Empirical research does not support optimism of tax incentive packages

As has been widely publicized, on September 19, 2017, Wisconsin governor Scott Walker approved of Assembly Bill 1. This is the legislation that creates an electronics and information technology manufacturing zone, makes changes to the enterprise zone tax credit program, authorizes the limited use of the design-build construction process, grants contingent highway bonding authority, and makes appropriations, all of which made the historic FoxConn business incentive package possible.

When he signed the bill, the governor vetoed three provisions with an explanation, as provided in his veto message. His vetoes do the following:

1. Eliminate the Joint Committee of Finance's ability to object to, and then potentially vote to deny, the request to expend the proceeds of the general obligation bonds provided for under the bill. Gov. Walker reasoned that these provisions could hinder the state's ability to receive federal funds for the project, and jeopardize Wisconsin's ability to compete with other states for federal funds.
2. Narrow the scope of the provision that enabled a town adjacent to a city or village that contains an electronics and information technology manufacturing zone to incorporate. The veto eliminates the provision’s applicability to a town adjacent to a city because of the potential for uncertainty and disruption between a city and town considering a boundary agreement. Eliminate the provisions that would have, once incorporation actions had been initiated, prevented a city or village from annexing territory under certain conditions. The governor thought that this had the potential to create too much uncertainty, and also to delay economic development projects.

A Department of Revenue fiscal estimate contained the details of the information technology manufacturing zone credit, which has two components:

1. 17 percent of payroll expenditures for jobs located inside the zone, with a cap at $1.5 billion.
2. 15 percent of significant capital expenditures in the zone, with a cap of $1.35 billion. 

The fiscal estimate projects these credits as follows:

• Payroll credits: $1.5 billion through fiscal year 2032, starting in calendar year 2017.
• Capital expenditure credits: $1.35 billion through fiscal year 2026, starting in calendar year 2018. Projections of capital expenditures during this time are $10.7 billion.

Other tax incentives include a sales and use tax exemption for the sale of building materials, supplies and equipment used to construct the facilities at issue. The fiscal estimate cited a study calculating that construction expenditures would be $5.57 billion, with half of that as taxable building materials.  This would reduce state sales tax revenues for the state by about $139 million. In turn, local sales tax revenues would drop by about $10.7 million.

Michigan

The Great Lake state is another state that recently enacted a package of tax incentives to encourage job growth. Referred to as the Good Jobs for Michigan package, approved by the governor, Rick Snyder, in early September, the crux of the trio of bills is to allow firms to "capture" state income taxes withheld from certified new employees, subject to approval by the Michigan Strategic Fund, as an incentive to create new jobs in Michigan.  Businesses already set up in Michigan, and those newly locating to the state could take advantage of the tax breaks.

According to the house fiscal analysis that analyses all three bills, the capture amount is up to 100% of withholding tax captures for up to ten years for firms that create 3,000 or more certified new jobs in Michigan, with an average annual wage that is equal to or greater than the prosperity region average wage.

Creating between 500 and 3,000 certified new jobs in Michigan, with an average annual wage that is equal to or greater than the prosperity region average wage, entitles a firm to capture up to 50% of withholding tax capture revenues for up to five years.

Firms that create between 250 and 500 certified new jobs in Michigan, with an average annual wage that is equal to 125% or more of the prosperity region average wage could capture up to 100% of withholding tax captures for up to ten years.

The Michigan Strategic Fund can enter into no more than 15 such agreements each year, and disburse a maximum of $200 million in total withholding tax capture revenues over the life of the program. As it currently stands, no new agreements can be entered into after December 31, 2019.

The research

Both of these deals have their share of detractors and supporters, but there is increasing evidence that such arrangements are not as lucrative as they seem. The title of a recent Bloomberg piece, “Good Jobs Program or Bad Economic Policy?”  discusses the issue. Pointing to Michigan Gov. Snyder’s praise for the Good Jobs for Michigan Program as enacting “forward-thinking policies that make us more competitive for new jobs and industries in a fiscally responsible fashion,” the article contends that “empirical research on targeted tax incentives and job growth does not support this reckless optimism.

More specifically, Bloomberg cites these studies:

• Research published in Regional Studies that found that the number of tax incentives offered in a state has no relationship with employment.
• Likewise, analyses of enterprise zones published in both Regional Science and Urban Economics and the Journal of Urban Economics found no evidence of increases in employment as a result of the tax incentive.
• Research from economists at the University of Tennessee found that the siting of new, large firms (1000+ employees) has no impact on regional employment growth. 
• Research from a Georgia State University economist suggests that “the net economic impact of large, new firm [300+ employees] locations generally are overestimated” and that “local governments are not likely to receive significant long-term employment or population benefits from large new firm locations.” 
• Empirical evidence suggests that centering economic development efforts around the recruitment of large firms is unlikely to produce significant employment benefits.

One reason that there is such “lackluster” job growth when new incentives are enacted is that the new enterprises, propped up with special tax incentives, may put existing ones out of business. Additionally, the stress that the influx puts on infrastructure congestion makes an area less compelling for those that are left out of the incentives program.

Furthermore, targeted incentives distort decision-making, causing leaders to make determinations that they might not otherwise make. Using the Michigan program as an example, the package could have the unintended effect of causing executives to refrain from “investing in research and development in favor of hiring more employees even if investing in more R&D would make the business more productive. The business receives a tax break for job creation, but the loss of productivity from less R&D makes the overall economy worse off.

Yet a third problem is the loss of innovation, stemming from the expenditure of resources to curry political favor, rather than to create new products and services.

Amazon’s expansion plan

There is already an enormous amount of buzz surrounding Amazon’s just-launched search for its second headquarter location. By all accounts, the offering of the city that lands this prize will dwarf that which FoxConn will receive. But whether society is better off because of its redirected tax dollars remains to be seen.