By Marisa Lupica
Tax incentives are a significant but ineffective part of states’ economic development policy. As of 2012 states spent an estimated $80.4 billion annually on tax incentives for businesses. Yet, most economic research on the subject finds that targeted tax incentives are ineffective at attracting businesses, creating jobs, or improving a state’s economic performance. In 2014, Florida spent $367 million on economic development programs and forewent $1.2 billion in such tax expenditures.
Tax incentives have been gaining popularity since the unemployment crises of the 1970s and the recessions of the early 1980s, when states began competing with each other to lure businesses. Tax incentives come in many forms, including corporate income tax credits, property tax abatements, sales tax exemptions, and payroll tax refunds. Some incentive packages include direct grants and special financing deals. States offer eligibility to firms and industries they consider most likely to spur employment and spending. For example, Florida’s Qualified Target Industry Tax Refund is offered to businesses in aviation and aerospace, life sciences, and manufacturing, among others. In Florida, most tax incentive programs are administered by the public-private partnership Enterprise Florida, the Department of Revenue, and the Department of Economic Opportunity.
State governments offer these benefits to specific industries, often courting particular companies from out-of-state. For instance, multiple states engaged in a bidding war for a Tesla factory in 2014. However, predicting winners and losers in a market economy is difficult for public officials and private investors alike. For instance, state tax incentive programs are biased toward big businesses, despite the fact that small businesses employ far more people and contribute more to GDP. Businesses receiving incentives generally employed fewer people and spent less than national and regional averages for their industries. A report by Florida’s Office of Economic and Demographic Research found that only half the targeted number of jobs had been created by companies receiving incentives. From a national perspective, tax incentives sometimes result in no net growth as firms that would have resided in one state merely move to another.
Despite their ubiquity, state tax incentive programs are ineffective at increasing employment. Deciding which industries and businesses would be most beneficial is the main difficulty. Interventions of this kind risk a misallocation of resources from productive industries and into less productive ones. Information about the demand for and scarcity of resources is communicated to producers and consumers through prices. Firms employ labor and capital equipment in different industries, in part, because of the profits they expect to make. When state governments favor one industry over others using the tax code, prices are distorted, and profits do not reflect market costs. Industries that aren’t necessarily productive or efficient thus receive an advantage in the tax code. While the industries that are most valued and beneficial in terms of employment are constantly changing, tax incentives can remain in place for years.
If a state is a good location for a firm, the firm will move there on their own accord because their incentives are aligned with long term profitability. When a company moves to a state because of tax benefits, they receive a competitive advantage because of lower production costs. Local companies not receiving incentives struggle in the face of increased competition, and sometimes fail, even if they are more productive than firms receiving incentives. Allowing markets, rather than public officials, to determine where firms locate provides an even playing field at a lower cost to taxpayers. Small businesses themselves support a simpler tax code with few loopholes, low rates, and a broad base over targeted tax incentives.
Tax incentives have not been effective at promoting economic development. A simpler tax code with few loopholes, low rates, and a broad base would be more likely to attract business and provide a fair playing field for all firms.
