Full text of Chicago Fed Letter : Bidding for Business, No. 16
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ESSAYS ON ISSUES THE FEDERAL RESERVE BANK OF CHICAGO DECEMBER 1988 NUM BERlfi Chicago Fed Letter B idding for business States compete for business. The stakes are high and the game is rough. Among the bargaining chips that states can use, selective tax incentives and fiscal inducements are favorites. Competition among local and state governments can sometimes result in a bidding frenzy. For example, 25 states (and an untold number of localities) offered generous packages of tax abatements, special services, and im provements to infrastructure in an at tempt to land General Motors’ Saturn auto facility. State governors made personal visits to GM headquarters and appeared on national television to plead their cases in public. In another instance, the State of Illinois reportedly offered a package worth over $80 million in its successful effort to bring the Chrysler/Mitsubishi Diamond-Star auto production facility to the Bloomington/Normal area. The value of this package has become a matter of keen interest because the pri vate investment at that site was only expected to be $500 million. This letter looks at the value of these abatements and inducements—Let’s call them tax breaks and be done with it. What evidence we find is so uncer tain and so difficult to assess, we con clude that any case for tax breaks for relocating or expanding business is un proved at best. The community’s perspective In granting tax incentives, states and localities expect that the return will be greater than the cost. This benefit may not be achieved. To the extent that tax breaks and fiscal inducements merely reshuffle rather than reduce the overall tax burden, state and local govern ments may be doing more harm than good.1 LTnlike general competition between localities in providing appropriate public services at a reasonable price, selective tax breaks do not necessarily redress any inefficiencies in the delivery of public services. Accordingly, the capricious and uncertain assignment of tax burdens—the hallmark of a selective incentives program—may actually repel businesses that have a long-term per spective on community investment. And, it is just that type of commercial neighbor that can be most valuable to a community. From a community’s perspective, the appropriate way to evaluate its incen tive program is to ask whether the benefits to the community exceed the costs. There has not been adequate research to measure the effectiveness of these programs in general for every community. Yet, given what is known, along with careful attention to the logic behind the programs, there are basic questions that public policy makers must answer before engaging in a costly and widespread program of selective industry fiscal inducements. Are tax breaks a good lure? A steady stream of studies on the re lationship between overall state and local tax burdens and business growth has emerged over the past 35 years. These selective incentive policies must be distinguished from more general ef forts to make a state’s overall fiscal and tax structure favorable to business and development. Such incentive packages are offered by state and local govern ments to individual companies, or in dustries, and not on a uniform basis to all businesses within the community. They are selectively negotiated by public officials in hopes of snaring ad ditional business activities that will pay a return on investment in terms of added jobs, income, and tax revenues. As one commentator has noted, the re sulting competition to attract industry has become a dog-eat-dog, Indianaeal-Ohio