Volume 12, Number 3 – October 2015

Business Incentives: What do We Know? What Should We Know?

When you talk to the average informed person about economic development, it’s not unusual for them to equate business incentives with the business of economic development.  There’s a reason for this—most news stories about economic development tend to be about business incentives.  It might be a funding package for a new sports stadium or a multi-state competition to woo the next big automotive plant. 

Practitioners know that the economic development tool kit is much more diverse and multi-faceted than just doing business incentives.  But, that doesn’t mean that business incentives don’t matter.  In fact, they still matter a lot and still represent the largest share of state and local spending on economic development.  Some studies have estimated that states and localities spend as much as $80 billion per year on various business incentives. 

My personal preference would be to eliminate business incentives—perhaps by getting all states to agree to a “mutual cease fire” on their use.  Since this wish is probably not feasible over the near term, we’re likely to see the continued and perhaps expanded use of business incentives in coming years.   If this is indeed the case, it’s important that we “do incentives right” and ensure that they are used in limited circumstances and are deployed in a cost-effective manner.   Supporting this mission has been the focus of an ongoing project sponsored by the Pew Trusts, the Center for Regional Economic Competitiveness, and a host of other outside consultants, including EntreWorks Consulting.*   The Business Incentives Initiative is designed to help states develop and share leading practices for managing economic development incentives and to test new ideas for improving the use and management of business incentives.  The project includes six partner states (Indiana, Maryland, Michigan, Oklahoma, Tennessee, and Virginia) and has provided technical assistance to officials from dozens of other states.   These states are pioneering of host of new and interesting approaches to managing their incentive programs.

This type of work is much needed as more states and localities are using incentives nowadays.  Every state now provides incentives and most states operate dozens of such programs.  In fact, the C2ER State Incentives Database profiles nearly 2,000 incentive programs now operating across the U.S.

So, if incentives are here to stay, how can we ensure that they are managed effectively?  Our work on the Business Incentives Initiative has yielded a number of important insights which we highlight below:

Due Diligence:  Do Your Homework Early

Lots of companies seek out economic development incentives, and lots of companies don’t deserve them.  Many incentive deals blow up later because firms and economic developers get caught up in the rush of the deal and fail to do adequate homework on a company or a project.  

We need to do better due diligence of potential projects.  This is not just about putting in more hours of research; it’s about building a system for reviewing potential deals.    Standard procedures and timelines should be put into place to assess both the company (e.g. its major customers, markets, management team, track record, etc.) and the deal itself (i.e., the “pitch” vs. the “reality”).    Tennessee has been a national leader on this front, instituting a rigorous review process before any incentives are considered or provided.   In addition to tracking company performance, this assessment examines the firm’s use of incentives (and subsequent performance) in other states and localities.

Transparency and Openness:  Share Everything

Many incentive deals are shrouded in secrecy.  When negotiations are underway, some secrecy is required.  But, there is no need for secrecy once an initial incentive agreement has been reached.  Smart communities and smart states are committed to transparency.  Transparency makes sense for many reasons.  Primarily, it makes sense because incentives use taxpayer dollars and taxpayers need to know how their funds are spent.  But, transparency will now matter even more because of new guidance from the Governmental Accounting Standards Board (GASB) which now requires that state/local governments must now disclose information about tax abatements on their financial statements. 

What do effective transparency efforts look like?  Indiana and Maryland offer useful models here.   Both states manage databases that provide information on all government grants and investments—the Indiana Economic Development Corporation Transparency Portal and the Maryland Finance Tracker.   Maryland’s tax credit programs are also undergoing extensive outside review by a newly created Tax Credit Evaluation Committee that is undertaking a systematic review of major state tax credit programs.

Performance and Clawbacks:  Get Your Money’s Worth

You’ve done your due diligence and shared information.  Now comes the hard part—ensuring that you get your money’s worth for your incentives.   Finding ways to effectively track company or project performance is likely the major challenge facing incentive program managers. 

States and especially localities could still improve their data collection capacities.  The C2ER incentives database shows that about 70% of programs regularly or occasionally capture data for program evaluation.  Meanwhile, about 1/3 have no such data.   When capturing data, program managers generally seek to track jobs, new investments, revenue growth, and the quality of new jobs.

Collecting and using performance data sounds much easier than it is in practice.  In many states, multiple agencies are involved in incentives and much of the data (such as tax returns) is confidential.  Thus, issues about handling and sharing data can get quite complicated.  Most of the states involved in the Business Incentives Initiative are working on these issues.  Oklahoma has enjoyed substantial success.  It has a robust evaluation system in place, and all of the key agencies have signed agreements that allow full data sharing along with effective protections for confidential information.  It is now in the process of setting up additional systems for regular outside evaluation of its incentives and for better projection of future costs of various tax incentive programs.

Effective incentives use a both the carrot and the stick. Incentives are carrots.  The stick comes in the form of clawbacks, i.e. requirements that firms repay money if they fail to perform as advertised.  Fortunately, clawbacks are now a common practice in smart incentive policies.

Ensure Return on Investment: Track and Assess Outcomes

Assessing performance is required over the short term; evaluating outcomes matters for the long-term.  In other words, how can we be sure that incentives are generating a positive return on investment to the taxpayer?  More states and localities are doing evaluation now, and that’s a good thing.  C2ER’s research shows that 92% of U.S. programs are doing some kind of post-investment evaluation. 

Many of these assessments are not really evaluation, but are instead simply reporting program data.  That’s good, but it’s not enough to effectively track outcomes and ensure that the programs are worth doing.  More sophisticated states are developing tools and approaches that help them do rigorous assessment of the ROI from their incentive programs.  Florida’s Office of Economic and Demographic Research has published an interesting study on incentive ROI.  Meanwhile, Virginia, via the Virginia Economic Development Partnership, has been developing an interesting ROI model of this own.   Virginia operated dozens of incentive programs managed by a diverse mix of agencies, so this task can get quite complex.  The Virginia approach, which is begin improved and updated every year.  It tracks the state’s return on invested capital and seeks to ensure that incentives generate a payback to Virginia within 2-3 years.   (The Pew Trusts published an excellent guide to incentives evaluation in 2012).

Other Resources:  In addition to the items and organizations noted in this essay, you can learn more about effective business incentive programs at the following sites:

Smart Incentives:  My colleague, Ellen Harpel, has an excellent blog and newsletter with the lasted on “smart incentives.”

International Economic Development Council:  The IEDC, the world’s largest economic development trade association, has published a number of research guides on new directions in incentives policy.    These reports require a fee, but they are free to IEDC members and the executive summaries are also available at no charge.  You can obtain the reports at http://www.iedconline.org/web-pages/resources-publications/edrp-publications/

Good Jobs First: This labor-backed watchdog is not the favorite of many incentive advocates, but they do a very good job of tracking new program directions and making the case for why transparency and accountability matter.

*The views expressed here are solely those of Erik R. Pages and EntreWorks Consulting and do not represent the opinions or positions of the Pew Trusts, CREC, or any other party.

What’s New at EntreWorks Consulting?

With the return of fall, many go back to school.  We seem to go back to new projects.  In the past several weeks, we have kicked off new projects in the following locations:   the Poconos region of Pennsylvania (Monroe County), Northern Alabama, and the state of Maryland.  In addition, we’ve just embarked on large-multi-year project to evaluate the Defense Industry Adjustment program supported by the Pentagon’s Office of Economic Adjustment.   When time permits, we also continue to provide more regular news and updates at the EntreWorks blog at http://entreworks.net/blog.   You can also access blog updates at our Facebook and LinkedIn pages and on Google Plus.