crossed, then, when the total cost of any incentive exceeds 50% of the annual compensation for any jobs kept or created by the incentive. The formula is a fairly straightforward one: to keep or create 100 jobs with an average annual compensation of $100,000, the total cost of an incentive should not exceed $5 million, or $50,000 multiplied by 100.

Part 2: Any job kept or created by a jobs incentive must remain viable in the state offering the incentive after its expiration. Otherwise the jobs will disappear with the incentive, blunting any impact it might have had on the state’s long-term job growth.

Part 3: Jobs incentives should only be applied to jobs that would otherwise not come to a state or would otherwise leave it. Incentives should not be used to reward companies for hires that they were likely to make anyway.

In states adopting such a three-part test, companies would be required to submit an application explaining how any incentive they seek meets each of the three criteria. Applications would be reviewed by the states’ Department of Economic Development, or the equivalent thereof.

A three-part test for jobs incentives would hardly be foolproof in preventing waste and fraud. Unlike part 1, which is a straightforward mathematical calculation, parts 2 and 3 are more difficult to determine. However, an application process would at least place the burden of proof on the company seeking an incentive and create a far greater level of transparency than that which currently governs the usually ad-hoc, back-room process by which incentives are awarded in most states.

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