affair. S tate loans fo r building construction SOURCE: S i t e S e le c tio n State financing aid fo r existing plant expansions Tax exem ption o r moratorium on land and capital im provem ents a n d I n d u s t r i a l D e v e l o p m e n t , C onw ay Publications. State provides free land for industry M o s t e a rly stu d ie s su g g e ste d th a t tax es w e re n o t r e la te d to s ta te a n d lo c a l e c o n o m ic g r o w th .' A c c o rd in g ly , p o lic y a d v ic e w a rn in g lo c a l c o m m u n itie s a g a in s t th e use o f ta x b re a k s b e c a m e w id e s p r e a d .3 H o w e v e r, as th e s o p h is tic a tio n o f stu d ie s in c re a s e d , n e w e v id e n c e seem s to in d ic a te th a t, a t th e m a r g in , tax es c a n in d e e d h e lp a t t r a c t b u sin esses to specific lo c a litie s. S tu d ie s o f firm lo c a tio n d ecisio n s w ith in a m e tro p o lita n a r e a h a v e su g g e ste d th a t, o n c e th e su p p ly o f p ro p e r ly z o n e d a n d a v a ila b le la n d is a c c o u n te d for, lo c a l ta x e s b e c o m e im p o r t a n t in sitin g d e c isio n s o f m a n u f a c tu r in g p la n ts .4 In d e e d , stu d ie s c o n s id e rin g th e lo c a tio n o f e c o n o m ic g ro w th h a v e su g g e s te d t h a t ta x b u r d en s, ta x s tru c tu r e , a n d th e c h o ic e a m o n g ty p es o f s ta te a n d lo c a l p u b lic e x p e n d itu re s a n d serv ices c a n a ll b e sig n ific a n t in lo c a tio n d ecisio n s. T h e se fin d in g s re - o p e n e d d e b a te a m o n g a n a ly s ts o f s ta te a n d lo c a l fiscal in c e n tiv e s p o licy . B u t, w h ile it seem s th a t tax es d o m a tte r , th is h a r d ly im plies th a t tax es a re a sig n ific a n t c o n s id e ra tio n fo r e a c h in v e s tm e n t d e c is io n .5 Q u e s tio n n a ire s d ir e c te d a t p la n t o r c o m p a n y officials h a v e b e e n used to d e te r m in e th e e x te n t to w h ic h re lo c a tin g o r in v e s tin g b u sin ess w o u ld h a v e u n d e r ta k e n th e in v e s tm e n t w ith o u t th e selectiv e ta x b re a k . R e sp o n se s c e rta in ly a re in flu e n c e d b y th e f irm ’s r e lu c ta n c e to b ite th e h a n d t h a t feeds it. B u t, n o n e th e le ss, th e su rv e y fin d in g s su g g est th a t th e success ra te o f in c e n tive p ro g r a m s te n d to b e v e ry lo w .1’ F irm s w ill u n fa ilin g ly ask fo r in c e n tiv e s i f th e y a re a v a ila b le , b u t s ta te a n d lo cal c o m m u n itie s fin d it d iffic u lt to d is tin g u ish th o se firm s t h a t ask fro m th o se firm s t h a t n e e d . F o r th is re a s o n , th e d e b a te h a s sh ifte d to ask w h e n a n d w h e re se le c tiv e ta x b re a k s w ill be effective. M o re im p o r ta n tly , it is n o t c le a r w h e th e r th e s ta te a n d lo c a l officials w h o g r a n t b re a k s at th e ir o w n d is c re tio n c a n d is tin g u ish s itu a tio n s in w h ic h ta x b re a k s a re su c cessful in g a in in g n ew b u sin ess fro m those in w h ic h ta x a b a te m e n t c o u ld h a v e b e e n a v o id e d . C le a rly , ju d g m e n ts o n th e n e t b en efits o r costs o f fiscal in d u c e m e n t p ro g r a m s w ill d e p e n d o n su c h c o n sid e ra tio n s. c o s t-b e n e fit a n a ly s is w o u ld r e q u ir e th a t su c h costs b e c o n sid e re d . T h e m a in c o n se q u e n c e o f a lo w success r a te is th a t sta te s a n d lo c a l c o m m u n i ties m u s t h e a v ily d is c o u n t th e jo b s a n d in c o m e th a t a re sa id to re s u lt fro m i n c e n tiv e p ro g ra m s , in d e c id in g w h e th e r o r n o t to e n