More Evidence Tax Incentives Don’t Spur Development

By Adam Millsap. 

"State and local governments often use firm or industry-specific tax incentives in attempts to improve their economies. Several studies that examine the effects of narrow tax breaks and subsidies—including movie production subsidies, stadium subsidies, enterprise zones, and others—find that while tax breaks often help the firms or industries that receive them, they typically don’t improve the broader economy. A new study by economists Cailin Slattery and Owen Zidar that uses a unique data set of state-level incentives once again finds that incentives don’t stimulate broader economic development. 

In their new study, “Evaluating State and Local Business Tax Incentives”, Slattery and Zidar analyze a data set consisting of 543 different state-level tax incentive deals given to firms from 2002 to 2017. What’s neat about this data is that it was collected and combined from a variety of sources, including the Good Jobs First subsidy tracker and Site Selection Magazine.

The authors find that the number of deals per year increased over this period, from a low of 14 in 2003 to a high of 53 in 2012. Firms typically promise a certain amount of investment and jobs when lobbying for a tax break, and the authors find that the incentive amount per job has also increased since 2002. Over the entire period, the average deal was worth $178 million and firms promise around 1,500 jobs.

Another interesting part of the study is the finding that larger, more profitable firms are more likely to receive a tax subsidy. Firms that received subsidies had eight times as many employees as the average firm and gross profits 14 times larger than average. Among establishments with more than 1,000 employees, over 30% received a subsidy compared to only 0.2% of establishments with fewer than 250 employees.

These numbers support what many people already think: Larger and more profitable firms are getting most of the government handouts while their smaller and less profitable competitors are on their own. This can result in more industry concentration and less competition which can lead to higher prices for consumers, fewer jobs, and less economic growth. 

Next, the study notes that states with higher corporate tax rates tend to hand out larger incentives per capita. This is shown in the figure below from the report, where there is a clear positive correlation.

corporate tax rate, tax incentives

Slattery, Cailin and Owen Zidar. “Evaluating State and Local Business Tax Incentives” (2020)

Several studies have found that higher corporate taxes reduce economic growth, so it’s not surprising that states with high corporate tax rates try to offset some of their tax burden via tax incentives to select firms. In fact, this strategy is explicit in a 1999 report to the California Council on Science and Technology regarding the state’s research and development tax credit:

“…California is perceived as a high-tax business environment by firms contemplating setting up business or expanding. For this reason, and because other states have similar policies, a variety of tax incentives and “industrial policy” measures have been adopted to overcome the reluctance of fairly footloose national or international companies to open establishments in California.”

The authors also find evidence of political motivations for tax incentives. Tax incentives that appear to lure in businesses provide opportunities for positive publicity—like ribbon cuttings—and there is a significant increase in incentive spending in years when incumbent governors are up for re-election. The authors note that this result is consistent with other research that finds that offering tax incentives increases governors’ re-election chances.

Finally, the authors analyze the effect of tax incentives on employment in the targeted industry, employment in other industries, total employment, and per capita personal income. The effect on each is calculated by comparing data from the county where the firm that got the incentive is located to data from the county where the runner-up firm is located.

They find that employment in the industry of the firm that got the tax incentive increases by about 1,500 jobs after five years relative to the county with the runner-up. However, they don’t find any significant increase in employment in other industries, total county employment, or county per capita personal income. So, like many other studies, the authors find little evidence that tax incentives to specific firms or industries generate widespread economic development or employment spillovers in other industries.

This study is not the first or last word on the effect of narrow tax incentives on economic development, but it is another unique addition to the body of research that finds such incentives typically don’t work. The next step is getting elected officials to finally pay attention."