W.E. Upjohn Institute for Employment Research
04/04/2024 | News release | Distributed by Public on 04/04/2024 11:34
What Standards Make Sense for Economic Development Tax Incentives
Economic development tax incentives are often controversial. By "economic development tax incentives," I mean providing some sort of cash tax break, compared to normal taxation, for a business that is locating or expanding in a state. The controversy arises in part because the immediate beneficiary of the tax break is the firm. But the ultimate beneficiaries may include state residents if the tax incentive successfully creates new jobs, and if those new jobs help state residents by boosting their employment rates and real wages.
As I have reviewed in much prior research, economic development tax incentives can pay off if properly designed and in the right local circumstances. The devil is in the details. For example, incentives in distressed local labor markets, financed without undermining productive public services such as education, for export-base businesses with high multiplier spillovers for other jobs, can have high benefit-cost ratios, even if the tax incentives per incented job are large. But if these conditions are not met-incentives are in a booming local labor market, incentives lead to downward pressure on state education spending, multipliers are low-then incentive benefits may be much lower than costs.
One incentive design issue is whether incentives can have their benefit-cost ratios improved by various standards. Frequently discussed standards include higher wage standards, more local hiring standards, and industry targets. Less frequently discussed standards include targeting distressed local areas and making sure incentives are paid for by tax increases. This memo provides a very brief discussion of these design issues. Fuller discussion can be found in my book on incentives, in the various papers discussing my benefit-cost model of incentives, or in my recent paper on the Ford Soar project in Marshall, Michigan.
Higher wage standards
Wage standards are sometimes set for a firm's eligibility for incentives or the magnitude received of incentives. How should such standards be set?
Ideally, such standards should be set based on the wages paid by the firm for particular jobs relative to the educational credentials and other credentials that these jobs required. For example, Amazon HQ2 supposedly offered jobs paying $150,000 per year -a very high wage. But since these jobs also had high credential requirements, it is not clear that they offered a "wage premium," which is the key. A firm that paid far less than Amazon per job but was willing to hire workers with only a high school diploma might offer a higher wage premium.
To my knowledge, no state's wage standards adjust for credentials required by the firm. This could be readily done. A state could calculate what the median wage rate per hour is in various local labor markets in the state for workers with different educational credentials, from a variety of federal statistical sources. And then the firm's wage rates for jobs with different educational credentials could be compared with those standards.
Simply setting wage standards by some wage relative to the area median wage runs into the problem that it may target incentives to high-paying firms with very high credential requirements, and penalize firms with lower wages but with a greater likelihood of hiring workers with lower educational credentials.
Sometimes proposals have been made to tie wage standards to median household incomes. This has some additional problems. In particular, since many households have more than one worker, this standard may penalize jobs that may in fact offer good wages relative to credentials required for the many households with more than one worker.
Hiring standards
Sometimes proposals are made to tie incentives to local hiring, so that state residents benefit more from the local jobs. Some proposals go further to tie incentives to hiring the local non-employed. In other cases, particularly in states that are suffering from slow population growth or population decline, the idea has been floated of tying incentives to bringing in new residents.
To discuss hiring standards, we need to understand how job creation due to incentives may affect local employment rates and population. First, if the incented jobs are induced, in some "export-base industry" (a firm that mainly sells its goods and services outside the state), the new jobs in the incented firm will have some multiplier effects on other state jobs. Some suppliers to the incented firm will add jobs. Furthermore, the added workers at the incented firm and its suppliers will buy more goods and services in the local economy, creating local retail jobs.
How do these induced jobs, both the incented induced jobs and the resulting multiplier jobs, lead to higher employment rates and population? The new hiring in the induced incented jobs and multiplier jobs comes from three sources: 1) already-employed state residents, 2) non-employed state residents, 3) in-migrants to the state. But the first source, already-employed state residents, creates a job vacancy, which is filled in the same three ways. The resulting job vacancy chains are only terminated when the initial new jobs-both incented and multiplier jobs-ultimately result in additional jobs for either the state's non-employed or additional in-migrants. There is no other alternative.
But note that the extent to which jobs go to the state's non-employed or in-migrants depends on far more than who is hired by the incented firm. The proportion of jobs for the non-employed versus in-migrants also depends on hiring patterns for the multiplier jobs and hiring patterns for every employer along the various job vacancy chains.
Having said that, it is still the case that who the incented firm hires matters to the ultimate impact. The incented jobs will be a sizable share of the initial jobs created, although multiplier jobs also matter. If more of the incented jobs are filled by hiring the local non-employed, this will tend to raise the ultimate effects of the project in helping the state's non-employed. On the other hand, if more of the incented jobs are filled by bringing in workers from other states, this will tend to raise the ultimate effects of the project in increasing state population.
Which is more valuable, more jobs for the non-employed or inducing in-migration? In most circumstances, increasing jobs for the non-employed is much more likely to increase benefits relative to costs. More jobs for the non-employed reduces the social costs of non-employment (e.g., substance abuse, crime, family break-ups, etc.) and reduces the need for welfare payments. More jobs for the non-employed also increases tax revenues without much increase in public service requirements.
On the other hand, inducing in-migration does not reduce social problems for state residents. Furthermore, although the new workers and residents will increase state and local tax revenues, these new residents will also require more public spending to maintain the quality of public services. Teachers will need to be hired to keep class sizes from exploding; police and fire personnel will need to be hired to keep response times reasonable; roads and other infrastructure will require costly investments to accommodate population growth. The resulting public service costs in many cases will outweigh the revenue gains, resulting in a net fiscal loss.
In deciding on hiring standards, one must further consider that requiring firms to hire the local non-employed may in many cases be perceived by the firm as a costly unfunded mandate. Sometimes a state or local area with many new job prospects can succeed in insisting on such local hiring, but this is a difficult position to maintain for any state or local economy that perceives itself to be short of jobs.
One alternative to a hiring standard mandate is to encourage firms to engage in cooperative arrangements with local job training agencies. This cooperation will often lead to firms hiring workers who otherwise would be unemployed or underemployed. Such cooperation could be encouraged by giving firms extra "points" on incentive applications if they are willing to cooperate with local job training agencies. Alternatively, states can provide funds to firms for customized job training programs that are managed by local job training agencies.
Furthermore, if a state incentivizes a new firm that is "large" relative to the local labor market, or with potentially large multiplier effects relative to the local labor market, local hiring of the non-employed might be encouraged by providing supplemental funding to local job training agencies. Policymakers should want to provide training and job placement help to encourage more diverse hires along all the job vacancy chains in the local economy, not just at the incented firm.