g a g e in a b r o a d p o lic y o f selectiv e ta x b re a k s. F in a lly , a c o m m u n ity p o lic y o f selectiv e ta x b re a k s m a y f u r th e r c ro w d o u t p o te n tia l b u sin e ss in v e s tm e n ts t h a t w o u ld o th e rw ise o c c u r in th e a b s e n c e o f th e p ro g r a m . S o m e p o te n tia l firm s m a y feel t h a t a c o m m u n ity w ith la r g e scale in c e n tiv e p ro g r a m s c a n n o t b e c o u n te d o n fo r a s ta b le a n d e ffic ie n t fiscal c li m a te in w h ic h to c o n d u c t b u sin ess. ( O f c o u rse , a b u sin e ss t h a t h a s a lr e a d y d e c id e d to lo c a te o r re in v e s t in a c o m m u n ity w ill a sk fo r a ta x a b a te m e n t if it is a v a ila b le o r i f th e y b e lie v e th e y c a n e x tr a c t a su b sid y —to d o o th e rw ise w o u ld n o t be a r a t io n a l e c o n o m ic r e sp o n se b y th e firm .) Do breaks crowd out as they bring in? E v e n i f a ta x b re a k d o es p ro m o te in v e s tm e n t, d ir e c t e c o n o m ic b e n e fits c a n b e w h o lly o r p a r tly offset if e x istin g b u sin esses o r re s id e n tia l a c tiv itie s a re c ro w d e d o u t o f th e c o m m u n ity , o r i n v e s tm e n ts b y lo c a l b u sin esses a re d is c o u ra g e d . F o r e x a m p le , w h e n th e ta x b re a k p o lic y allo w s th e in c o m in g firm to g a in a c o m p e titiv e a d v a n ta g e o v e r a lo c a l firm e n g a g e d in th e sa m e serv ice o r p r o d u c t, it m a y th e re b y d riv e a w a y in v e s tm e n t d o lla r fo r d o lla r. M o s t e v id e n c e o f this effect is a n e c d o ta l. F o r e x a m p le , a m a k e r o f h y d ra u lic e q u ip m e n t, A b e x C o rp o ra tio n , D e n iso n D iv isio n , a n n o u n c e d p la n s to close a C o lu m b u s, O h io , fa c ility in th e la te 1970s. T h is w as in re sp o n se to a g e n e ro u s ta x b re a k b y th e C o lu m b u s C ity C o u n c il to its d ir e c t c o m p e tito r, L. S c h u le r G M B H , o f W e st G e rm a n y , to lo c a te a fa c ility in C o lu m b u s .7 T o th e e x te n t t h a t s ta te a n d lo c a l g o v e rn m e n ts c a n n o t fo resee su ch situ a tio n s, ta x u n ifo rm ity r a t h e r th a n selectiv e ta x b re a k s is a b e tte r p o lic y c h o ic e to m a in ta in th e c o m m u n ity ’s sta b ility . E v e n w h e n p o te n tia l firm s d o n o t c o m p e te d ire c tly in fin a l m a rk e ts w ith e x istin g c o m m u n ity firm s, th e y d o c o m p e te in th e c o m m u n ity fo r o th e r fa c to rs o f p ro d u c tio n , su c h as la b o r a n d in f ra s tru c tu re . W e d o n o t k n o w th e e x te n t to w h ic h “ in v ite d ” busin esses ra ise som e lo c a l fa c to r costs to th e p o in t w h e re o th e r a c tiv itie s a re c ro w d e d o u t o f th e c o m m u n ity . T h e ta x re lie f a n d g e n e ro u s u p g ra d in g o f in f ra s tru c tu re th a t w as o ffered to V o lk sw a g e n to lo c a te its p ro d u c tio n fa c ility in N ew S ta n to n , P e n n s y lv a n ia , w as lo u d ly p r o te ste d b y so m e lo c a l b u sin e ssm e n w h o fo resaw th e ir ta x b u rd e n s b e in g h ik e d w ith o u t a tt e n d a n t b en efits. A c a re fu l M o re o v e r, a firm ’s p r io r a sse ssm e n t o f th e ta x p o lic y o f a c o m m u n ity w ith a n e x te n s iv e in c e n tiv e p r o g r a m m a y also re c o g n iz e th a t its o w n fu tu r e ta x b u r d e n w ill d e p e n d o n th e d e v e lo p m e n t d e c isio n s o f th e n e x t g o v e r n m e n t in of fice. F u tu r e officials m a y g r a n t ev en la r g e r b re a k s to th e n e x t fo o tlo o se i