Incentives! What are they good for?

Financial incentives make sense from an economist's point of view--you offer money, more people are likely to respond to whatever it is you're offering. It works sure enough in business development: a town has an empty building thanks to the demise of a local manufacturer; it offers 10 years of reduced property taxes for any new business taking the property (and putting people to work in the process). The result? More companies take a harder look at the deal than would have otherwise. Right? Right??

Well, it turns out it's more complicated than that, though I probably don't have to tell you that. You can offer me free land in (city and state name removed) to publish Business Facilities and I wouldn't take it (not that the decision is mine to make, but that's another story). I mean, where would I find qualified editors, marketers, and salespeople? Free land is no good if the rest of the business climate is no good, and businesses know that very often, those places with the strongest innate attractions for business are those least likely to dish out generous incentives--these places know they don't have to. As one economic development consultant put it to a group of executives last year at LiveXchange, "Remember, economic developers are not in the business of giving you the best possible incentives--their job is to give you the least amount of money while still getting you to commit."

So you'd think companies would be skeptical when viewing a location willing to throw in everything and the kitchen sink before even meeting (kind of like those 0% APR offers I get in the mail that jack up to usurious rates after six months--there's always a catch, right?) In fact, most companies I have ever interviewed are far more concerned with long term business fundamentals like the availability of labor and cost of shipping than with tax and other incentives. They will sometimes also admit that the incentives were icing on the cake, though they are not always a deal-clincher. I've spoken to some executives who freely say there was no real chance that they were going to relocate or expand elsewhere, but there was money on the table and the economic developers, as part of a good retention strategy, helped them to claim it and even make them aware of it in the first place. Even this makes sense--this effective subsidy of a local company could give them a leg up over competition, enabling them to grow faster, create more jobs sooner, etc., thus fulfilling the mission of the economic developers.

So is there debate over such granting of incentives? Is this a rhetorical question? Some call it corporate welfare. Personally, I think that's oversimplifying things. It always made sense to me that to create a level playing field, you make up for your faults. Is your product inferior? Charge less. (You make less profit, but you get to stay in business.) In the case of locations, it's too insulting to say "inferior product;" it's more like a combination of atoning for past sins of the development views of our grandparents' generation in our local community, combined with a location's God-given blessings or curses (landlocked versus riverside, tundra versus temperate, etc.). But I'm not so close-minded as to be unwilling to seriously consider arguments that incentives don't work, and are thus a wasteful use of taxpayer dollars. You really should read this article by Jack P. McHugh of the Mackinac Center for Public Policy, a "a nonpartisan research and educational institute devoted to improving the quality of life for all Michigan citizens by promoting sound solutions to state and local policy questions." Entitled, "
Targeted Tax Breaks: 'How's That Working for You?'," Mr. McHugh provides some very convincing arguments as to why Michigan's major tax incentive program isn't working. (Actually, the argument between him and state economic developers won't be over why it's not working, but over whether it's working.)

This isn't the only argument out there, of course, just a nice succinct one. (If you want a full-length argument, try "The Great American Jobs Scam: Corporate Tax Dodging and the Myth of Job Creation" by Greg LeRoy.) What do you think? Please send us citations to other arguments, for or against--or give us your own opinion--in our comments section below, which doesn't require registration by the way.

My own opinion? Well, I said I was open minded, and I'm still weighing the evidence on both sides. There are undoubtedly deals that have been lost to competition because the incentives did not equal those of a rival state or county--this I know for a fact. And I'm sure that incentives are given to companies that didn't really need them, and that did not pay off for taxpayers. But on the whole, do incentives benefit taxpayers? Sure, Michigan has not seen the 10-year job net job creation numbers it would have liked...but would it have been worse without the efforts of the Michigan Economic Development Corporation? I may not be in a position to argue since I don't have my own "rigorous econometric analysis" in hand as those folks at the Mackinac Center do. It's also tough because I've read studies that support incentive use that are written by equally authoritative institutions.

As a follow-up, I'm going to ask the Michigan Economic Development Corporation if they would like to post a response to the Mackinac Center article here on this blog. Stay tuned--it should be interesting.