Bringing the Economy Home

One Take on How Tax Incentives Work

Center on Budget Policy and Priorities

Michael Mazerov

Michael Mazerov is a Senior Fellow with the State Fiscal Project at The Center on Budget and Policy Priorities.  I contacted the center to discuss the potential shortfalls of Idaho tax incentive programs after coming across this article.

The Center on Budget and Policy Priorities is a non-partisan research and policy institute which works at the federal and state levels on fiscal policy and public programs that affect low and moderate income families and individuals.

Q: How do state tax incentives work?

A: There’s a wide variety of incentives that state governments and local governments use to try and attract new businesses or encourage businesses that are already in the state to expand their investment or job creation.  Basically, a tax that a state imposes on a business could theoretically have an incentive added to it.  At the state level the most common kinds of incentives are reductions in the state corporate income tax based on increasing investment or increasing the number of employees a company has or increase the amount of R & D in the state.  Some states have credits or reductions in the state corporate income tax if the company moves its headquarters to a state.  But, they all basically involve cutting a tax in exchange for doing something the state thinks will benefit its economy.

Q: Does the state end up losing money?

A: Certainly, when the state first grants the credit, they’re definitely reducing the revenue from the tax that they’re allowing the break on.  What they’re doing is hoping that in the long run what they’re doing will generate enough economic activity as a result of the credit that the economic activity will recoup some of the revenue lost that they initially lost by granting the credit. 

But, there is just an overwhelming amount of research that suggests that — some of these incentives can stimulate economic activity that might not otherwise occur in this state — it never generates enough activity for a credit to quote unquote pay for itself.  And any policy maker who makes that claim just is doing it without any support from economic literature.

Q: If the benefit doesn’t outweigh the loss why do states keep doing this?

A: Even if it doesn’t pay for itself, they might think that it’s a worthwhile expenditure of state tax revenue to try and create jobs.  But what you have to consider is the revenue loss also can result in a loss of jobs.  The revenue that’s being foregone from the tax incentive was being used to hire people to work on roads, or state police officers or teachers.  And the revenue is also frequently used to create jobs in the private sector.  States spend a lot of money hiring private contractors to provide various kinds of services to the state.  Whether we’re talking about the people who build roads for the state or supply food to the correctional institutions, all that state spending creates both public and private sector jobs.  So, when the revenue isn’t there to do that because it’s been given to private business, you’re losing jobs initially in the hope that jobs will be created as a result of the incentive down the road. But, usually at best, it’s a wash and there are no net jobs created.

Q: So, it’s a matter of trade-offs, or priorities?

A: There’s a notion that private sector jobs are just inherently preferable to public sector jobs and that’s why there are so many people — policy makers — who are willing to give away tons of state revenues in order to stimulate private job creation.  But, it ignores the fact that many of the public sector jobs are performing functions that we all need, and that private businesses need.  So it can be very harmful to states’ economic prospects if the consequences of providing additional tax incentives means a cut back in education, which means a less skilled workforce for the private sector, deteriorating roads that may impose costs on businesses in the state that need those roads to get their goods to market and so forth.  So, it can be very counterproductive for economic development to give away too many tax cuts in the name of job creation. It can be self-defeating, in other words.

Q: Are states offering more credits or incentives now than in the past?

A: Unfortunately, they’ve been around for a long time.  Most people would say that most of these incentives were first instituted in states in a limited way during the recession of the 1930s.  And in part because that was really the first time they had enough revenue to be able to devote to this, what was called ‘smoke stack chasing’.  So it has a long history, but I think it’s also true that it’s really accelerated in the last couple decades because the international economy has become so much more competitive, because the U.S. has lost so many manufacturing jobs, which has worried state policy makers.  So I think unfortunately it’s kind of a growing trend.

Q: How do policy makers determine if the tradeoff is worthwhile?

A: There has been a great deal of research that’s been done on this issue over the years and one thing it’s important to understand is that even the studies that show incentives can have some impact, some positive impact on job creation or economic growth, conclude it’s a very small impact that isn’t realized for a very, very long period of time.  The consensus of the research concludes that you have to cut the entire state and local tax burden of a business by about 10 percent to encourage even just a two percent increase in job creation in a state.  And no state can afford to give away 10 percent of a business tax base.  So you’re talking about a very small pay off given the amount of revenues that states can realistically forgo through this.  It’s just much better for states to be focusing their economic development efforts on doing their basic job well.  Having a good education system, having a well-functioning road system so businesses have the services they need and the skilled workforce they need, in the long run that’s the best economic pay off for the state.


About StateImpact

StateImpact seeks to inform and engage local communities with broadcast and online news focused on how state government decisions affect your lives.
Learn More »