n v e sto r, th e r e b y in c re a s in g th e ta x b u r d e n o n th e c o m m u n ity ’s e x istin g businesses. O p in io n s o b ta in e d fro m m a n y c o m p a nies in d ic a te th a t, w h e n assessing a c o m m u n ity , firm s lo o k fo r a lo n g - te rm re c o rd o f fiscal s ta b ility a n d efficien cy in p ro v id in g p u b lic services. S u c h a fiscal c lim a te w ill in s u re t h a t a la r g e p riv a te in v e s tm e n t w ill n o t b e u lt i m a te ly so u re d b y d e te r io r a tin g p u b lic serv ices o r u n e x p e c te d a n d u n d e s ira b le c h a n g e s in ta x p o licy . Are gains in business activity long-term? I n e v a lu a tin g p o te n tia l b e n e fits, c o m m u n itie s m u s t also re c o g n iz e th a t p ro m ise s o f lo n g - te rm jo b s a n d fu tu r e in v e s tm e n ts b y in c o m in g firm s d o n o t a lw a y s m a te ria liz e . A m id s t m u c h f a n fa re , V o lk s w a g e n ’s a ss e m b ly p la n t in N e w S ta n to n , P e n n s y lv a n ia , o p e n e d in 1978. I t s h u t d o w n in 1988. A u to p r o d u c tio n b y C h ry s le r C o r p o r a tio n a t A M C ’s fo rm e r p la n t in K e n o s h a , W isc o n sin , w ill cea se th is D e c e m b e r fo llo w in g a tw o -y e a r ru n . T h e S ta te o f W isc o n sin w ill p r o b a b ly re c o u p its in v e s tm e n t b e c a u se C h ry s le r h a s r e s p o n d e d to p u b lic o p in io n o r p u b lic n e e d s (m a n y o th e r c o m p a n ie s a re n o t so resp o n siv e). U n lik e m a n y E u r o p e a n c o u n trie s, s ta te s in th e U .S . h a v e b e e n slow to a d o p t “ c la w b a c k ” p ro v isio n s, w h ic h a llo w c o m m u n itie s to re g a in su b sid ie s w h e n p ro m ise d jo b s a re n o t re a liz e d fro m firm s re c e iv in g p u b lic su b sid ies. H o w e v e r, o n e re c e n t c o u rt d e c isio n (s u b je c t to re v ie w ) h a s p la c e d lim its o n th e a b ility o f a firm to close a p la n t a n d re lo c a te o p e ra tio n s w h e n th e firm h a d b e e n a re c ip ie n t o f a su b s id iz e d lo a n to e x p a n d in its o rig in a l lo c a tio n .8 O th e r ju d ic ia l tests a re n o w in p ro g re ss. Administrative costs I n a d d itio n to a n s w e rin g th ese q u e stio n s, c o m m u n itie s m u s t c o n sid e r th e h ig h a d m in is tr a tiv e co sts o f in c e n tiv e p ro g ra m s . T h e c o m m u n ity m u st s tu d y w h o w ill b e fa v o re d b y ta x b re a k s a n d sp e c ia l serv ice in d u c e m e n ts ; w h a t th e costs a n d b e n e fits a re o f e a c h ty p e o f fa c ility ; w h o w ill be b e n e fitte d in th e c o m m u n ity ; a n d w h o w ill b e h u r t. I t m u s t also a n a ly z e w h a t p u b lic services a n d fa c ilitie s w ill n e e d to b e e x p a n d e d b e c a u se o f th e in v e s tm e n t a n d to w h a t d e g re e it c a n b e e x p e c te d to e x p a n d e m p lo y m e n t a n d p o p u la tio n . Conclusions C o m m u n itie s a re u su a lly a w a re o f th e d ir e c t costs a n d b e n e fits o f a tt r a c t in g b u sinesses w ith ta x b re a k s a n d o th e r fiscal in d u c e m e n ts . T h e lo st ta x r e v e n u e s o r re sh u ffle d ta x b u rd e n s a re h ig h ly v isib le fro m new s a c c o u n ts o f p la n t n e g o tia tio n s b e tw e e n s ta te offi cials a n d b ig -n a m e c o rp o ra tio n s . T h e a tt e n d a n t b e n e fits o f e m p lo y in g th e u n e m p lo y e d a re re a d ily a c c e p te d a n d h ig h ly v a lu e d by th e g e n e ra l p u b lic . B ut, b e y o n d th ese o b v io u s c o n s id e r a tio n s, a b r o a d c o m m u n ity p o lic y o f selectiv