Sometimes, tax incentives can be useful. Public officials can offer them to encourage a company to clean up and reuse land in a struggling postindustrial city, or open a grocery store in a food desert.
But more often than not, cities and states provide tax breaks in a desperate attempt to compete with one another for jobs, using them even when they play little, if any role in a company's decision about where to locate.
In a recent presentation at the Lincoln Institute – the second installment in our series of lectures under the theme of municipal fiscal health – Greg LeRoy, executive director of the Washington, DC-based organization Good Jobs First, described how large companies pit cities and states against each other, encouraging them to offer greater and greater incentive packages, to the tune of more than $70 billion per year nationwide.
"Public officials' view of the process gets incredibly distorted because they think they're actually influencing the behavior when they are not," LeRoy said in a conversation with Lincoln Institute President George W. "Mac" McCarthy.
LeRoy discussed the variety of property tax abatements, corporate income tax credits and other breaks offered in increasingly large amounts to retain or attract jobs, such as the state of Washington's record-breaking $8.7 billion offering to Boeing in 2013, or Nevada's $1.3 billion package awarded to Tesla Motors in 2014. A relatively modest but still notable package of incentives was offered to General Electric in that company's relocation of headquarters from Fairfield, Conn. to Boston.
When large companies relocate, or open a new facility, they focus on the factors that relate directly to their business model, such the cost of labor, the availability of a skilled workforce, or the proximity to important infrastructure. A Lincoln Institute study found that tax breaks have almost no impact on a firm's profitability. Property taxes, the study found, average much less than 1 percent of total costs for the U.S. manufacturing sector.
However, companies have come to expect state and local tax incentives, and they have the leverage to push for them.
For local and state officials, the political risk of losing a company to a rival location outweighs that of providing overly generous incentives, even though they come at taxpayers' expense, LeRoy said.
The good news is that some cities and states are taking steps to reduce the use of wasteful tax incentives. They are creating agreements with one another to refrain from actively "poaching" companies, and requiring companies that receive tax breaks to meet performance requirements. In addition, new disclosure requirements – especially at the state level – and government accounting standards are helping to provide more transparency about the cost of tax incentives.