Playing the Incentives Game

Two questions dominate the debate over tax breaks and other financial incentives that states and localities offer companies to attract new operations or retain existing ones: On balance, is this practice good for the citizens? And do companies really care if they get these goodies or not?

The answers are maybe, and maybe.

A recent New York Times “investigation” of the issue found that governing entities are “giving up more than $80 billion each year to companies” across the U.S. as mayors and governors “desperate to create jobs [are] outmatched by multinational corporations.” At a time of unprecedented fiscal strains for states brought on by the Great Recession, an ambiguous economic recovery and the Obama administration’s own financial woes, such a narrative of corporate victimization of hapless government officials can strike a popular chord.

The trouble with this portrait is that even the Times admitted a “full accounting” of whether the awards end up being worthwhile disbursements by governments “is not possible.” Also, most of the story dealt with blows administered to localities by plant closings in the wake of the 2009 bankruptcy of General Motors—a one-off disaster for economic development if ever there was one.

What’s more, these incentives aren’t nearly as dear to “scheming” business executives as it might appear.

“State and local incentives” placed just fifth on the list of site-selection factors considered by company executives in the most recent survey by Area Development magazine. “Highway accessibility” was No. 1, followed by “labor costs” and “availability of skilled labor,” which tied for No. 2, then “corporate tax rates.” “Occupancy or construction costs” tied with incentives for No. 5.

The magazine’s companion survey of site-location consultants placed state and local incentives as No. 7, also adding “proximity to major markets,” “available land” and “energy availability and costs” as priorities ahead of incentives.

“There’s not strong evidence either way as to whether [incentives] are important [to companies] or not,” says Jared Konczal, senior analyst in research and policy at the Kauffman Foundation, the Kansas City-based outfit that studies American entrepreneurship. Adds Mark Arend, editor-in-chief of Site Selection magazine: “There is no yes or no.”

Many people involved on either side of such negotiations leave no doubt that other major factors dwarf the allure of incentives per se, for states as well as companies.

“In order to pay for them, [states] basically have to raise taxes on everyone else, so then you become a higher-tax state for other companies deciding where to locate,” notes Ben Zimmer, executive director of the Connecticut Policy Institute. “Everyone who’s not getting that incentive may locate somewhere else. So if it’s a long-term strategy to attract jobs to a state, I don’t think [financial incentives] are a particularly sound approach.”

“Lower, broad-based, uniform taxes are better than targeted tax incentives, top to bottom,” agrees Frank Conte, project manager for the Beacon Hill Institute State Competitiveness Report by Suffolk University in Boston. “What’s important is general tax policy, as well as other things, especially human capital.”

So the case of Spreadshirt is typical. With an American headquarters in Boston and manufacturing in Greensburg, Pennsylvania, the Germany-based maker of cloth-printing equipment wanted to add production in the Western U.S. While Nevada offered six-figure tax incentives for capital improvements and training, they ranked only fourth or fifth on Spreadshirt’s list of priorities for deciding between Nevada and California.

“Proximity to an international airport, a large labor pool and the availability of space were all clearly more important” than incentives in the company’s decision to open a plant last year in Las Vegas that now employs 60 people, with an expansion in the works for late 2013, says Mark Venezia, Spreadshirt’s vice president of global sales and marketing. “But the tax rates in California definitely weren’t attractive.”

There were no financial incentives that Illinois possibly could have offered to get Roger Sessions to change his mind about moving Ferris Manufacturing and its 50 or so jobs from Burr Ridge, Illinois, to Fort Worth last year.

“Just as the business climate is bad in Illinois because no one wants to be the last guy there, businesses want to be in Texas and look at it with a different attitude,” says the chairman/CEO of the $25-million manufacturer of wound-care dressings. Ferris “dropped a few hints” to Illinois officials about wanting to move the company “but no one seemed to notice or care.”

While other factors loom much larger in qualifying a locality for consideration as a site, financial incentives remain an essential condition for any state or city that wants to be considered a serious player near the end of a potential deal.

“You can’t get businesses to think about moving without them, and states that don’t offer them are handcuffed from making any major strides in getting businesses to move to their state,” says Jerry Kremer, chairman of Empire Government Strategies, a Uniondale, New York-based economic-development consulting firm and former state legislator.

“Tax incentives are one of the most important things in our [closing] arsenal,” adds Reed Hall, CEO of Wisconsin Economic Development.

Robert Hess, an executive managing director of site consultant Newmark Grubb Knight Frank’s global corporate services practice, argues that the appeal of incentives simply comes down to the bottom line. “If they can move the internal rate of return to 15.1 percent from 14.7 percent on an operation, for instance, it helps make the financial case, and that’s always what’s most important.”

Surprisingly, however, even after going to great trouble to garner financial incentives for site-selection deals, the vast majority of such benefits actually go unclaimed “because companies don’t understand the reporting requirements and don’t file claims properly, or there’s a loss of transition with a change in management,” according to Angela Lockman, a vice president in the workforce-solutions unit of Equifax.

On the other hand, state officials don’t want to be taken by companies and discover a few years down the road that the recipient of huge incentives hasn’t undertaken the expansion or hired the number of employees agreed to. That’s why the number of “clawback” clauses in incentive agreements has multiplied. But so far, in most places, poor monitoring and inadequate measuring sticks have kept states and cities from calculating their true returns on such “investments.”

And here’s a dirty little secret: Sometimes, states really don’t care about actual ROI on incentives because the relatively intangible benefits of being perceived as a serious player in the economic-development game may outweigh the tangible costs.

“Sweeteners can get obscene because states are so anxious to prove they can attract business,” says Kremer of Empire Government Strategies. “Sometimes the only thing they won’t offer is regular haircuts for the executives.”

2013 Best & Worst States for Business Links

2013 Best & Worst States for Business – Homepage
States More Aggressive in Competing With One Another
California Dreaming
Playing the Incentives Game
8 State Advocate CEOs
How CEOs Grade the States
Click here to see a slideshow of the 10 Best States for Business in 2013
Click here to see a slideshow of the 10 Worst States for Business in 2013

Dale Buss: Dale Buss is a long-time contributor to Chief Executive, Forbes, The Wall Street Journal and other business publications. He lives in Michigan.