e tax b re a k s c a n b e risky. T h e success r a te o f ta x in c e n tiv e p ro g ra m s in a c tu a lly in d u c in g firm s to re lo c a te o r e x p a n d is d iffic u lt to g a u g e fo r b o th th e g e n e ra l p u b lic a n d p u b lic officials alik e. I n a d d itio n , th e e x te n t to w h ic h in c e n tiv e p ro g r a m s crow d, o u t o th e r p o te n tia l in v e s tm e n t, th e re b y c re a tin g u n c e rta in ty as to th e c o m m u n ity ’s fiscal sta b ility a n d busin ess c lim a te , is h a r d to assess. B e tte r e c o n o m ic a n a ly sis a n d in f o rm a tio n o n th e se im p a c ts w ill b e re q u ire d b e fo re th e u tility o f in c e n tiv e s p o lic y c a n b e d e te r m in e d fo r e v e ry c o m m u n ity . M e a n w h ile , g iv e n th e p o te n tia l p itfa lls, p u b lic officials sh o u ld b e c a u tio u s in m a k in g selectiv e in c e n tiv e p ro g ra m s -ta x b re a k s a k e y sto n e o f s ta te a n d lo c a l d e v e lo p m e n t p o licy . — W illia m A. T e s ta a n d D a v id R . A lla rd ic e *1 ' This article does not argue th a t general competition between state-local govern ments in providing low-cost, high-quality public services, financed through a wellstructured tax system, should be discour aged. See J o h n Shannon, “ Interstate T ax C ompetition T h e Need For a New L o o k ” ; an d “T a x Competition: Is W h a t ’s Good For the Private Goose Also Good For the Public G an d er?” , in Reform Or Re venue, Symposium, N ational T ax Association/Tax Institute of America, Arlington, VA., M a y 19-20, 1986, Vol. X X X I X , No. 3. 2 T h e seminal works in this area are: C.C. Bloom, State and Local Tax Differentials and the Location o f Manufacturing, Studies in Business an d Economics, T h e University o f Iowa, No. 5, 1956; an d J o h n Due, “ Studies of State and Local T a x Influences on the Location of Indu stry ” , National Tax Journal, ol. 14, J u n e 1961, pp. 163-173. 3 See G ary C. C ornia, William A. Testa, an d Frederick D. Stocker, Stale-Local Fiscal Incentives and Economic Development, A cad emy F or C o n tem porary Problems, Columbus, O hio, 1978; and Michael Kieschnick, Taxes and Growth: Business In centives and Economic Development, Council of State Planning Agencies, Washington, D.C., 1981. " 1 See R o b e rt J . N ew m an and Dennis H. Sullivan, “ Econometric Analysis of Busi ness T a x Im pacts on Industrial Location: W h a t Do Wc Know, and H ow Do We K n o w It?” , Journal o f Urban Economics, Vol. 23, pp. 215-234. ’ J a m e s A. Papke has constructed a micro-simulation model which estimates the after-tax rates of return for h y p o th e t ical capital investments at alternative sites. All else is held constant except for state and local tax effects, their interaction with each other, and their interaction with the federal tax system. A 1985 study am ong sites in 15 states revealed that there w r i t significant differences in after-tax rates of return for a hypothetical investm ent which was p a ttern ed after the S atu rn C o rp o ration subsidiary of G M . However, and not surprisingly, the state where the in vestment was finally located, Tennessee, did not have the most favorable profit rate (based on tax structure an d incentives alone). See J a m e s A. Papke, The Taxation o f the Saturn Corporation: Intersite MicroAnalytic Simulations, C enter For T ax Policy Studies, P u rdue L’niversity, West Lafayette, Ind., M a r c h 1985. 