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States Smarten Up on Economic Development Incentives

States and localities have long regarded corporate tax incentives as handy tools for economic development. Experts, meanwhile, have equally long found occasion for criticism in their implementation.   Now, steadily accumulating evidence suggests that states are getting smarter in their design of incentive packages and that the practice is changing, gradually, for the better.

Incentive packages have become so prevalent that an entire boutique consulting industry exists around helping corporations maximize them.   A fierce competition for capital compels states to offer increasingly generous packages to would-be investors in the name of job creation, even though everybody would be better off if no state risked taxpayer dollars to secure the investment. 

The sums of money at stake are far from paltry. A new book, “Investment Incentives and the Global Competition for Capital,” estimates that state and local governments grant $50 billion to $70 billion in tax breaks each year through these programs.

But a recent article by Karen Thuermer in fDiMagazine suggests that the recession has forced states to rethink current practices and deploy these tools more strategically.  This coincides with an increasingly recognized focus among economic development practitioners on organic growth in well-nurtured regional systems.

It’s about time too. Good Jobs First, an advocacy group, criticizes incentive programs for their poor or undocumented job-creation results, favoring of large corporations over smaller growth firms, and weak accountability practices, for starters.

What is more, research from Jed Kolko at the Public Policy Institute for California found that no more than 2 percent of annual job gains across states nationally can be attributed to business relocations anyway, while more than 95 percent come from the expansion of existing businesses or the birth of new establishments. 

So reform is long overdue. Brookings’ own research for the state of Nevada--itself grappling with how and when to use a deal-clinching fund to execute its economic diversification strategy--advances some basic principles on leveraging incentives. For starters, a project should relate to the state’s broader economic strategy. The investment should add depth or breadth to an existing regional industry cluster; such embeddedness will position the region for further growth and innovation and offer taxpayers a higher return on investment.  

Thuermer highlights other elements that define best practice, like joint capital investments and workforce training provisions. The value of the incentive should be scaled to the size of the investment. States should attach strings deliberately.

Incentives are a legitimate tool for catalyzing economic development, but too often they have been irresponsibly deployed. Accountability and transparency are on the rise, thankfully. Meanwhile awareness of the organic regional nature of job creation is increasing too. As it does, incentives will come to be seen as one tool among many for bolstering the regional industry clusters that do the real work of job creation and economic development.