Are Tax Incentives an Economic Development Answer?

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Economic development deals are in the news all the time. As companies announce expansions or headquarter relocations, the media is rife with details about incentives offered to secure these projects.

Some argue that these incentives would not be necessary if governments did not compete against one another for projects. But the fact is, competition does exist. As a result, cities and states without an effective toolkit of incentives at their disposal are at disadvantage.

One regular criticism against the use of incentives is that the so-called benefits of economic development projects don’t outweigh the cost in lost tax revenue. In fact, many state and local governments use a return-on-investment calculation to determine whether a company even qualifies for incentives. For those businesses that are offered incentives, the ROI analysis often drives the level and types of incentives offered.

Another fact often ignored by detractors is that hundreds of companies are turned away every year for participation in these programs. Indiana, like most states, requires a project to meet a "but-for" test before incentives can be offered: But for the incentives being provided to the project, the company would not locate or expand its business in the state. This requirement makes state incentives unavailable to many projects and industries.

Some economic development projects receive incentives that are not competitive in the traditional sense of one state competing against another. For example, tax increment finance, or TIF, is a local program that uses future property tax revenues on projects to offset capital costs. These projects often occur at redevelopment sites that have cost-prohibitive infrastructure needs. In such instances, the deciding factor in utilizing incentives is not a traditional but-for test. Rather, the question is whether the project can move forward without the use of incentives to reduce the higher costs of developing the site.

Because the benefit of programs such as TIF is often paid upfront, the scrutiny to approve their use is greater. That said, upfront incentives programs are more the exception than the rule in Indiana. Most state-level incentives programs are performance-based. This means that the incentives are not paid out until the companies create the jobs and/or makes the anticipated investment.

A final criticism levied against economic development programs is that tax credits and other benefits are paid to companies that eventually move their operations outside the state. In most states, protections are put into place to penalize such companies. For example, Indiana’s economic development agency, the Indiana Economic Development Corp., enters into incentives contracts that require companies to file reports on an annual basis, verifying their compliance with the terms of these contracts. If a company has received incentives and subsequently leaves the state while the deal is still active, the IEDC has the ability to claw back those incentives, a practice it enforces consistently and aggressively.

Despite the various controls in place, not every deal goes as planned. The projects that go south are often the ones that receive the lion’s share of the attention in the media and from critics. But if Indiana is going to continue to vie for economic development projects, incentives are a vital part of remaining competitive. By taking steps to mitigate or eliminate its risks in providing incentives, Indiana is able to enhance its stewardship of taxpayer dollars while directing the cost/benefit analysis of using incentives decidedly in its favor.

Tim Cook is Chief Executive Officer and Katie Culp is president of KSM Location Advisors.

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