6 F o r example, a recent study by George W. Morse an d M ich ael C. F a rm e r found that, ou t of 23 investm ent decisions in ru ral O hio communities, in only one was the deciding factor found to have been the tax ab ate m en ts according to on-site interviews. However, all 2.3 companies received tax abatements. See R og er J . V au g h n , “A New Look at State T a x Incentives” , The Entrepreneurial Economy, J u l y 1984, pp. 8-9. U n d e r New York City's “J o b Incentives P ro g r a m ,” tens o f millions o f dollars in exemptions an d abate m ents were gran ted to New York firms in an a tt e m p t to a tt r a c t and retain firms. V a u g h n cites, as an example of an incentive th a t was prob ably a give-away, a ten-year, 3>8 million bonus to Tiffany’s for the reh ab o f two floors of its building at 57th St. an d 5th Avc. in New York City (arguably one of the most valuable pieces o f real estate in the country even w ithout the tax incentive). 7 Columbus Dispatch, T hu rsd ay, S eptem ber 7, 1978. p. 3. 8 T he case involves the City of Duluth, M innesota versus T riang le C orporation, Stamford, C onnecticut and its a tte m p t to move D iam on d Tool an d Horseshoe Co. For reference to o th er judicial challenges see “ Factory T ow ns S tart T o Fight Back Angrily W h en Firms Pull O u t ” , W all Street Journal, M a r c h 8, 1988. K a r l A. S ch eld , S en io r V ic e P resid en t a n d D ir e c to r o f R e s e a rc h ; D a v id R . A lla rd ice, V ice P r e s id e n t a n d A ssistan t D ir e c to r o f R e s e a rc h ; E d w a r d G. N ash , E d ito r. C h i c a g o F e d L e t t e r is p u b l i s h e d m o n t h l y b y t h e R esea rc h D e p a r tm e n t o f the F e d e ra l R eserv e B a n k o f C h ic a g o . T h e view s e x p re s s e d a r e th e a u th o r s ' a n d a re n o t necessarily those o f the F e d e ra l R eserv e B a n k o f C h ic a g o o r th e F e d e ra l R e se rv e S y stem . A rticles m a y b e re p r in te d if the s o u r c e is c r e d i t e d a n d t h e R e s e a r c h D e p a r t m e n t is p r o v i d e d w i t h c o p i e s o f t h e r e p r i n t s . C h i c a g o F e d L e t t e r is a v a i l a b l e w i t h o u t c h a r g e from th e P u b lic In fo rm a tio n C e n te r. F ed eral R eserv e B a n k o f C h ic ag o , P .O . Box 834, C h ic ag o , I l l i n o i s 6 0 6 9 0 , o r t e l e p h o n e ( 3 1 2 ) 3 2 2 - 5 1 11. ISSN 0895-0164 Manufacturing activity in the nation edged up only 0.2 percent in September, fueling speculation that the economy is beginning to slow down. The nonelectrical machinery industry, reflecting the strength in business equipment, continued to post solid gains, as did the transportation equipment industry. However, pro duction of consumer durables (except autos) and nondurables declined along with basic metal materials, such as steel. Manufacturing activity in the Midwest fared slightly better than the nation, rising 0.3 percent in September after experiencing no growth in August. Midwest man ufacturing was aided by a relatively strong performance in its primary metals and electrical equipment industries, when compared to those industries nationally. Chicago Fed Letter mm F E D E R A L R E SE R V E BA NK O F C H IC A G O P u b lic In fo rm a tio n C enter P .O . B o x 834 C h ic ag o , Illin o is 60690 (312) 322 -5 1 1 1 04 2SOI ARCHIVES CHI RECORDS MANAGEMENT N O T E : T h e M M I is a com posite index o f 17 m an u factu rin g industries an d is constructed from a w eighted com bination o f m onthly h o u rs worked an d kilow att hours d a ta . See “M idw est M a n u facturing Index: T h e C hicago F ed ’s new regional econom ic in d icato r,” Economic Perspectives, F ederal R eserve B ank o f C hicago, Vol. X I, N o. 5, S ep tem b er/O cto b er, 1987. T h e U n ited States represents the F ederal Reserve B oard ’s In d ex o f In d u strial P roduction, M anu factu rin g .