Pew: States Rely Heavily on Tax Incentives, but Few Evaluate Whether They Work

Every state offers tax incentives to attract, retain, and expand businesses and jobs. But no state ensures that policy makers rely on good evidence about whether these investments deliver a strong return, according to a new report by the Pew Center on the States. The study comes at a time when most states are trying to rebuild their budgets and many have not regained private-sector jobs lost during the Great Recession.

Pew's 50-state report examined both the quality and scope of states' evaluations of their tax incentives for economic development. The study, Evidence Counts: Evaluating State Tax Incentives for Jobs and Growth, identified 13 leaders: Arizona, Arkansas, Connecticut, Iowa, Kansas, Louisiana, Minnesota, Missouri, New Jersey, North Carolina, Oregon, Washington, and Wisconsin. Twelve other states have mixed results. Half the states have not taken the basic steps needed to know whether their incentives are effective.

While no one knows the exact total, policy makers spend billions of dollars annually on tax incentives for economic development.

Every state has at least one incentive program and most have several. States offer credits, exemptions and deductions to businesses in specific industries, such as manufacturing or movie production. They also give them to firms willing to locate in struggling neighborhoods, or to firms that pledge to hire new workers. Frequently, states try to outbid each other. If one state offers a tax incentive to a business, its competitors often feel compelled to match it—or risk being left behind.

States that have conducted rigorous evaluations of some incentives virtually ignore others, or evaluate infrequently. Others regularly examine these investments, but not thoroughly enough.

“Deciding whether to make these investments, how much to spend, and which businesses should receive them involves policy choices with significant implications,” said Jeff Chapman, senior researcher, Pew Center on the States. “When states forgo revenue by offering economic development tax incentives, they have less money to spend on education, transportation, health care, and other critical services. Conversely, if states do not use incentives or use them well, they may be missing opportunities to create jobs and attract new businesses.”

Some states are leading the way in the scope of their assessments. They reviewed all of their major tax incentives and took steps to integrate the results into lawmakers' policy deliberations. The report highlights promising practices. Among them:

• Under a new Oregon law, tax credits expire after six years unless lawmakers act to extend them. During budget deliberations in 2011, legislative leaders set a spending cap on the expiring incentives, driving policy makers to rely on evaluations to make tough choices about which investments should continue and in what form.

• In 2006, Washington began a 10-year process to review every tax incentive the state offers. Nonpartisan analysts work with a citizen commission to examine a particular group of incentives each year and make recommendations on whether and how the incentives should change. Lawmakers review the recommendations at hearings.

Other states stand out because of the quality of their evaluations, at least in some cases or for some programs; they have measured the economic impact and drawn clear conclusions.

• Using solid data and analysis in calculating the number of jobs an incentive was creating, Louisiana's economic development agency took into account that some of the businesses receiving the incentives compete with other businesses in the state. As a result, the agency concluded that some of the new jobs merely displaced existing Louisiana jobs.

• In 2010, Connecticut's economic development agency assessed the state's major tax credits using sophisticated analysis techniques. The agency concluded that while some incentives were not meeting the state's goals, others were beneficial and cost-effective. For example, one tax credit designed to encourage businesses to hire more workers was found to have created jobs in 2009.

“Policy makers should know whether these tools deliver a strong return on their investment,” Chapman said. “Regular, rigorous, and comprehensive evaluations of tax incentives are critical to their ability to do so.”

Pew reviewed nearly 600 documents and interviewed more than 175 government officials and experts to examine how—and how well—states gauge the effectiveness of their tax incentives, if they do so at all. The study does not take a position on whether tax incentives for economic development are good or bad, but does identify promising approaches to evaluation.

Pew Center on the States
The Pew Center on the States is a division of The Pew Charitable Trusts that identifies and advances effective solutions to critical issues facing states. Pew is a nonprofit organization that applies a rigorous, analytical approach to improve public policy, inform the public and stimulate civic life.  www.pewstates.org

View the full report here.