Offering tax incentives to businesses could actually harm state economies, according to a recent analysis by the Institute on Taxation and Economic Policy (ITEP). Senior Analyst Carl Davis investigated the academic literature on how effective business tax incentives really are at meeting their goals, and found mostly cautionary tales.
Davis points out that the vast majority of business decisions aren’t responsive to tax credits. “As many as 9 out of 10 hiring and investments decisions subsidized with tax incentives would have occurred even if the incentive did not exist.”[i] This consensus indicates that at best a tax break just sweetens the deal for a business, but at worst it reduces a state’s business tax revenue while barely impacting the business one way or another.
The high cost to states is especially troubling since states often pay for tax incentives with reduced spending elsewhere. And that reduced spending risks public services and investment that makes a state attractive to businesses in the first place.
“If offering more tax incentives requires spending less on public education, congestion-relieving infrastructure projects, workforce development, police and fire protection, or high technology initiatives at public universities, the overall impact on a state’s economy could actually be negative.” – Davis
Davis primarily recommends that states pull back on their dependence on tax incentives, but acknowledges that as a political impossibility.[ii] Instead, he says, states should improve their incentive design to avoid the pitfalls he warns against. His recommendations line up with the way North Carolina has designed its discretionary programs: Lawmakers should target their incentives towards economically underdeveloped areas, and include claw-back mechanisms (basically, money-back guarantees) and size caps to protect state investment.[iii]
So far it seems that North Carolina’s doing pretty well in avoiding the pitfalls that Davis enumerates. According to analysis from the Pew Charitable Trusts, North Carolina already leads the pack in making sure its incentives have strong oversight and effective impacts.[iv]
When devising a smart economic development strategy, North Carolina should retain a balance between incentives and investments in education, infrastructure and quality of life. It doesn’t have to be an either/or proposition.
[i] Davis, Carl. (August 12, 2013). Tax Incentives: Costly for States, Drag on the Nation. Institute on Taxation and Economic Policy. Presented to the NCSL Executive Committee Task Force on State and Local Taxation. Available at http://www.itep.org/pdf/taxincentiveeffectiveness.pdf
[ii] See note i.
[iv] The Pew Charitable Trusts. (April 12, 2012). “Evidence Counts: Evaluating State Tax Incentives for Jobs and Growth.” Available at http://www.pewtrusts.org/en/research-and-analysis/reports/2012/04/12/evidence-counts-evaluating-state-tax-incentives-for-jobs-and-growth